How to Finance a Rental Property
Thinking about purchasing a rental property? It can be a lengthy process. Unlike your home mortgage application, you’ll encounter stricter terms and conditions set by your mortgage broker. Knowing how to finance a rental property can make or break the long-term success of your real estate purchase. Take a look at these financial tips to help ensure that you’re ready to purchase that second home or multi-unit property.
Should You Go With a Mortgage Broker or a Direct Lender?
If you’re new to real estate, there’s a difference between mortgage brokers and direct lenders. Mortgage brokers offer their services as both a financial advisor and a mediator that shops your loan around to various underwriters. Direct lenders are financial institutions that offer mortgages, but in this case, the buyer has to apply individually to each lender which can be a lot to manage if you're new to the process. Here are some details to consider when trying to figure out if you should go with a mortgage broker or a direct lender when seeking a loan for rental properties:
Know the benefits of a mortgage broker. If you’ve already got a good relationship with a mortgage broker, you may be in luck. Similar to choosing a real estate agent who specializes in investment properties, it’s wise to choose mortgage brokers who also specialize in investment properties. Government-sponsored programs like Fannie Mae and Freddie Mac often provide cost benefits like lower interest rates and decreased origination fees that can be otherwise hard to match. Mortgage brokers will work with them to help you secure the best possible terms for your loan and they may be able to help you understand how much you can safely borrow. As brokers, they’ll shop your application around to several lenders to get you the best interest rate.
The (often overlooked) benefits of working with a direct lender. When you’re dealing with a broker, you’re giving them a lot of control. Underwriters may shift the loan’s lending standards on mortgage brokers, and they’ve even been known to pull the plug on deals right before closing. One of the benefits of financing your loan through a direct lender is the removal of the mortgage broker from the equation. You may be able to work more efficiently with a direct lender and they typically can get more creative with their chosen financing method by seeking off-the-beaten-path sources to finance your loan. And seasoned real estate investors with multiple properties may prefer working with direct lenders because they can better manage the terms and conditions that go into approving a mortgage loan.
How Does My Financial Situation Impact My Ability To Get a Second Mortgage?
Buying real estate is one of the biggest investments you’ll ever make, so it’s key to be aware of what factors impact your odds of landing another mortgage. Because the lending requirements can get stricter as you own more properties, you’ll need more cash up front for this second piece of real estate. As a current homeowner, home equity loans may be able to help set you up with the cash you’ll need for the down payment. Here are some details on what you should know about how your financial situation impacts your ability to get a second mortgage:
Anticipate 20 percent down. Home equity lines of credit are a great way to leverage your current property’s worth and spin it into a down payment for real estate investments. Remember that if you do use your primary residence to secure a home equity loan, you may not have access to those funds for repairs or improvements to your primary residence. Typically, you’ll need to have substantial equity in your current home to qualify.
Plan a fund for upkeep. Depending on your skill at maintaining an investment property or your physical distance to it, you may likely need to develop relationships with maintenance contractors. A trusted third-party resource is invaluable in order to deal with problems as they arise and take care of the place if you’re unable to do so yourself. Hiring an outside firm like a property management company can accomplish this goal for you, but it’s going to cost you money you’ll need to budget for. Plan on socking away about 1 to 1.5 percent of the home’s purchase price as cash you’ll be spending annually to keep the place up. Because this are frequently considered a business expense, you may be able to recover some of that money in the form of tax deductions.
Consider an owner-occupied property. Purchasing a duplex or a multi-unit property is one way to purchase both a primary and a rental property at the same time. If the circumstances are right, you may be able to land an FHA loan, which often comes with a lower mortgage interest rate than you’d be able to find otherwise. You’ll benefit from lower mortgage payments as an owner/occupant and stand to pay off the equity on the property more quickly with other tenants shouldering some of your monthly mortgage burden. If you plan on exploring this option, be sure you’re able to commit to living in the house for at least five years so you'll have some equity when it comes time to sell. Many banks require that you live in the house for so long before you’re able to purchase a new house.
Buying a second home can be a great way to pursue your dreams and build wealth. While you may be new to being a landlord, we’ve been assisting and insuring investment property owners for years. With great services like our landlords toolbox we've built out a suite off resources that really help you succeed in your new role. While you’re considering your financial options for purchasing a second home, remember to check in with your American Family Insurance agent. Our agents are trained to help make sure you understand your policy completely — so you know exactly how well you’re covered.