Buy A Rental Property With Lower Upfront Costs
Real estate investments have several advantages over other investment vehicles – including preferential tax treatment, leverage, and a hedge against inflation.
But it usually takes a bigger sum to purchase rental property than it does to buy a mutual fund or stock. And completing your first investment purchase can be challenging.
Fortunately, rental property mortgage rates are very low.
Rock-bottom rates reduce the monthly payment on a property, making it more feasible to rent it out at a profit.
The initial barriers can be overcome more easily by finding a partner to go in on a rental property purchase with you. There is no requirement that you be related or that any previous relationship exists. You can buy a home with anyone you would otherwise feel comfortable going into business with.
Your upfront costs will be lower, and your partner could help you qualify for the loan more easily.
Work Up A Written AgreementThere’s nothing wrong with investing with a like-minded friend if your ethics and work style are compatible. If you want to remain friends, however, you can head off many problems by formalizing your partnership. Many experts recommend a Limited Liability Company, or LLC, for real estate investing. It protects your personal assets in the event of investment-related defaults or lawsuits and offers tax advantages as well. Other workable formats include Limited Liability Partnerships (LLPs) and S-corporations. You’ll want to agree in writing how much each of you will put into the partnership, and what you’ll get for your investment. The most straightforward setup has both partners investing an equal amount for an equal share of the assets and income. You’ll want to address potential problems before they occur. Create a list of scenarios and how you agree to handle them.
- One partner is unable to cover their portion of unforeseen expenses
- A partner wants to buy out the other
- A partner wishes to sell his interest to a third party
- Partners wish to sell the property at different times.
- A partner no longer wants to be in charge of collecting rent or making payments.
Get Outside HelpAn attorney can help you sort out the above-mentioned issues and create bulletproof organizational agreements. Don’t rely on office supply store forms to address your unique concerns. Today’s market is seeing many new real estate investors. Low mortgage rates, a strong rental market, and reasonable home prices are enticing first-time rental property buyers. There’s nothing wrong with being a new investor and no reason to think you can’t do it. However, new investors should consider hiring a property management firm. They take some of the pressure off for new landlords who have other obligations like full-time employment elsewhere. These companies can handle everything from finding and vetting tenants, dealing with repairs and collecting your rents, for about ten percent of the gross monthly rent.
Qualifying For Rental Property LoansFinancing investment property is similar to borrowing for a primary home, but there are important differences. When you buy a home to live in, you have access to government-backed mortgages like FHA, VA loans, and USDA Rural Development financing. These loans require small downpayments and lower credit scores. But these financing options are not available for investment properties except in special cases. Conventional loans are the go-to loan type for rental properties. These loans are underwritten based on guidelines from Fannie Mae and Freddie Mac. Both these agencies provide generous loan limits and relatively lenient rental property guidelines. However, conventional rental property mortgages require higher credit scores, larger down payments and more financial reserves. The advantage to buying a rental property with a partner is that you can pool your income and assets to qualify more easily. Make sure your business partner’s credit is good, because the cost of the mortgage is determined in part by the borrower with the lowest credit score.
Investment Property Downpayment Requirements
Most programs require a minimum 15 percent downpayment for a single home with a fixed-rate mortgage. Downpayment requirements are higher for other situations.
- 1 unit fixed-rate investment property purchase downpayment: 15%
- 1 unit adustable-rate investment property purchase downpayment: 25%
- 2-4 unit fixed-rate investment property purchase downpayment: 25%
- 2-4 unit adjustable-rate investment property purchase downpayment: 35%
Downpayments under 20 percent will trigger a private mortgage insurance (PMI) requirement. The mortgage insurance provider will review the loan for approval, which is a separate approval process from the lender’s.
According to mortgage insurance provider MGIC, a $250,000 loan would require PMI of $120 per month with 15% down and a 740 credit score.
If each partner can contribute at least ten percent of the purchase price, your costs drop. But a sub-20% downpayment is not a deal breaker.
Cash Requirements After Closing
In addition to your down payment and closing costs, you and your partner will need reserves.
“Reserves” are savings that are available to pay your mortgage if your income is temporarily interrupted.
Reserves are measured in months. For example, your mortgage principal, interest, taxes and insurance (PITI) come to $1,000 a month. You will have $2,500 in savings after you make your downpayment and closing costs. In this case you would have 2.5 months of reserves.
Reserve requirements are typically between six and twelve months for investment properties. If your rental property will cost you $1,500 per month, you could need at least $9,000 after closing to qualify.
It makes sense to open a special property account into which both partners hold the money needed to purchase and maintain the rental. You might want to require both of your signatures to withdraw from this account. Just make sure you keep a paper trail for any funds being deposited, so you can prove the source of any large deposits into the account.
Can You Use Future Rental Income To Qualify?
Ideally, your incomes are sufficient to qualify without the subject property rental income. If this is not the case, though, you may still qualify using the property’s income potential.
If it’s currently rented, you’ll supply a copy of the lease to the lender. If it’s not currently rented, the appraiser will complete a rental schedule, known as Fannie Mae Form 1007 or Freddie Mac Form 1000. This form compares the home to similar rentals in the area to arrive at an estimated future rent.
The lender will reduce the estimated or actual monthly rent by 25 percent. This is because, as a rule, lenders assume the property will be vacant 25 percent of the time.
The lender then adds that amount to your income to help offset the future cost of the rental property.
For instance, the home will cost $1,500 per month in principal, interest, taxes, and insurance. Estimated rent is $1,200 per month.
The lender will add $900 per month to your income. For qualification purposes, the new property will add only $600 per month to the applicant’s total debt load.
One More Piece Of Rental Buying Advice
While no longer required for most mortgage programs, you might want to purchase a landlord insurance policy. This covers the perils of ordinary homeowners insurance, plus extra liability coverage and rent income interruption coverage.
Finally, it’s smart to require your tenants to protect their belongings with renter’s insurance. This insurance is very affordable and covers the renter’s personal property if it is damaged or stolen.
What Are Today’s Mortgage Rates?
Owning an investment property is a good wealth-building strategy. Doing so with a business partner can make the initial purchase and ongoing management easier.
Get a rate quote for your rental property purchase mortgage. Today’s rates are low, making owning a rental property a real possibility for first-time and repeat home investors.