How to Get Your Finances in Order for Real Estate Investing

Before you can invest, you need to get your finances in order.

Now that you’ve determined that real estate investing is right for you, the next step for real estate investing beginners starts is getting your finances in order. Although location is crucial for investing in real estate successfully, having the right financing in place is essential. For example, financing real estate for your first investment property can involve using current assets, getting a loan, or using your home equity. In addition, financing a real estate deal involves a complete review of your current financial situation: sorting out your income, credit score, debt liabilities, and savings.

Understanding everything involved with real estate finance can be challenging. Apart from getting your finances in order, you must keep track of investments and the health of the real estate market. Additionally, as your investment portfolio grows, funding sources change, and there are additional factors to consider when financing new deals. 

This article is a comprehensive guide to real estate finance and how to prepare for purchasing your first investment property. We’ll cover:

• What is real estate finance?
• How to get your finances in order
• How to finance real estate investments
• Financing your future as a successful real estate investor

So, what does it take to become a real estate investor? What should your finances look like before you get into real estate? And is it possible to invest in real estate with little money? Please read on to find the best financing tips for real estate investors.

What is Real Estate Finance?

Real estate finance refers to the various funding sources available to property investors. For real estate rookies, the most common source of financing is a conventional loan to buy a rental property. The finance is used to pay the mortgage, rehab costs, and relevant taxes and fees.

Real Estate Investing for Beginners — How to Get Your Finances in Order

To get into real estate, you must clearly understand your current financial situation. Before applying for a loan or buying an investment property, you should have sufficient cash reserves. In addition, having a good credit score, low credit utilization, and an acceptable debt-to-income ratio are vital.

Your debt-to-income (DTI) ratio is a percentage that tells lenders how much money you spend paying off debt versus how much money you have coming into your household.

These factors ensure you are not a borrowing risk and help you secure excellent interest rates on a conventional or personal loan. 

Let’s look at what it means to get your finances in order to start investing in real estate.

Current Assets

Before buying an investment property, the first thing to consider is your current assets. These can include your home, cash reserves in savings accounts, and your 401(k) retirement account. It may be possible to use the equity in your home or savings to put toward a down payment on an investment property. 

Equity is the difference between what you owe on your mortgage and what your home is currently worth.

So, ask yourself: how much are all your current assets worth? Do you need to have more savings before buying a rental property? Or would it be best to build more equity in your current home and apply for a home equity loan? These are crucial questions to answer to make a good investment.

Personal Income

When applying for an investment property loan, a lender will consider your current income. Of course, you expect real estate investments to generate regular monthly cash flow, adding to your monthly income. However, lenders usually want to ensure you already have stable income and enough cash reserves to pay the equivalent of six to 12 months’ worth of mortgage payments.

Remember, you will need substantial cash reserves for a down payment when applying for an investment property loan. Therefore, the more you can save before buying an investment property, the better. 

Cash for a Down Payment

Getting enough cash for a down payment is one of the biggest challenges of first-time real estate finance. New property investors typically need enough cash to make a down payment of between 20 and 25 percent. And while it may be possible to get a conventional loan with a 15 percent down payment, a larger payment will secure better interest rates. House hacking, an investment strategy in which your investment property is also your primary residence and you rent our rooms or separate units, offers investors an opportunity to put even less money down, but again, the tradeoff is usually higher interest rates.

However, it’s good to remember you will need cash for more than the down payment. Most lenders expect you to have at least six months of liquid reserves, usually cash. Additionally, you need enough funds to ensure a rental property passes state inspections, make any upfront repairs, and cover potential vacancies out of the gate. These factors can also affect how much cash you need to start investing in real estate.

Credit Score

Your credit score is one of the most important factors when getting your finances in order for real estate. A good credit score of at least 670 will mean you can secure lower interest rates on a conventional or personal loan. In addition, it will allow you to build passive income from real estate faster. 

If you currently have a poor to fair credit score, you must take steps to improve it. Two easy ways to get your credit score in order are to lower your credit utilization and pay bills on time. 

Credit Utilization

Credit utilization factors into your overall credit score and thus becomes an important part of getting your finances ready for real estate investing. Your credit utilization ratio is based on revolving credit — credit cards and personal lines of credit. It is simple to calculate how much credit you are using: simply divide the amount you owe by the total limit on your cards. 

Before investing in real estate, what should you do to sort your credit utilization? First, ensure your rate is always below 30 percent. For example, suppose you have a total credit limit of $15,000. The revolving balance should not exceed $4,500. If it exceeds 30 percent, you should work to pay off more of your credit card debt before applying for a conventional loan.

Your Debt-to-Income Ratio

Getting real estate finance in place requires calculating your debt-to-income ratio (DTI). Your debt-to-income ratio is a percentage that tells lenders how much money you spend paying off debts versus how much money you have coming into your household. A lower DTI ratio increases the chances of your loan application being approved.

How can you calculate your DTI? First, you must divide your monthly debt payments by your total monthly income. The resulting figure shows how much of your income currently goes toward debt payments. A DTI of over 43 percent is usually a bad signal to lenders. 

The key takeaway is this — reducing debt before investing in real estate is vital to purchase a rental property or to start flipping real estate. 

Loan-to-Value Ratio

The loan-to-value (LTV) ratio on an investment property is also a risk factor that lenders take into account. This figure represents the amount of a secured loan not covered by the down payment. Typically, most lenders require an LTV ratio of less than 80 percent. Therefore, having substantial cash reserves to make a larger down payment can reduce your borrowing costs and ensure a greater return on investment in the long term.

Simply put, your LTV ratio is the amount of your mortgage divided by the value of the property. For example, if you put $100,000 down for a $500,000 home, your LTV ratio is 80%.

How to Finance Real Estate Investments

Real estate finance is part of an investment strategy to make money from property investments. Unfortunately, many rookie investors don’t have enough cash savings to self-fund an investment property deal. Therefore, they rely on financing options to spread the cost of buying the property over several smaller payments. 

However, the only way to get a loan approval to buy a rental or fix-and-flip property is to prove that your finances are in order. Here are how your finances should look before making real estate investments:

• You have enough cash reserves to make a sizeable down payment to lower your loan-to-value (LTV) ratio.
• Ensure you have a good to excellent credit score.
• Pay off as much credit card debt as possible to lower your credit utilization ratio.
• Get debt payments in order to lower your debt-to-income ratio.
• Have cash on hand to cover mortgage payments for at least six months.
• Have cash on hand for unexpected costs that occur when taking ownership of a property

While these factors outline the best-case scenario, it is possible to finance real estate investments even with poor credit and little money down. Partnerships and creative financing can give you additional avenues to start your portfolio.

How to Finance Your First Real Estate Investment Property

Once you are sure you have a stable financial situation, you are ready to think about real estate finance. Here are some financing options for funding your first investment:

• Conventional loan: This is the most common source of financing for rookie investors. Banks, credit unions, or loan associations typically have good interest rates and are transparent. They also adhere to lending standards set by Freddie Mac and Fannie Mae. 
• Private money lender: Going to a private lender can be an option if you don’t qualify for traditional financing. The private lender functions like a bank with fewer stringent requirements. 
• Hard money loan: If you are looking for a short-term loan for house flipping, hard money loans may be a good option. Typically, you benefit from flexible repayment options and don’t need to worry about credit scores. However, hard money loans have higher interest rates than conventional mortgages. 
• Home equity loan: If you are already a homeowner, you could use the equity in your primary residence as a source of real estate finance. The home equity line of credit (HELOC) lets you borrow a portion of your equity without affecting your current mortgage. 
• Veterans Affairs (VA) loan: If you are a veteran and want to start investing in real estate, a VA loan may be a good finance option. With this loan, you can start investing with no down payment and buy a multi-family property with up to four units. However, you must live in one of the units. Those who are currently serving are also entitled to this benefit.
• FHA loan: You can get a Federal Housing Administration loan if you plan to start real estate investing by “house hacking”—an investing strategy in which your investment is your primary residence, and you rent out rooms or units in a single-family or multifamily property. The loan terms require that you live in the property for at least 12 months. 
• 401(k) loan: This loan allows you to borrow from your retirement account and can be a useful real estate finance option if you have significant savings. 

Other Considerations When Getting Into Real Estate Investing

There are other considerations when looking for funding to become a real estate investor. For example, being single or married can affect your tax returns and gross monthly income. Additionally, serving in the military or being a veteran could give you special funding and loan opportunities.

Financing Your Future as a Successful Real Estate Investor

A robust real estate investing business plan gives you a foundation for success. You can enjoy healthy cash flow from your first real estate investment. Many first-time landlords find that regular monthly rent payments supplement their regular income or even replace their W2 job. Flipping real estate allows investors opportunities to look for more diverse ways of expanding their portfolios. 

Moving forward, you will find that real estate financing options change. For example, there are limits to the number of mortgages you can take out. And many lenders are reluctant to approve more than four mortgages to real estate investors. 

As a real estate investor, you must consider additional real estate finance methods. For example, building substantial cash reserves can make it easier to secure private money loans, hard money loans, or even self-finance a new investment. Also, making a larger down payment reduces your loan-to-value ratio, thus helping to secure mortgages at competitive rates.

Getting Started With Real Estate Finance — In Conclusion

Real estate investing for beginners starts with getting your financial situation in order. This will help you build a portfolio of investment properties.

Although it is possible to invest in real estate with little money, having enough cash to make a large down payment minimizes the risk of failure. In addition, having a good credit score, low credit utilization, and a low debt-to-income ratio helps secure lower interest rates and better mortgage deals. Get these factors in place from the start, and you will speed up the time it takes to profit from real estate investing.

Once your finances are in order, you are ready to choose the ideal real estate strategy to build your wealth.