How I Chose to Finance My First Rental Property
First, let's first define the most common ways that someone could finance a purchase.
- Conventional Loan
- Commercial Loan
- Hard/Private Money
- Cash (but that isn't financing)
Below are definitions of each of each of these.
When I started exploring investing it was 2017, I was fired from my career job in 2016 and just got out of all personal debt with my wife of 2 years at the time.
Next was to pay off the house and invest in the stock market. My gut told me no, but I couldn't identify why.
After researching real estate investing, the BRRR method seemed like a great no-lose deal but I didn't have the knowledge of renovations.
But I did buy a personal home in 2010 with a first-time buyer tax credit and rented out rooms to my college friends. Ultimately that was my first rental property but I didn't even know it at the time.
What that did give me was equity in my personal residence to use as a down payment on my first rental property purchase. I bought a 4 plex and used my HELOC for the down payment. The deal was so good it still cashflowed at 100% financing. Looking back, every deal I bought was so good it would cashflow with 100% financing. Am I proud of that, not really, to be honest, I should have bought more that didn't cashflow as well, but were still solid deals.
I've since learned that a deal for me is a CRAZY good deal for most and I need to change my perspective on what is a deal. Buying equity with little to no cash flow is still deal in 5 years.
The ways to financing and how to explore those options...
#1 Conventional Bank Loans
- 1) Conforms to guidelines set by Fannie Mae- Not backed by the federal government
- 2) Downpayment of 20% of the home's purchase price
- 3) Your personal credit score and history determine your ability to get approved & your interest rate
- 4) Lender's review borrower's income and assets
- 5) Borrowers must be able to show that they can afford their existing mortgage and the monthly loan payments on the property
- 6) Rental income is not factored into the debt-to-income calculations
- 7) Most lenders expect borrowers to have 6 months of cash set aside to cover both mortgage obligations
- #2 Fix- and Flip Loans /Commercial( For some flipping houses allows for the owner to receive their profits in a lump sum when the house is sold rather than waiting on a rent check each month)
- 1) Short term loan- allows the borrower to complete he fixer upper and get it back on the market as soon as possible
- 2) Hard Money Loans- the loan is secured by the property itself
- 3) Easier to qualify for compared to a conventional loan- Primary focus is the property's profitability
- 4) Possible to get this type of loan in a couple of days rather than waiting weeks or months for a conventional loan
- 5) Interest rates are 18%+
- 6) Terms of less than 1 year
- 7) Origination Fees and Closing costs also tend to be higher
- #3 Tapping Home Equity
- 1) Home Equity Loan / HELOC or cash- out refinance ( Drawing on your home equity
- 2) Possible to borrow up to 80% of your home's equity value towards the property
- - HELOC- you can borrow against the equity the same as you would use a credit card and your monthly payments are often interest only
- *Interest rate is variable and can increase as the prime rate increases
- -Cash- Out
- *Fixed interest rate- may extend the life of your existing mortgage
- *Longer long term- paying more in interest
- - HELOC- you can borrow against the equity the same as you would use a credit card and your monthly payments are often interest only
Investing in any property is a risky adventure, but finding the money to take advantage of an investment opportunity could lead to a big pay off. Keep in mind short and long term costs and how it can affect your bottom line investment.
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