Real estate investors are searching for additional ways to create passive income. The real estate market in the greater Concord area is a lucrative locale for creating this kind of residual income. When it comes to the purchase of rental properties, one of the most common barriers to entry is that a significant amount of capital needs to be available for down payment. In this blog post, we are going to cover some of the different options that exist for investors seeking to finance rental properties.
The most common types of loans for investment property acquisitions are Home Equity Loans, Conventional Loans, and Hard Money Loans. Investors should research and understand the differences between these three different kinds of loans. Using the wrong type of loan for a specific investment property can jeopardize the potential for the transaction to be profitable, especially in the short term.
Home Equity Loans
In today’s market conditions, most homeowners are going to have a decent amount of equity available in their properties. This equity can be used to grow their real estate portfolio by acquiring additional properties. One way to access this equity is through a Home Equity Line of Credit (HELOC). It can also be tapped into through completing a cash-out refinance transaction on the asset. A property owner can typically borrow up to 80% of the equity in a property to purchase a second property. Depending on which type of loan they choose, there may be a different list of pros and cons. If you choose to get a HELOC, it will essentially function as a credit card. The monthly payments will likely be interest only. However, a HELOC is generally paired with a variable interest rate. This means if the prime interest rate the loan is tied to increases, the rate, and payment on the loan will also increase. On the other hand, a cash-out refinance comes with the stability that a fixed rate brings. One potential drawback is that it often extends the duration of your current mortgage.
Hard Money Loans
These loans are very beneficial when your goal is to purchase a property, make repairs and/or additions, and then flip it by quickly reselling it for a profit. A hard money loan will almost always be significantly more expensive than the other types of loans. It will need to be repaid in full within a year or less in most cases. A hard money lender is primarily focused on how much potential profit is wrapped up in the individual property itself. They are much less concerned with things like the credit score of the borrower, or what their credit payment history looks like. The terms of hard money loans are usually quite stringent, and interest rates can climb as high as 18%. Any penalties for missed payments are quite painful financially. However, these types of loans can be of tremendous value to an investor because they are much easier to qualify for than home equity lines of credit or conventional loans. Another benefit is that they will typically fund very quickly comparatively speaking (days instead of weeks) to the other options. This allows construction on the project to begin almost immediately.
Conventional Loans
A conventional loan conforms to standards set forth by Fannie Mae and Freddie Mac. In today’s marketplace, conventional lenders require a 20% down payment on most deals. If the property involved in the transaction is an investment property, the lender may require as much as 30% down. For conventional loans, things like whether or not an investor qualifies for a loan, and what interest rate they will be required to pay depend on the investor’s personal financial situation. A prospective borrower will also be asked to provide documentation showing that they can afford the monthly payments on the new loan in addition to their other monthly financial obligations. Their debt-to-income ratio will be reviewed before factoring in the rental income they are expecting from the property and approval or denial of the loan application is based on this.
As you are choosing the best type of loan for your investment property, be sure to consider both the short and long-term implications of each type of loan to ensure that your venture will be as profitable as possible! As always, don’t hesitate to reach out to PMI Contra Costa with questions about any aspect of acquiring and managing rental property.
*Disclaimer: This information is not a replacement for advice from a certified mortgage broker. PMI Contra Costa does not offer nor provide financing services for properties. We are a property management service in Contra Costa County dedicated to helping you maximize your rental investment’s potential.
