There's no denying that one of the biggest hurdles many newbie investors have to overcome is the hurdle of finding the money to buy that first property.
The truth of the matter is that this isn't just a problem for newbie investors, but often I see investors with one or two properties also having to face this same hurdle.
While investing in rental property has a great reputation for being a stable place to invest where you can find great returns....
...the reality is that there is a barrier of entry so to speak. You're not going to be able to buy that first rental property with the extra $200 you have each month.
You'll have to be committed to saving that extra $200 for quite some time for it to add up to a sizable down payment on a potential investment.
stats taken from biggerpockets.com
While it's a hard truth that anyone can invest in rental, but it is not for the weary or feign of heart.
It's for those who can see the long term game and who can have patience.
And the truth is...there are multiple ways for you to be able to finance a deal so you can overcome that barrier that holds many back.
So if you're getting curious about the financing options out there for you as an investor, you're in the right place.
Feel free to jump ahead to a section you're particularly interested in, email it to yourself or share it with your friends.
Getting Started with Financing Rental Property
While I may have scared you a bit earlier by talking about the barrier of entry for most investors, I want to reassure you now that there are many different avenues for financing rental property.
Yes, the traditional method of buying a rental property-taking out a conventional loan from a bank- requires that hefty 20% down payment...
...there are other methods out there that allow you some more flexibility or creativity when it comes to putting a deal together.
That's good news!
It may just require you to think outside of the box a bit or even step out of your comfort zone a little.
But the payoff of actually making your real estate investing journey begin will be well worth it.
Types of Financing...There's No One Size Fits All
I've alluded to the fact that there is no one size fits all for financing property. Here I'm going to go over what types of financing options may be available for you to consider.
1) Investment Property Loans
Using traditional financing to purchase rentals means that you went to a bank (Wells Fargo, Bank of America, etc.) and took out a loan for investment in a property.
Now loan types and products differ depending on varying things happening in your life. For instance, the typical investor loan that most get is the conventional loan. Where you put 20% down and are not planning to occupy the property at all.
But there are other ways and strategies to using financing to help you get your real estate investing journey started...but maybe just delaying it for a bit.
For instance, if you're looking to buy a property that you plan to live in first then turn into a rental or even buy a multi-unit where you live in one unit and rent out the other(s), there are other loan products available for you to use that may bring that barrier to entry down from 20% to as low as 3.5%.
With loan products like FHA, VA, USDA and 203k, you have the potential to buy these properties as owner occupying properties and later turn them into a rental when it's time for you to move on.
All the while, being able to put a lower down payment down.
Are there drawbacks to this?
The two major drawbacks to using some of the other loan products is since it's such a lower down payment some of the options require you to also pay mortgage insurance.
This helps protect the banks in a situation where you default on the loan, since you're putting less money down.
The other drawback to using one of these strategies is that it does delay your real estate investing journey.
Having to live in the property for a while will slow down the process...but the truth is if that's the way it will work for you, then it's worth it, isn't it?
2) Lending Companies for Real Estate Investors
Being a real estate investor does have some additional perks. If you find that using lending through a traditional banking institution doesn't fit your situation, there are lending companies that exist who lend only to real estate investors.
There loan products are created around rentals, flips, and new constructions and they don't have to answer to a lot of the red tape guidelines that traditional big banks do.
They underwrite the loans in house so there is a lot more flexibility than you'd find at a major bank chain.
What you'll find is that they will qualify the loan differently than a typical bank would as well. Instead of focusing so heavily on an individuals debt to income ratio they look at the property and the income it will actually produce.
You also will stay away from the limits of property that investors run into with financing from big banks. Most traditional banks will start to have more stipulations after 4 properties and won't lend after 10 total investments.
One of the downfalls with using a product from here is that the interest rates are a bit higher than you'll find at a traditional bank. However, if the numbers work, even at the higher interest rate, and it's what works for you...
why not use it?
3) Seller Financing
The basic understanding of seller financing is that the seller becomes the bank, so to speak. There are no banks involved in the process.
As the buyer, you negotiate terms, deposits, rates with the actual seller and come to a mutual agreement between buyer and seller.
Legal ownership turns over to you as the buyer; however, the payment will continue to go to the old owner (seller).
This can be a great option if you as the buyer are unable to qualify for financing from a bank. It also can be a great option if the seller owns the property outright, meaning they don't have a mortgage.
In this case, it can be advantageous for the seller as well as the buyer to go this route.
When the seller still owes a mortgage on the property, it may not work as the sale of the property can trigger the due on sale clause with the mortgage.
But I think it's always worth asking if the seller is interested. You never know anyone's situation and what they might be willing to do.
This is often a strategy used by newbie investors who are finding a way to overcome that barrier to entry.
Finding someone to go in on a deal with you can really help each of you bring down the initial down payment amount that you have to come up with.
While it may seem overwhelming or you might be asking yourself where am I going to find someone who wants to do this to...
I'll tell you that you might be surprised how easy it may be to find someone to partner up with.
Start with your network and begin talking to friends, family, colleagues about what you want to do. Once you open yourself up to sharing your vision with this journey, you may just find someone who you already know like and trust who would want to go down that road with you.
The other side to it is that there are a variety of partnership strategies that you can use to make it work for both parties involved. Strategies like full equity partnerships, down payment partnerships, private lending partnerships, and credit partnerships are all different ways of structuring a partnership deal so that all parties involved can benefit. (Learn more about these strategies in our Financing Course)
5) Home Equity Loans/Lines of Credit
This particular financing option is available for those who already own a home that they live in. If you've owned your home for a while and you owe considerably less than the value of the property, you have an untapped source of funding that you could use to purchase your rental property.
A home equity loan is a loan that you take out on the equity that is present in your current home. Meaning if you own a home and it's valued at $250,000 and you owe $100,000 you have approximately $150,000 worth of equity in the home that you could tap into.
However, be aware that if you over leverage yourself and you can't pay this loan back the lender can come after and take your personal home.
So it's not a decision you should take lightly.
And when dealing with home equity as as source of funding there are two ways that you can access those funds: home equity loan and a home equity line of credit.
While similar in nature, they do differ and it's important to know the deciding differences between the two.
When it comes to getting a home equity loan or line of credit you can turn to most banks and credit unions in your area. The mortgage rates on the two may differ as the home equity loan is a fixed rate loan for a certain period of time while the line of credit may have an adjustable rate.
The other thing to consider is that you will not be able to take out the full amount of equity you have on your personal home. Most banks will calculate a loan to value amount and where they will only allow you to take out a percentage of the total equity you have in the home (often you hear 70-75% LTV). This may differ on the bank so you'll want to talk to your lender about specifics for your situation.
In all, this can definitely be a source of funding that you tap into when you're getting started to help you get rolling with that first property.
While this list by no means exhausts all of the ways that you can find funding for rentals, it gives you a start to see that there are multiple avenues to funding deals it's just a matter of figuring out which one is right for you.
Qualifying for Financing
If you do plan to go the route of using traditional financing from a bank there are a number of things that are going to weigh into the decision of the bank to lend you the money.
While government regulations (Fannie Mae/Freddie Mac) and bank guidelines will may you jump through a lot of red tape, the truth is that we are still living in a time where we can borrow money at very low rates for a long period of time.
So, be aware if you plan to use bank financing for the purchase of your rental these are some of the things you'll need to be aware of:
Banks will look at your total income. So, if you are investing with a spouse, friend, or business partner, the bank will look at your total combined income for qualifying. If you currently own other rentals the cash flow from these properties will not be used for qualifying until you have two years of rental income on your tax returns.
LTV (Loan to Value) Ratio
When you borrow, the banks will look at how much you are planning to put down and how much you plan to borrow. The more money you put down will allow you to have a lower rate and a better chance of qualifying. Think about it, banks care about your ability to pay your mortgage. The more money you put down results in the banks having a cushion from you defaulting on the loan. In most cases for investors, you will need to put down 20% resulting in an LTV of 80%.
Even though you may make a lot of money, your debt can and will determine your ability to qualify. Your lender will look at your debt to income ratio- meaning your total debt may not exceed 40-45% of your gross income per year. What is included in total debt- things like car payments, student loans, credit card bills, current mortgages. What's not included- utilities, cable bills, phone bills, etc. So what is the moral of the story? Someone who makes very little money, but has little to no debt can have a better chance at qualifying vs. someone who makes a lot of money, but has incurred a lot of debt.
As an investor you must prove that you have 6 months of reserve payments for both your primary residence AND your investment property. For 100% of the cash value to be counted this reserve money must be in the form of cash, savings, and/or checking accounts. Banks will also look at retirement accounts and IRAs; however, they only count 70% of the account value because of penalties and tax rates that would ensue if you were to access these funds.
When buying an investment property, through a normal sale, in most cases you will have a downpayment of 20% of the purchase price. There are some programs that require a smaller downpayment. So, if 20% is too high for where you are right now, seek out programs like Homepath that require a lower down payment for investors.
This is 5 of many other things the bank will consider when qualifying you for a loan. Keep in mind that working with a reputable mortgage planning specialist who you trust will be key to having a good experience.
Credit's Impact on Financing
Believe it or not, your history plays a role in your future. Your credit score, which tracks your ability to repay borrowed money, will determine whether you can qualify for a loan and the interest rate that you will receive.
A higher credit score = a lower interest rate and better terms.
So it's important that you pay attention to your credit and do your best to keep it as high as you can as banks will pull your credit report when applying for a loan.
I realize, however, that things happen and not everyone has great credit. While having higher credit is definitely advantageous when trying to borrow money from a bank, there are more forgivable loan programs out there that will lend money to those with lower credit scores (i.e. FHA).
If you know now that credit may be issue an for you, start working towards remedying the problems.
One positive of dealing with credit is that it can be repaired, it won't happen overnight, but you can start taking little actions now to help get your credit going in the right direction.
2 Mistakes to Avoid When Financing Rentals
1.) Giving Up Because One Financing Option Doesn't Work For You
Too many times I see newbie investors say 'I can't get a loan so I can't buy rentals." and I hope that if you've learned anything from this post it's that there are multiple ways to go about finding funding for a property.
It just takes the determination to keep trying when one avenue doesn't work. Yes, it's easy to give up and say you can't do it. It's harder to find the one that will work for you or to admit that you can't buy right now, but with some actions taken over the next year or so you may be able to buy in the future.
Don't give up just because one window gets closed. That often means somewhere else there's a door open for you to find success.
2.) Not Listening to Your Mortgage Lender While Getting a Loan
Listen...I"m married to someone who used to work as a lender and I can't tell you how many times he would come home and complain about how a client had went and quit their job or bought a new car throughout the process of getting this new loan.
He'd be so frustrated because he told the client in the beginning, while going through the loan process don't do anything major with your finances.
So here's the story, if you're using a traditional bank for financing and you're in the midst of qualifying and getting the loan don't do anything crazy with your finances.
Don't quit your job....don't go buy a car with a loan....don't make any major deposits or take major monetary gifts from someone....
Because the bank will question all of this and it could ultimtmely affect your ability to actually get that loan.
Wrap Up & Next Steps
The reality is that there are a number of options out there for you to be able to finance rental property. And while the misconception that there's a one size fits all method hopefully was disproven throughout this post.
It's important to keep in mind that if one option doesn't work...there are other ways you can make a deal happen. And while sometimes the terms might not seem ideal or maybe it goes against your moral compass to pay a higher interest rate...if the numbers work why not do the deal.
I hope you're inspired, after reading this, to sit down and take some time to see which one of these options may work for you. And you may come to find out that multiple options might be available for you.
If you're looking for even more detail on these financing options and want to learn about examples of deals being done with these strategies, check out our Financing Avenues for Buy and Hold Investors course in our Pro Community for more guidance and tips.
AND if you're looking to get more questions answers and carry on the conversation about analyzing deals join our Private Facebook Group. It's our group of like minded investors who come together to support and help each along in the journey toward financial independence.