What Is Mortgage Loan Insurance
Mortgage loan insurance protects the mortgage lender in case you cant make your mortgage payments. It doesnt protect you. Mortgage loan insurance is also sometimes called mortgage default insurance.
If your down payment is less than 20% of the price of your home, you must buy mortgage loan insurance.
Your lender may require that you get mortgage loan insurance, even if you have a 20% down payment. Thats usually the case if youre self-employed or have a poor credit history.
Mortgage loan insurance isnt available if:
- the purchase price of the home is $1 million or more
- the loan doesnt meet the mortgage insurance companys standards
Your lender coordinates getting mortgage loan insurance on your behalf if you need it.
Investment Property Down Payments: How Much Will You Need
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One of the biggest obstacles that would-be real estate investors need to overcome before buying their first property is saving up enough money for a down payment. But how much is enough? Unfortunately, there’s no perfect answer to this question.
For example, down payment requirements on conventional loans can be different than commercial loans. And the down payment requirements for a vacation rental can be different than for an investment property.
With that in mind, here’s a guide to help you determine how much money you’ll need to put down when buying your next investment property. It should also help you analyze all the options at your disposal to find the one that works best for you.
Common Mortgages For An Investment Property
Its more common and usually more cost-efficient for people to finance a primary residence only. But if you are in the position to invest, there are a few things you can do. Keep in mind, down payments are usually higher for investment properties than primary residences. You will typically see lenders ask for a 15 to 25 percent down payment. Lenders will accept a wider range of down payments for primary residences because there is less risk.
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What Are My Other Options
With Genworth Financial’s 10% program and CMHC’s 5% program these really are the golden years of residential investment property mortgages in Canada.
But there are other options…
If you really want to get aggressive you can turn to “hard money” lenders. These are basically mortgage brokers or other professionals who have access to individuals willing to lend you money.
There are still qualifications to meet but they may be less stringent. You’ll pay for this privelege though, typical hard money loans have interest rates of 12% or higher with finder fees tacked on to them as well.
Venture into “hard money” investment property mortgages with caution and work with an experienced real estate investor/coach/mentor only.
And there are private institutions like Xceed Financial that have offered 5% down mortgages in the past for investors without perfect credit. With recent changes in the financial industry these may vanish soon.
However, for these types of investment property mortgages you will require high enough income, a good to great credit score and you will likely jump through a few extra qualification hoops.
Down Payment Of At Least 20%
A large down payment helps to offset the risk of having to foreclose on the investment property and sell it to make back the balance owed. The sale may not recover the total of the loan, so a large down payment helps mitigate this risk. In comparison, most conventional loans require a down payment of around 5 to 15 percent.
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What Else Should I Know
There are details, fine print and exceptions to almost everything.
Things like mortgage penalties, mortgage insurance rates and mortgage terms need to be addressed.
So you will need to do your homework and make sure the investment property mortgages you use are right for you.
Ask questions, don’t be scared.
If what the bank or mortgage broker is offering you is confusing, get clarification.
How Do I Determine The Potential Roi For My Rental Property
When looking for a great investment property, the first question you need to ask is Can I actually make money? If the answer is no, its obviously not a great investment. To see how much money your property could potentially make, youll need to consider the return on investment .
The ROI can be calculated by first finding the propertys net annual income. This is the rent money thats left over after youve paid the taxes, insurance, property management fees, expected repairs , potential vacancy periods, HOA fees and any utilities that arent going to be covered by the tenant.
To find the ROI, take the annual income and divide it by the amount you spent on the property. For example, if the net annual income is $7,500 and you spent $100,000 for the property, your ROI is 7.5%.
Use this calculation to see if each rental property is a good potential investment.
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Option : Private Money Loans
Private money loans are loans from one individual to another. The source of most private money loans are usually from the friends and family of an investor. If you do not have friends or family in a position to loan money to you for an investment property purchase, a great place to start looking for private money lenders is by going to local real estate investment networking events. The popular real estate investment podcast BiggerPockets keeps a directory of local real estate investment clubs that you can join for networking.
Actual loan terms and interest rates on private money loans can vary significantly, from extremely favorable to predatory, depending on the relationship between the borrower and the lender. These loans are typically secured by some sort of legal contract that allows the lender to foreclose on the property if you default on payments. If you are new to real estate investing, consider carefully how your relationship with the person lending you private money may sour if you default before you sign an agreement with a loved one.
Avoiding Capital Gains Tax With The 1031 Tax Exchange
When the time comes for you to sell your investment property, youll likely have to pay a capital gains tax at the time of sale. That is unless you reinvest your proceeds in another, similar property.
IRC Section 1031 provides an exception to tax gain payments and allows you to postpone paying that tax if you reinvest the proceeds a like-kind exchange. To qualify, both the relinquished property you sell and the replacement property you buy must meet specific requirements. Both properties must be held for use for investment. Property used primarily for personal use, like a primary residence, a second home, or vacation home, does not qualify for like-kind exchange treatment in the eyes of the IRS. You have 45 days from the date you sell the relinquished property to identify potential replacement properties. The identification replacement property must be in writing, signed by you and delivered to the seller of the new property. While there’s no limit on how many times you do a 1031, there are restrictions that accompany it. Be sure you consult with your real estate agent, investment broker, accountant, attorney, etc. to better understand 1031 rules.
How Buying A Fourplex Can Help You Build Wealth
Buying a fourplex can help you build wealth in two ways. One is the rental income you receive , which you can save or invest.
The second is through the equity in the property. As you pay down your mortgage loan, your equity will grow, and you can borrow against it using a cash-out refinance or home equity loan or line of credit. You can use that money to purchase additional rental properties and repeat the same process with those.
The profits you earn can be used however you choose, including for other wealth-building purposes such as paying off high-interest debt, renovations, and higher education expenses.
House Hack To Slash Your Down Payment
House hacking involves buying a home to live in, and finding a way to have someone else pay money put toward your mortgage.
There are plenty of approaches to house hacking, from buying a small multifamily and renting out the other units, to renting out bedrooms in a single-family, to living there for a year before moving out and converting it into a rental. Deni has found even more ingenious ways to house hack, by bringing in foreign exchange students and by renting out storage space in her house!
What does all this have to do with down payments? Simple: the down payment requirements for primary residences are far lower than for investment properties.
For example, instead of paying 15-30% in a down payment, most FHA borrowers pay 3.5%. And yes, they can still buy a two-, three-, or four-unit property.
Even conventional mortgage giants Fannie Mae and Freddie Mac now offer loan programs with as little as 3% down. Far, far less than you would need to come with for a minimum down payment on an investment property.
And, of course, you get someone elses rent to help you cover your mortgage payment. Definitely a win-win!
If you want more tips on house hacking and other ways to cut your expenses, Deni and I chat about ways to accelerate your savings for a down payment on an investment property here:
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How To Get Approved For An Investment Property Loan
To strengthen your chances of approval for a conventional investment property loan, youll need to meet the following loan criteria:
- A minimum 15% down payment. However, if youre buying a multiunit property as a primary residence and going the house-hacking route with a government-backed loan, your minimum required down payment could be less.
- A minimum 700 credit score. Unless you plan to make an investment property down payment of 25% or more, youll need at least a 700 credit score. To get quoted the best mortgage rates though, improve your score to 740 or higher.
- A maximum 45% DTI ratio. The percentage of your gross monthly income that is used to pay your monthly debt cant exceed 45%.
- A minimum of six months in reserves. Youll need at least six months in cash reserves to buy an investment property. Your lender wants reassurance that you can continue to pay the mortgage when youre in between tenants.
Arguably, the most important of these factors is your down payment amount. While your credit score, DTI ratio and savings hold weight, how much money you put down can make or break your real estate investing goals.
Traditional Ways To Finance An Investment Property
Traditional lenders, such as banks and credit unions, offering investment loans backed by Fannie Mae and Freddie Mac are a source investors may consider for financing an investment property.
Mortgage brokers often have access to alternative sources for financing a rental property, like portfolio lenders, while Stessa Mortgages is a good place to obtain a competitive mortgage quote for purchasing or refinancing a property.
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Types Of Rental Property Mortgages
When purchasing investmentproperty, you have access to many of the same property financing options aspeople buying their primary homes. They just cost more and are a bit harderto get.
You can use a standard conventional loan for an investment property. The minimum down payment is 15%, but 20% is recommended to avoid mortgage insurance.
You can buy an investment property with an FHA or VA loan loan IF you choose a multi-unit property and live in one of the units. These come with minimum down payments as low as 3.5% for FHA and 0% for the VA loan .
Portfolio lenders can make up their own investment property loan rules. You may be able to put less down or finance more properties with these programs, but you should expect higher interest rates.
Hard money loans
Hard money lenders charge high interest rates and steep fees, but these short-term loans could help when youve found a great investment opportunity and need the money fast.
Speed of financing is one of the only reasons to consider a hard money loan. Most real estate investors can find better financing options with another loan type.
Finally, for those who want to borrow solely against the income of the property, or buy projects with more than four units, there are commercial residential loans. They can be expensive and complex to set up.
Alternative investment property financing
Maintain High Personal Cash Reserves
If you have a significant amount of cash on hand, enough to make a down payment and pay six months worth of mortgage payments on your loan, it will go a long way towards convincing lenders that you arent a big risk. Having cash reserves is particularly important if youre looking to fix and flip a house since youll need money to pay for the repairs and renovations.
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Option : Conventional Bank Loans
If you already own a home thatâs your primary residence, youâre probably familiar with conventional financing. A conventional mortgage conforms to guidelines set by Fannie Mae or Freddie Mac, and unlike a Federal Home Administration , U.S. Department of Veterans Affairs , or U.S. Department of Agriculture loan, itâs not backed by the federal government.
With conventional financing, the typical expectation for a down payment is 20% of the homeâs purchase price. With an investment property, however, the lender may require 30% of funds as a down payment.
With a conventional loan, your personal and determine both your ability to get approved and what kind of interest rate applies to the mortgage. Lenders also review borrowersâ income and assets. And obviously, borrowers must be able to show that they can afford their existing mortgage and the monthly loan payments on an investment property.
Future rental income isnât factored into the debt-to-income calculations, and most lenders expect borrowers to have at least six months of cash set aside to cover both mortgage obligations.
Potential Cash Flow From Rental Property Investments
Cash flow is the difference between the rental income of an investment property and its expenses, or whatever is left over after paying all of the bills. Bills can include utilities, property management, repairs, and season expenses . It goes without saying, but the more positive cash flow your property can earn, the better of an investment it will be.
Something that may not be as obvious, that financial income may also be used during the loan qualification process that is if youre already a landlord. Thats right you can use the rental income of your current investment property to qualify for a new investment property mortgage, assuming you want to manage multiple real estate properties. Just be prepared, youll need to document property management experience for at least two years.
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What Is A Fourplex
Also known as a quadplex, a fourplex is a type of multifamily property consisting of four units individually connected under one roof.
Fourplexes can be great options for getting started with real estate investing, especially if you plan to live in one of the units. If it will be your primary residence, you can buy with a 5% down conventional loan, a 3.5% down FHA loan, or a 0% down VA loan. While you must live in one of the units, you can rent out the other three.
Not only does this allow you to purchase the property with less money down and a lower interest rate than if you bought it with an investment property loan, it also lets you ease into becoming a landlord.
Since youll also live on the premises, youll see right away when something has broken down or needs repair. Youll also be able to develop a relationship with your tenants, since youre likely to see them often.
You can learn the ins and outs of property management while living on the property, and that can give you a feel for what it takes to manage future real estate investments.
Of course, you dont have to buy a fourplex with the intention of renting it out. Some people buy multifamily properties whether thats a duplex, triplex, or fourplex for multigenerational living. They live in one unit while their parents, children, siblings, or other relatives live in the others.
Alternatives If You Don’t Have Enough For A Down Payment
It’s generally a smart idea to put at least 20% down when buying an investment property. Of course, there are a few exceptions. House-hacking is one of them. Vacation homes that you could reasonably afford without any rental income are another. However, in general, the more money you finance, the less margin of safety you’ll have.
There are a few ways you could raise the funds for a down payment on an investment property if you don’t have 20% of the purchase price sitting around. Just to name a few options that could be smart ideas in the right circumstances:
- Home equity loan or line of credit : This can be a decent way to fund some or all of an investment property purchase. Because they’re backed by the equity in your home, creditworthy borrowers can get this type of financing with relatively low interest rates and fees.
- Personal loans: The personal loan industry has become huge over the past few years and you can get unsecured loans for up to $100,000 in some cases. Plus, borrowers with top-notch credit scores may be able to get interest rates comparable to investment property mortgages.
- 401k loans: I’m generally not a big fan of this option, but it could be a smart move in some cases. 401k loans are cheap as far as interest rates go . And since you’re technically borrowing money from yourself, the interest is being paid back to you, not a bank.
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