When it comes to buying a real estate investment property, the first deal is the hardest. I know this from personal experience. I kept talking about buying a rental property for several years until my husband finally took the initiative, found a property, and made me buy it. From a hotel room in Texas, where I was staying on business, I nervously signed a contract and committed myself to buying a “bread and butter” house in Florida. Thanks to rising real estate values, the house has appreciated substantially…leaving me to wish I had bought ten more!
I know that financing your first investment property can be daunting. It scared me — and I have a mortgage broker’s license, for heaven’s sake! But as they say, it’s usually the things we don’t do that we regret later in life. So if concerns about financing your first property are stopping you from getting started, here are some tips:
Check your credit early for mistakes and items you may need to address, but don’t let less-than-perfect credit stop you from trying to get pre-approved for a loan. You may be surprised by what lenders will approve these days. Once you review your credit report, do not take any drastic action without first consulting with an expert. In particular, don’t close old accounts or pay off collection accounts right before trying to get a loan. Either action may hurt your credit score rather than help it. Also, don’t procrastinate any longer: lenders are being scrutinized for making risky loans, and standards are likely to get tougher in the near future.
If you are not eligible for a loan based on your credit or other qualifications, look for an investor partner to go in on the property with you. There are many others out there wishing they owned more real estate who lack the time and/or expertise to find and buy property. There are also “hard money” or private loans for good deals. The interest rates are high but can be worth it if you can refinance or sell the property in a relatively short period of time.
Decide What You Are Buying
All things being equal, second homes may offer better financing, but it will depend on where the property is located and what you intend to do with it. Talk with your tax advisor about how you plan to use the property to decide whether it would be better to buy a second home or an investment property. I am not a fan of stretching the truth on applications. If you are buying an investment property, call it what it is. Whatever you do, don’t buy a property where someone talks you into saying you will live in it when you won’t. There are illegal scams that solicit “straw buyers,” and these can get you into hot water.
Understand the Numbers
Investors have different goals. Some want to buy a rehab property, fix it up, and sell it quickly for a big profit. Others specialize in pre-construction, which means they put a contract on a home or condo in a development before it is built and then sell it for a profit, sometimes before they complete the purchase! Others will buy a home they can rent out, and are happy to break even or make just a little money each month, expecting appreciation to be the pay off. Still others want to buy a vacation home in an area they want to visit. They may use it from time to time and rent it out the rest of the year for a profit. Whichever approach you decide to take, make sure you understand the numbers, including the cost of financing, a down payment, advisor fees, repairs, etc. Be realistic about whether you can afford to make the mortgage payments for as long as it may take to find a buyer or a tenant.
Don’t Sweat the Down Payment
While I had to come up with 10% down on my first investment purchases, there are loans now that allow for 100% financing on investor properties. Another option is to get a first mortgage for 80% of the purchase price and a 10% home equity line of credit behind it for a total of 90% financing. Sellers may also offer to help out by agreeing to accept part of the purchase price in the form of a note (I.O.U.) that you can pay off in the future. Certain loan programs allow sellers to contribute toward the closing costs to help minimize your out-of-pocket expenses. You also may be able to borrow against equity in your primary residence to come up with your down payment.
Still another possibility is to secure your down payment with funds you already have in a brokerage account, according to investor and loan expert Deborah A. Ten Brink, president of LLC Loan Network. She describes it this way: Sam wants to purchase an investment property for $100,000.00. Sam has a brokerage account with $50,000.00 in it. He must pledge 143% of the $25,000 down payment required by the lender or $35,750 (143% times $25,000.00 = $35,750.00). The funds are retained in his brokerage account, still accruing interest, but the lender puts a lien on the account to protect its interest, then loans him the full $100,000.00 to buy the property. When the investment property achieves 25% equity (proven by an appraisal), the lien on the account is released and the pledged amount plus accrued interest is once again completely under the borrower’s control.
Even if you have cash for a down payment, you may not want to tie it up in your new property. So, for example, Sam can open a certificate of deposit (CD) with the lender using his down payment funds of $25,000.00, and still borrow 100% of the purchase amount of $100,000.00. When the investment property achieves 25% equity (proven by an appraisal), the lien on the CD is released and the CD, plus accrued interest, is returned to Sam.
In both cases, 100% financing is achieved! These options are also available to investors who want to close and hold title in a business entity (such as a limited liability company, limited partnership, or corporation) instead of in their personal name in order to protect their assets. We will cover that subject in just a moment.
Now that you see the possibilities, here are the steps you will want to take to make things move smoothly:
1. Gather Your Paperwork
Be prepared to provide copies of: two month’s worth of your bank statements, investment account, and retirement account statements (all pages; not Internet statements); the last two pay stubs if you have a regular paycheck job; driver’s license and Social Security card; and bankruptcy, divorce or separation papers, if applicable. If you are self-employed, you may be asked for some or all of the following: business license or occupational license, letter from your CPA establishing two years’ self-employment, last two year’s tax returns, business bank statements, and/or business financial statements.
2. Assemble Your Team
You will want an accountant who understands investment property tax strategies; a realtor or real estate attorney who can help you make sure you use the properly worded contract and include the right contingencies; a mortgage professional with experience in investment properties; an attorney who understands asset protection to help you form the right structure for holding your investment property (often a limited liability company or LLC); and an experienced insurance agent. I strongly believe all of these professionals should invest in real estate themselves since investment property transactions have special nuances.
Advisors with investment property experience can help identify potential problems before they happen. One of the big ones: holding investment property in your own name, warns Rich Dad Advisor Garrett Sutton, an attorney and author of Own Your Own Corporation (Warner) How to Use Limited Liability Companies and Limited Partnerships (SuccessDNA). By doing so, you expose your real estate and personal assets if a lawsuit arises.
3. Get Pre-Approved
Before you start house-hunting, get pre-approved for a loan through a mortgage broker or lender, and request it in writing. That piece of paper can be very helpful when you negotiate the purchase of a property since it gives the buyer greater assurance that you won’t tie up the deal and not qualify.
Now it’s time to dive in! You’ve heard of “analysis paralysis?” It’s a disease I, and many other would-be investors, suffer from. Fortunately, I have a spouse who drags me out of it from time to time. While you don’t want to dive in blindly, if you have done your homework and have found a good deal, at some point you have to just go for it. If you can’t seem to take the plunge, ask financial advisors to help you make progress, get involved with your local real estate investment club, or find an investor who can act as a sounding board.
“The biggest deadly deal disaster of all is hiding behind analysis because you are afraid to pull the trigger on the deal,” warns Peter Conti, author of The Real Estate Fast Track: How to Build a $5,000 to $50,000 per Month Real Estate Cash Flow. “At a certain point as an investor you will need to step forward in the deal and commit.”
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