Financing a Rental Property: What to Know

Financing a rental property has its share of challenges. but it’s worth the effort if you find the right one to invest in. Investing in a rental property is an ideal way to create an abundant income source and turn it into a rewarding venture. Once you own a property, renting out a room would be a great way to start the inflow of cash into your business.

To be a successful landlord, you first need to accumulate a certain amount of cash. How exactly do you do that? Here are a few options to make the process less overwhelming.

1. Explore an Online Lender

Many investors still use banks and credit unions to finance property investments, although today we have multiple options to choose from. Today, it’s much simpler to secure your loans from online marketplaces. The benefit of an online marketplace is that you’re not required to hop from bank to bank and attend unnecessary meetings to see whether you qualify for a loan. You just need to fill out a form, compare and contrast various loan options, and select the one that works for you.

While we’re on the subject of loans, it’s important to add here that you have different types of loans that you can apply to finance your rental property. Let’s delve into them:

Conventional Financing

The lender takes the property you wish to purchase as security against the loan they offer you. With conventional loans, you end up paying a small amount of money for about 15 to 30 years. Most lenders ask for a down payment somewhere between 20 to 30 percent of the mortgage. Furthermore, conventional financing often makes it essential for the borrower to have sufficient funds for their primary home and the new property without depending on future rental income.

Private Funding

Several lenders go for private funding with a secured interest in your home, like mortgage lending, which may be quicker than securing a conventional loan. Do note that you’ll need to pay a high rate of interest, but it’s a good idea to consider it. Suppose the property you’re interested in has positive cash flow and is likely to appreciate in terms of value. In that case, you could secure short-term private funding until conventional financing options come up.

HELOC or Home Equity Loan

A home equity line of credit (HELOC) happens when a lender uses a property you own as security for the loan. It works like a credit card whereby the lender offers you a line amount, and you get to borrow or charge funds from it. You get billed monthly and the minimum payment comprises only the interest. On the other hand, a home equity loan is where a lender will give you all the money at one go, and you need to make a specific monthly payment comprising the principal and the interest. Most lenders will permit you to borrow up to 90 percent of a primary residence value and 80 percent on the second home.

Cash-out Refinance on a Primary Residence or a Second Home

This option works when a lender uses a property that you have (either a primary or second home) as security against the funds offered. It’s similar to the application process for a mortgage, so it takes around 30 to 45 days. You can get a loan that amounts to about 80 percent of the value of your home. The cash-out refinance option takes care of the remaining debt on your property. A new mortgage is set up and you end up getting the difference as cash-out.

Find the Right Loan

2. Collate a Substantial Down Payment

You may encounter issues in qualifying for a mortgage or getting a reasonable interest rate on your loan. Under such circumstances, it’s advisable to wait for a couple of months and accumulate more cash. If you can manage to collect 25 percent of the property amount, the interest rate might work in your favor. Also, if you can fork out more than half the amount, you might come across a hard money lender with even better terms than you can imagine.

3. Gather Knowledge about Seller Financing

Seller financing is another option you can consider and works well when it’s difficult for you, as an investor, to get a loan from a bank or other regular lending sources. In this situation, the property seller assumes the role of a bank. You become the owner of the property and make monthly ‘mortgage’ payments to the previous owner. In case you can’t pay a certain month, the erstwhile owner has the option of taking their property back. Should you want to explore this option, you need to put together a proper plan. Going to a seller without any specific details about what you’re looking for might not generate any interest in your venture. You need to create a plan that contains all the requisite information and is ready to be implemented.

4. Bring a Group of Investors Together

You may not be financially sound enough to buy a property with cash that you own, which is fine because there may be an alternative. You can speak with a group of potential investors, gain their confidence, and request them to invest the capital essential for your property purchase. For instance, if you’re keen on buying a rental property worth $300,000 and can find four other investors, you can put in $60,000 individually and jointly own the property. It’s an excellent investment with minimal risk because it’s now evenly distributed among the five of you.

In conclusion, a word of caution that you may want to consider while purchasing a property or considering buying a property, is to exercise patience. If you rush into buying a property, you may have to face issues that you never imagined would crop up. It’s always a good idea to wait till you can secure the appropriate financing option, no matter how good some properties might look to you.