Everything You Need to Know About Financing a Rental Property

For the longest time, real estate has been an ideal choice for many investors in the U.S., whether for personal or business investment. When you own investment property you enjoy many benefits. There is immediate cash flow in the form of rental income every month, it provides an excellent hedge against inflation, and offers long-term rewards of equity growth as well as appreciation. Not to mention rental property investments provide an excellent opportunity for obtaining some decent tax breaks.

As a first-time investor or an investor looking to expand your real estate portfolio, it can be challenging to secure financing, especially when it comes to the 20% or higher down payment that lenders often require to finance a rental property.

Don’t stress if you aren’t sure where to begin. Here are some useful tips to help you achieve your goal of financing a rental property.

1. Ensure you have enough money for a down payment

If you’re thinking about obtaining a conventional loan, you need to make sure you have enough down payment. With a down payment, you can be sure to obtain the best interest rates possible.

Conventional financing is a type of financing where the lender uses the rental property you are looking to purchase as security for the loan. The lender will often require you to put a 20%-30% down payment. If you can’t afford the down payment, there are other financing alternatives out there – your goal of purchasing a rental property doesn’t have to end here. Buying a property isn’t a quick and easy process. Be patient and diligent in your search for financing

2. Maintain a Good Credit Score

Prior to seeking financing for a rental property, be sure to check your credit score. This is because your credit score will not only determine the amount you are eligible for, but it will also have an impact on the interest rate.

For example, a credit score that is below 740 can result in a higher interest rate or a requirement that you have to pay a fee to reduce the amount of interest. Even worse, a poor credit score can reduce your chances of obtaining financing at all.

Since a poor credit score can affect the profitability of your rental property, it’s important that you maintain a good credit score. Do this by always making your payments on time, regularly monitoring your credit score, and promptly handling any issues or errors.

Read more on the ideal credit score to secure a mortgage

3. Consider Paying Off Any Debts

Do you have any outstanding debts? If yes, then you should consider clearing them prior to applying for financing. The lender will first assess whether you have too much debt for your income level.

They will also determine your debt-to-income ratio to access your ability to make monthly payments. If your debt-to-income ratio is high, it could negatively impact your ability to obtain a favorable interest rate from the lender. By clearing your debt, it will be easier for the lender to trust that you will make the payments.

4. Prepare the required paperwork

It’s important to prepare the required paperwork as proof of your current financial situation. The paperwork may include recent bank statements, at least two recent pay stubs, brokerage statements, statements for your investment and retirement accounts, your driver’s license. Preparing these documents will avoid time wastage and ensure a smooth process.

5. Show history as a rental property owner

If you own other rental properties, consider showing the lender at least a two-year history of successfully managing a rental property. The lender might consider offsetting the mortgage payment on the rental property you are purchasing with the expected income minus about 25% for vacancy and expenses. Of course, this would significantly benefit you.

6. Select the most suitable financing option

There are many financing options out there. Choosing the most suitable one can be overwhelming. You need to be diligent when it comes to choosing a financing option. Choose one that fulfills your financial needs and carries a favorable interest rate.

Some of the best and most popular financing options include:

• Conventional financing
• Home Equity Loan
• Proceeds from Cash-out Refinance
• Private Funding
• Exchanging property
• Buy as an owner occupant
• Assume the seller’s mortgage
• Look for “subject-to-financing
• Find a lease with an option to buy property
• Find an investment partner
• Use your self-directed IRA

7. Negotiate the Closing Costs

It’s important that you have a clear understanding of the closing costs. These costs will include credit check fees, appraisals, title insurance, title transfer fees, underwriting fees, including others. Because these costs can add up to thousands of dollars, it’s important to check with the lender in order to obtain an estimate of these costs.

Consult an Expert

Before settling for any financing option, it’s important to consult an expert. They’ll give you the best advice on how to go about obtaining financing for a rental property and even assist with legal matters if any.

Regardless of what financing option you choose, having an idea of what the entire process entails can help a great deal. Being a rental property owner is a great decision. Get out there and start taking action.