Investors are always looking for additional ways to create passive income. The real estate market in the greater Hampton area is a perfect place for creating this kind of residual income. However, one of the common barriers to entry is that in order to buy real estate, a significant amount of capital needs to be made available up front. In this blog post, we are going to go over some of the different options investors have for financing their investment property purchases.
The three most common types of loans used in investment property acquisitions are Home Equity Loans, Conventional Loans, and Hard Money Loans. It is of paramount importance to understand the differences between these loans. Choosing the wrong type of loan for a specific transaction can jeopardize the potential for the investment to become a profitable one.
Home Equity Loans
Especially in today’s current market conditions, most homeowners have a fairly significant amount of equity tied up in any property that they own. You can access this equity through a Home Equity Line of Credit (HELOC), or through a cash-out refinance. A property owner can usually borrow up to 80% of the equity they have in their home in order to purchase a second property. Depending on which of these loan vehicles you decide to utilize in order to tap into your equity, there may be a different list of pros and cons involved. If you choose to get a HELOC, it will essentially function as a credit card, and the monthly payments will likely be interest only. However, a HELOC often comes with a variable rate, which means if the prime rate it is tied to increases, your rate and payments will also increase. A cash-out refinance usually comes with a fixed rate, but the potential drawback is that it can extend the duration of the term of your current mortgage.
Hard Money Loans
These types of loans are the most beneficial when your intent is to purchase a property, fix it up, and then flip the property quickly by reselling it for a profit. The loan is much more expensive and it will need to be repaid in full rapidly. A hard money lender is mainly focused on how much potential profit is wrapped up in the property itself. They tend to care significantly less about things like the credit score of the borrower or what their payment history might look like. The terms of hard money loans are usually somewhat harsh, and interest rates can be 18% or more. Penalties for missed payments are typically quite severe as well. However, these loans can be a great option because they are much easier to qualify for than home equity lines or conventional loans. Another benefit is that they typically fund very quickly comparatively speaking (days instead of weeks), allowing construction on the flip to begin ASAP.
A conventional loan must conform to current standards set forth by Fannie Mae and Freddie Mac. In today’s market, conventional lenders often require a 20% down payment to be made. However, if the property involved is an investment, the lender may require up to 30% down. Things like whether or not an investor qualifies for a loan, and what interest rate they will have to pay depend on their personal credit history and credit score. A prospective borrower will be asked to prove that they can afford the monthly payments on the investment property in addition to their other monthly obligations. Their debt-to-income ratio will be reviewed before factoring in the rental income the property will generate so that a decision can be made.
As you are choosing the best type of loan for your investment property, be sure to consider both the short and long-term implications of each type of loan to ensure that your venture will be as profitable as possible! As always, don’t hesitate to reach out to PMI Green Rock with questions about any aspect of acquiring and managing rental property.