Interest Only Versus Principal
If you do choose to take out an investment home loan, an important decision youâll have to make is whether to take out a principal-and-interest loan, or opt for an interest-only one.
As the name implies, with a principal-and-interest loan, youâll make contributions towards paying off the value of your property while also paying interest calculated on your total loan amount. With an interest-only loan, youâll only make interest repayments and wonât pay off any principal at all.
Many investors choose interest-only loans because they offer lower repayments while letting them take advantage of any price growth. The downside with an interest-only loan is that you wonât be making any inroads into the amount youâve borrowed.
That said, most interest-only loans revert to principal-and-interest loans after a certain period of time. When that happens, youâll usually have the option of paying off the capital with your repayments or refinancing.
Choosing Between Home Equity Loans And Helocs
Home equity loans come in a lump sum and have fixed interest rates that are repaid in monthly payments over a set period of time of usually 10 to 15 years. The total amount you can borrow is based on the amount of equity youve built in your home.
A HELOC is similar to a home equity loan because the maximum amount of credit extended to you is dependent upon the total equity youve built. Unlike the home equity loan, however, a HELOC is a line of credit that you can draw on multiple times during the draw period. HELOCs also have variable interest rates that fluctuate with the market.
If you think you just need the loan for a single expense, such as a downpayment on your investment property, then a home equity loan may the better choice because of the fixed rates and predictable repayment. If you want an ongoing line of credit that can be used on future expenses, go with a HELOC.
Loan Approval Based On Property Cash Flow
Circling back to the comment above about no income being disclosed on the loan application.
No. Were not getting back to the old days when anyone with a pulse is approved for a mortgage. These loans are fully underwritten and evaluated for ability to repay the loan.
But the ability for the loan to be paid lies within the monthly liability in relation to the fair market rent.
So how is fair market rent evaluated?
Pretty simple really. If youre purchasing an investment property, the appraiser will do a standard 1007 rent schedule. This is used to calculate fair market rent for the lender. The lender will then take a percentage off of that amount .
If you already own the property, and are refinancing, the current lease will be evaluated as well as a 1007 rent schedule to be completed by appraiser.
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Investment Property Mortgage Definitions To Remember
First you need to know the basic terms thrown around when it comes to home loans and property investing interest rates, so lets break some of them down.
- Interest rates are the percentage of your loan that you pay your lender for the use of their assets.
- Fixed interest maintains the same interest rate throughout your borrowing period, while variable interest is an interest rate that will change over time.
- The effective rate is the rate of interest that you will pay annually after you take compounding interest into consideration.
Now that weve covered some of the basic terms, its time to tackle the big decision: interest-only or principal and interest.
Risks Of Using Home Equity On A Rental Property
As with any financial product, there are some risks to consider when using a home equity loan or HELOC on an investment property.
- Primary residence acts as collateral. If you can no longer make payments on the home equity loan or HELOC, the lender will foreclose on the collateral property in order to fulfill your debt obligation. In this case, that is your primary residence.
- Closing costs & fees. You will have to pay closing costs and fees on your home equity loan or HELOC. While these arent typically as high as closing costs on mortgages, other loan optionssuch as personal loansoften dont have any fees.
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Home Equity Loans For Investment Properties
Using your home equity is a great financing option for a long-term income property or a flip. Home equity loans for investment properties are a type of debt that allows homeowners to borrow against the equity of their home to use towards buying a second home or an income property. The loan is based on the difference between the homeowners equity and the propertyâs current market value. Many lenders provide real estate investors with up to 80% of the homes equity value!
Using home equity loans for investment properties has some advantages and disadvantages and the situation will differ depending on the type of loan you go for. The lender will run a credit check and appraisal on your home to determine your creditworthiness. This financing option provides an easy source of cash and obtaining the loan is quite simple. Moreover, interest paid on home equity loans is tax-deductible.
Home equity loans for investment properties are essentially a second mortgage, but they have higher interest rates than the first mortgage. As with any mortgage, if the real estate investor doesnt pay off the loan, the lender gets to repossess the investment property and sell it to satisfy the remaining debt. Plus, if property investors default, lenders get to keep all the money earned on the initial mortgage and the home equity loan.
To learn more about how we help property investors make faster and smarter real estate investment decisions, click here.
Which Lenders Can Help
From an Australian banks point of view, investors who tend to borrow more are considered to be higher value clients.
However, an investment loan is typically a higher risk to the bank.
For example, if you had a home loan secured by your home and an investment loan secured by your investment property, which would you pay for first if you were in financial strife?
In the event that the bank has to sell your investment property to recover your debt, they may have problems with the tenants refusing to move out or destroying the property. It is for these reasons that banks tend to have lower s and stricter lending guidelines!
Therefore, it is important to find a bank that encourages investors, not one that has a conservative view of investment loans. We know which banks like dealing with property investors, do you?
In Australia a range of both Bank and Non-Bank lenders can consider 95% investment loans. Each lender has different qualifying criteria, so we dont recommend any lenders until we have seen your full details and assessed your capacity to borrow.
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How Much Will Property Taxes Be
Property taxes are taxes that homeowners pay to support their community and local government. Property taxes fund fire departments, public schools, libraries and other local projects. The amount you pay in property taxes is directly related to the value of your home. If your home is worth more money, you pay more, and vice versa.
Local governments set their own property tax rates, so the specific amount you pay in property taxes depends on your houses location. Speak with a local real estate agent or mortgage lender to calculate how much a certain house will require in property taxes. No estimate is going to be perfect because every homeowner qualifies for different levels of exemption as well.
Federal Housing Administration Mortgage Loans
The Federal Housing Authority offers loan options with low down payments and low credit score requirements to make it easier to purchase properties. However, Federal Housing Administration loans are not intended to be used to finance rental properties since they must be owner-occupied. There are ways to get around this, but certain rules and regulations will need to be followed.
According to the FHA, the borrower must live in the property within 60 days of closing on the mortgage and for at least one year before considering renting it out. For a single-family property, youll need to prove youve lived there for a minimum of one year before you consider renting out your house.
On the other hand, if youre purchasing a multi-unit property, then you can still meet the requirements of occupying the property while allowing tenants to rent out the other units.
You can put down anywhere from 3.5% to 10% for an FHA loan, depending on what your current credit score is. Its important to note that if your down payment is less than 10%, you will need to invest in mortgage insurance to increase your chances of getting approved.
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Veterans Affairs Mortgage Loans
Veteran Affairs loans are backed by the U.S. Department of Veterans Affairs and offered to current service members, veterans, and eligible spouses. According to the U.S. Department of Veterans Affairs, these types of loans can be used to finance a rental property with a few restrictions to be aware of.
To finance an investment property with a VA loan, at least one of the units in the property will need to be owner-occupied. However, VA loans cannot be used to buy an individual rental unit or land intended for investment purposes only. So while this can be an option worth exploring, it may make more sense to look into a conventional loan or other types of loans specifically intended for real estate investing.
Discover Financing Options With Realtorcom
To successfully begin your real estate investing journey, youll need to have the proper financing in place to purchase a rental property. Whether thats through a conventional loan or seller financing, there are different methods you can explore to ensure you find the right option for your rental business.
Get connected with trusted lenders and find available properties near you by visiting Realtor.com® today.
- Advertise your rental online
- Collect rent online and more
- Access lawyer-reviewed lease agreements
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Why Are Interest Rates Higher On Investment Or Rental Properties
Your interest rate will generally be higher on an investment property than on an owner-occupied home because the loan is riskier for the lender. Youre more likely to default on a loan for a home thats not your primary residence. Thats a good reason to use our investment property mortgage rate tool to compare prevailing interest rates that you qualify for.
In addition to paying higher investment property interest rates, its likely youll have to make a higher down payment. Conventional mortgages generally require at least 15% down on a one-unit investment property and 25% down on a two- to four-unit investment property. And loan terms are usually shorter than the typical 30-year residential mortgage. After all, its a business transaction, rather than a home purchase.
Hard Money Loans For Investment Properties
You can obtain hard money loans from professional individuals or companies that lend money specifically for real estate investing purposes. The best thing about these types of loans for investment properties is that they are faster to secure than conventional mortgage loans. Moreover, hard money lenders donât look at the real estate investorâs credit score â instead, they evaluate the value of the income property youâre planning on buying to decide whether or not to grant you the loan.
Looking to buy an incomeproperty? Click here to analyze and find the best investment properties in your city and neighborhood of choice!
Although this is one of the common types of loans for investment properties in real estate, it does come with a list of formalities, documentation, and guarantees. Another thing to keep in mind before approaching hard money lenders is that these are short-term and they come with higher interest rates .
As a result, these loans for investment properties are not suitable for any type of income property. Hard money loans are a good financing option for property investors who aim to buy cheap investment properties, renovate them, and quickly sell them for a profit and pay off the loan in due time . On the other hand, you wont possibly be able to pay off a hard money loan on a long-term residential investment property in only 3 years.
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Should You Flip Or Rent
Should you flip houses or purchase rental properties?
It all depends on your goals, and to what degree you can leverage your skills, expertise and your current financial situation.
In general, house flipping is usually the bigger gamble because these deals hinge on whether property values will rise in the near future. Although price depreciation is never a good thing for property owners, stable and/or falling prices have less impact on someone whose main source of income comes from rents versus a fast resale of a property.
In mid-2017, the highest flipping returns were in Pittsburgh, at 146.6% Baton Rouge, LA, at 120.3% Philadelphia, at 114% Harrisburg, PA, at 103.3% and Cleveland, at 101.8%, according to ATTOM Data Solutions. These cities topped the list because they had lots of affordable, older homes that could be quickly renovated. At the same time, housing prices there were also rising.
For rental properties, the best markets in early 2017 were Cleveland, with an 11.5% annual return Cincinnati, at 9.8% Columbia, SC, at 8.6% Memphis, TN, at 8.5% and Richmond, VA, at 8.2%. The worst markets were generally located in the biggest cities on either coast, where real estate prices have long been sky high.
But local markets are always changing. Like any other type of investment, real estate carries both risks and rewards. You can reduce the risks by thoroughly researching markets and your financing options, but you can never entirely eliminate them.
How Do Investment Property Loans Work
For investors with only a few residential rental properties vested in their own names, the application process is similar to a personal mortgage. If the investor has many properties or vesting is in a business name , the application process will likely be heavily focused on the properties and underlying lease agreements. This is particularly true in the case of non-recourse investment property loans.
While you can often get a 30-year fixed-rate mortgage for residential rental properties, some lenders instead offer a fixed-rate loan with a balloon payment due in five years or less.
Fix-and-flip investment property loans are a bit different, as these are loans you can use to make improvements to a home you intend to sell. These loans are short-term in nature, typically less than a year, and the funds will often be released to you incrementally rather than in a lump sum. Plus, instead of fixed interest rates with principal and interest payments, fix-and-flip loans often have variable interest rates with interest-only payments.
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Where To Find Investment Property Loans
You have several options when looking for an investment property mortgage. Investment property lenders include:
- Online lenders
- Hard money lenders
Traditional rental property lenders banks, credit unions and even online mortgage lenders vet your credit report and your overall finances to determine whether you can repay an investment loan.
On the other hand, hard money lenders are private investors who specialize in real estate lending. They may be willing to finance a property without running a credit check, but youll pay for that leniency with a higher interest rate. Youll also have a shorter repayment period than you would with traditional investment property lenders. Hard money lenders also charge a prepayment penalty and other fees, and typically require a higher down payment, perhaps upward of 30%.
In some cases, a hard money lender can finance a house flip, for example. But they can work on shorter timelines, giving you a very small margin of error for completing a fix-and-flip sale, Burgess said. If you fail to repay the loan on time, youll default and lose the property to foreclosure.
Its a very competitive market, so you have to be really careful when youre thinking about buying flips, Burgess said. What you dont want to do is buy something for too much and put too much into it and not be able to sell it for what youve got into it.
Better Mortgage: Quick Conventional Mortgages
Better Mortgage, otherwise known as Better.com, launched in 2014 with headquarters in New York Cityâs financial district. SoftBank backs the company, and the lender has funded $14 billion in loan volume in the Q1 of 2021. Better Mortgage provides conventional financing and refinancing in 47 states and Washington D.C. The only states where Better Mortgage is not available are Hawaii, Nevada, and New Hampshire.
Investors can qualify for a conventional mortgage or refinance with Better and receive a pre-approval in a few minutes. The application takes into account credit, income, existing debt, and other factors.
To apply, investors must submit some basic identifying information and consent to a soft credit check. This is an advantage over some other lenders, since it protects the credit report from hard checks, which could reduce the score. The initial application takes three minutes, after that Better requests additional documents to complete the underwriting process. Better pairs investors with a licensed mortgage broker that works on the loan with the customer. While Betterâs mortgage brokers are well-equipped, they are not only focused on a single customer, nor are they experts in real estate investment lending.
Better is offering a $2,000 discount to Awning customers, to be deducted from closing costs.Reviews by Better borrowers are very positive and the internal experience with Awning advisors and investors that have used the service reinforced this.
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