What You Need to Know Before You Buy an Investment Property
Buying an investment property can bring along a series of potential advantages, including predictable cash flow from tenants, substantial returns, tax benefits, and the increase in value of the property over time. Whether you’re an investor or an average person who intends to buy an investment property, considering the following factors is imperative in order to make sure that your investment will deliver the return expected.
The Financing Options Available for an Investment Property
Buying an investment property can be a smart way to get a steady source of passive income. However, one notable disadvantage is that it takes a large sum of money to get started. Even if you can afford to pay cash for an investment property, borrowing could actually be the best way to go about it.
Currently, you can finance the purchase of an investment property with:
- Conventional mortgages – You probably know a lot of things about conventional financing products and how they work, especially if you already purchased a home with the help of a mortgage. However, using a conventional mortgage to purchase an investment property is slightly different. To start with, the mortgage products available for financing investment properties often carry higher interest rates than the loans for primary residences. Because borrowers are more likely to default on the mortgages of second homes/investment properties, lenders consider these loans riskier. To compensate for that risk, they charge higher interest rates.
Most applicants also need to put down between 20% and 30% of the home’s asking price, although exceptions may apply. One exception is a down payment as low as 10% on the properties that meet the definition of second homes. However, the good news is that you can use the equity from another property that you own in order to obtain the money you need for the down payment on an investment property. Home equity loans, HELOCs, and cash-out refinance loans typically have lower interest rates and more reasonable conditions than other financing options.
- FHA loans – In general, FHA loans are used to purchase primary residences. That’s because, under the FHA rules, the buyer must take possession of the home within 60 days after the closing and live in it for the majority of the year. However, you can also use a FHA loan to buy an investment property. This is possible because the FHA allows homeowners to buy a multifamily building with up to 4 units on the condition that one unit is occupied by the owner. If you purchase a triplex, for instance, you can live in one unit to make the property FHA-eligible and rent out the other units for income.
- VA loans – To finance the purchase of an investment property with a VA loan, the residence must also be a multifamily property no larger than 4 units. What’s more, you must live in one of the units full-time, although the VA allows for intermittent occupancy due to employment. Also, you can rent out a home previously purchased with a VA loan after you’ve satisfied the 12-month occupancy requirement and get a second VA loan for another home if you meet the requirements for the subsequent use of the VA loan benefits.
The Type of Property
When buying a piece of property to earn rental income, choosing a home that’s more likely to increase in value over time is very important particularly if you intend to sell it in the future. Additionally, each type of property comes with its own set of pros and cons. For instance, a single-family home is usually less expensive than a multifamily property, which may result in a lower monthly mortgage payment amount. On the other hand, making improvements or adding amenities to a multifamily property may cost you less than upgrading 2 or 3 separate properties.
When shopping around for an investment property, one important consideration is the renter demographic characteristics. While larger homes with more rooms are in high demand particularly near universities or in neighborhoods renowned for being great places for families with children, a smaller home may be a good investment if it’s located in a senior retirement community. As well, choosing a neighborhood with low property taxes, access to public transportation, decent public schools, specific amenities, like parks and grocery stores, and a coherent development plan can be a very lucrative investment strategy in the short and long term.
Buying an investment property can go either way: you could earn a lot of money, or it might turn into a terrible experience. To be on the winning side, it’s important to play it safe from the start. Because choosing the most suitable financing option for an investment property is as important as consulting with an experienced real estate professional, please contact our mortgage originators who can provide expert advice on the best financing alternatives for your investment strategy!
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