With the housing market at an all-time high, many are looking to make money by investing in real estate. Buying an investment property has become a way for many people to successfully rack in extra cash. But with so much money involved—sometimes hundreds of thousands of dollars—investors will want to be well-versed about what all goes into an investment property purchase.
As you think about buying a rental property, consider these tips to ensure the loan process goes as smoothly as possible.
5 Tips for Buying an Investment Property
If you want to invest in rental property, there are some key things to know before getting started. Although the investment process can be overwhelming, knowing as much information upfront will help you make the most logical financial decision.
1. Pay Down Personal Debt
As with any other mortgage loan, you’ll want to pay down as much personal debt as possible before applying. Minimizing your debts gives you a better chance of being approved for an investment loan, and making all monthly payments on time improves your credit score.
Your return on investment (ROI) from your real estate should be greater than the monthly costs that go towards paying off debt. Keep in mind that you will also want a cash cushion to avoid putting yourself in a situation where you don’t have enough money to make your monthly payments. When paying down personal debt, think about how big your margin of safety should be, as well.
2. Find the Right Location
Your investment property purchase should preferably be in a location that is appreciating rather than decreasing in value. These areas attract more prospective tenants, especially if they have abundant amenities, revitalization plans, and other benefits.
When considering location, some key elements to look out for include:
- Low property taxes
- Expanding job market
- High-quality school districts
- Access to public transportation
- Low crime rate
- Other amenities like restaurants, coffee shops, trails, parks, entertainment businesses, shopping centers, and others
More amenities and a growing job market will give you a larger pool of renters to work with.
3. Calculate Expected Profit Margin
You should never go into an investment purchase blindly. Instead, you should estimate all costs and what profit margin you expect to make. Most investors set an ROI goal of 10% annually. However, an ROI of 6% to 7% in the first year is considered healthy, especially since this percentage is expected to increase over time.
For example, if your investment property is worth $300,000, you should expect to make 10% annual gross rental income—$30,000. However, you must factor in operational and maintenance costs to know your official profit margin. These types of expenses are usually priced at around 1% of your investment’s value; for this example, you’d be spending $3,000 annually.
As an investor in real estate, there are other costs you’ll need to consider when buying a rental property, such as:
- Property taxes
- Vacancy cost
- Property management
- Property and liability insurance, including homeowner’s, flood, and rental
- Association fees
- Normal wear-and-tear
- Monthly expenses, including pest control, landscaping, erosion control, maintenance, repairs, and renovations
- Inspection and appraisal costs
- Required city certifications and costs associated with bringing the property up to code
Those looking to invest must also weigh their risk versus reward when calculating their profit margin. Investment property purchases are tangible physical assets, and they can be great money-makers if the real estate market is high. Still, the market experiences rises and dips all the time, and unlike stocks, you can’t instantly sell real estate if you need cash. Always consider how your profits may change if the real estate market goes sour.
4. Consider Your Duties as a Landlord
As a landlord, you’re more than just the owner of the rental property. You must find reliable tenants that will pay their rent, and you must perform all maintenance and repairs. Hiring someone else to do maintenance tasks can eat into your profit, but this may be your only option if you own investment properties in other parts of the country.
Hiring a reliable property management team can help to ease some of the stress surrounding landlord duties. While this can also take away some of your profit, it’s usually worth the time to let someone else handle responsibilities like collecting rent and taking care of the tenants’ needs.
5. Understand All Legal Obligations
As a landlord, you’ll need to understand all legal obligations to avoid any legal issues. All landlords should be familiar with federal, state, and local tenant laws, including regulations about lease requirements, security deposits, tenant privacy, eviction, fair housing, and others.
Getting an Investment Property Loan
Getting an investment loan for your new rental property may be challenging if you don’t meet all the loan requirements. These include:
- Down payment: Unlike a primary residence mortgage where you can put down as little as 3%, investment properties require more. You should be prepared to pay at least 15% to 20% for your investment loan down payment. Fortunately, down payments can be financed through personal loans if necessary.
- High Credit Score: Most investment loans require a minimum credit score of 620. For scores of 740 or higher, you’ll be offered better loan terms and interest rates.
- Debt-to-Income Ratio (DTI): As mentioned above, you’ll want to pay down as much personal debt as possible before purchasing an investment property. To qualify for a rental property mortgage, your DTI should fall somewhere between 36% and 45%.
Investment Loan Options at First Fidelis
First Fidelis is now offering two new investment loan options for all who are wanting to invest in real estate:
- Those with no job or stable income can apply for a loan on a 1-to-4-unit rental property at 20% down with a 720 credit score or above, as long as they have assets to cover three to six months PITI (principal, interest, taxes, and insurance).
- Those who meet the guidelines above can also apply for a cash-out refinance of 80% LTV (loan-to-value) on up to five properties.