Investors are usually looking for additional ways to create passive income. The real estate market in the greater Atlanta metropolitan area is a perfect place for creating this kind of residual income. When it comes to rental properties, one of the most common barriers to entry is that in order to purchase real estate, a significant amount of capital needs to be available for down payment. In this blog post, we are going to cover some of the different options that are out there for investors seeking to finance these types of property acquisitions.
The most common types of loan vehicles used to acquire investment property are Home Equity Loans, Conventional Loans, and Hard Money Loans. It is prudent for investors to research and understand the differences between these three different types of loans. Picking the wrong type of loan vehicle for a property can jeopardize the potential for the investment to be profitable, especially in the short term.
Home Equity Loans
With market conditions the way they currently are, most homeowners have a fairly decent amount of equity available in any property they own. This equity can be utilized to help them grow their real estate portfolio by acquiring more assets. The equity they have can be accessed through a Home Equity Line of Credit (HELOC). It can also be tapped through a cash-out refinance of the mortgage on the asset. A property owner can usually borrow up to 80% of the equity they have in order to purchase a second property. Depending on which of these loan vehicles they choose there’s also a list of pros and cons to consider. If you choose to get a HELOC, it will essentially function as a credit card. The monthly payments on the Home Equity Line of Credit will likely be interest only. However, a HELOC usually comes with a variable rate, which means that if the prime interest rate the loan is tied to increases, the rate and payment you owe will also increase. A cash-out refinance usually comes with the stability that a fixed-rate brings, but one potential drawback is that it often extends the duration of the term of your current mortgage.
Hard Money Loans
These types of loans are most beneficial when your intent is to purchase a property, fix it up, and then flip it quickly by reselling the asset for a profit. In most instances, a hard money loan is significantly more expensive than the other types of loans we are discussing. It will need to be repaid in full much more rapidly as well. A hard money lender is mainly focused on how much potential profit is wrapped up in the individual property. They are much less concerned with things like the credit score of the borrower or what their credit payment history might look like. Additionally, the terms of hard money loans are fairly harsh, and interest rates can climb as high as 18%. Any penalties for missed payments are typically quite severe. However, these types of loans can be of great value to an investor because they are much easier to qualify for than home equity lines of credit or conventional loans. Another potential benefit is that they typically fund very quickly comparatively speaking (days instead of weeks) to the other options. This allows construction on the project to begin far sooner.
A conventional loan needs to conform to standards set forth by Fannie Mae and Freddie Mac. Conventional lenders by mandate have to require a 20% down payment. Sometimes if the property involved in the transaction is an investment property, the lender can require up to 30% down. For conventional loans, things like whether or not an investor qualifies, and what interest rate they will be required to pay depend on their personal credit score. A prospective borrower will be asked to prove that they can afford the monthly payments on the investment property loan in addition to their other monthly obligations. Their debt-to-income ratio will be reviewed prior to factoring in the rental income they are expecting from the investment property, and approval or denial of the loan application is based on this calculation.
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 Perimeter with questions about any aspect of acquiring and managing rental property.