Investing in real estate is profitable for most people. How do they do it, though? The housing crisis made lenders tighten their restrictions so much. It is hard for many people to secure financing for their own home, let alone residential rental properties. Do people really invest in real estate anymore?
The truth is, there are many people buying investment properties. If you look at the housing inventory, you will see they have decreased by a large amount lately. This isn’t just because people are buying the homes to live in them. There are many investors out there. Do you want to be one of them? Here’s how you can join the crowd.
Don’t Use Big Banks for Residential Rental Properties
We all tend to run to the big banks because they are more well known. They should have the program you need, right? Probably not if you are an investor. They tend to still run a tight ship. This means they make it a nightmare for investors to purchase a home. If you own a few investment homes already, you can quadruple the headaches. They are very choosy about who they lend to for investments.
Shop the little banks – they have more options. These are the banks who may not sell to the secondary market. If they do, it isn’t Fannie Mae or Freddie Mac. instead, they have a targeted pool of investors who want mortgages for investment properties. These lenders have more flexibility and can look at you as a human, not just another number that doesn’t meet the requirements.
We suggest, before you apply, ask the lender a few questions. Here are a few to get you started:
- Do you offer investment property loans?
- How many investment property loans do you have on your books right now?
- How long does it take to get to escrow for an investment property?
- How many investment loans do you decline?
These questions start the conversation and help you make the right decision.
Maximize Your Borrowing Power
Before you apply for a loan for residential rental properties, look at your financial profile. Are you a good risk or a bad one? The less risky you are, the more likely you are to secure an approval. Here are a few things lenders look at:
- The size of your down payment – The more you put down, the less risky you become. Lenders call this “skin in the game.” It means you have your own money invested in the property. You are less likely to default on it for fear of losing your money. The minimum down payment is usually 20%, but don’t be afraid to put more down.
- Credit score – Your credit score shows your level of financial responsibility like nothing else. A great score shows you don’t overextend yourself and you pay your bills on time. A mediocre score says you are a middle of the road risk. A low score leaves you without the ability to invest in real estate. Pay your bills on time, limit your new debts, and pay your debts down to maximize your credit score.
- The amount of assets – The more money you have on hand after you make your down payment and pay closing costs, the better. This shows the lender you can afford to pay the mortgage should your renters stop paying. This helps alleviate some of the risk the lender must take on you.
Figure Out How to Verify Your Income
Stated income loans used to be a thing, even for residential rental properties. Today, they are not. You probably won’t even hear the words stated income from anyone. There are alternatives, though. Obviously, the best case scenario is to verify your income with W-2s, paystubs, and/or tax returns. If you can’t, there are other ways.
The most common way is with bank statements. This is called an alternative documentation loan. You don’t provide the lender with paystubs and W-2s, but you do provide 12 months of your bank statements. On these bank statements, lenders must be able to tell where your income comes from. They should see regular deposits that cover your monthly payments with extra money left over. Borrowers who use this method are often those who own their own business or make rental income, but do not claim it on their tax returns.
Home Equity Loans on Your Own Property
If you cannot secure financing on a rental property you wish to purchase, you may have one more choice. If you own the home you live in and have plenty of equity, you may be able to use that equity to purchase the rental property. Of course, this means you must have a large amount of equity and/or cash on hand to help pay for the home.
The good news is, if you take out a home equity line of credit, you can continually reuse the funds during the draw period. This usually means 10 years. If you pay the loan off, you can use the funds again to purchase another rental property. This is how many investors fill their portfolio and maximize the return on their investment.
Residential rental properties are not impossible to purchase, but they may prove to be a little more difficult. The best way to succeed is to properly prepare yourself. Save as much money as you can and increase your credit score as much as possible. The earlier you start on this process, the better your chances of approval. Even the least risky borrowers meet with some difficulty though, so don’t be afraid to think outside of the box. Talk with lenders who are not big box banks. They may have a unique program that fits your needs perfectly. In the end, you get the rental property you wanted and make extra income to help you get ahead in life.