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Buying An Investment Property

Real Estate has been the path to great riches for many of the world’s wealthiest individuals.  It has also been one of the principal historical drivers of household wealth creation in the U.S.  as families have purchased, paid off and then sold their homes.  Purchasing an investment property with the purpose of renting can be a fantastic way to improve your personal wealth.  The lure of residual income & appreciation are great motivators.  As time goes by, and you pay down any mortgages associated with your investment real estate portfolio the residual income generated compounds & property values tend to increase over time.  To become a successful real estate investor though, it’s best to be well-versed in the world of purchasing Investment Property.  Preferably before you jump in and invest a lot of your hard-earned money.

The definition of an Investment Property is a home that is owned for business purposes- such as a rental property.

Lenders underwrite Investment Properties differently than primary residences or second homes.  Investment properties are considered the highest risk of the three occupancy categories.  Loan products, down payment requirements, interest rates, and underwriting guidelines can vary when compared to similar transactions on a primary residence or a second home.

It is a good idea to communicate with your Mortgage Banker prior to making an offer when purchasing an investment property to understand the loan program requirements, financial details ability of your property to cash-flow.

Below are some examples of how Conventional Investment Property Loans differ from loans against a borrower’s primary residence.

  • FHA & VA loan programs are ineligible for the purchase of an Investment Property.

  • The minimum down payment for the purchase of an Investment Property with a conventional loan is 15%.

  • Debt-To-Income ratios for investment properties are more restrictive and usually cap out at 43% or less.

  • The cost of mortgage insurance is higher if you make less than a 20% down payment.

  • Lenders will require additional post-closing reserves.

Foundation Mortgage Also Offers a Reduced Documentation Portfolio Loan Program for Experienced Real Estate Investors. Below are some details of our Portfolio Investor Loan Program:

  • Stated Income (For Self-Employed Borrowers)

  • Stated Assets

  • LTVs up to 75%-80%

  • In some cases the LTV may be calculated off of the higher of the Purchase Price or Appraised Value.

Contact a Foundation Mortgage Banker today for detailed information on our Portfolio Investor Loan Program.

Am I Ready to Buy An Investment Property?

Becoming a real estate investor and purchasing an investment property is significant financial decision not to be taken lightly. How do you know if your finances are ready to support a move into the world of real estate investment? Below are some considerations to take into account when deciding whether the time is right for you to purchase an Investment Property.

Step 1:  Determine Whether you can Afford to Carry an Additional Property

Take a look at your current financial picture. Get a feel for how comfortably you are carrying your existing mortgage payments and other monthly obligations. Are you able to make these payments and still have money remaining to direct to your savings each month?  If you are struggling to meet your existing obligations, it might not be the best time to add the additional housing payment associated with an investment property.  Many buyers imagine offsetting the carrying costs of the property with anticipated rent payments.

This can be effective, but you should account for what will happen if you lose a tenant or they do not pay or your rental revenue declines for another unexpected reason.  Rent payments aren’t guaranteed; what is guaranteed though is that you’ll need to make your mortgage payments each month.  Be sure you factor occupancy vacancy into your modeling.  Lenders use a 75% rule when qualifying borrowers.  They assume that a property will only generate 75% of the expected income.  This is a good place to start.

Step 2:  Determine your Employment and Income Stability
Ownership of Investment property can have it’s unexpected costs and expenses.  It’s not always as simple as determining your monthly payment, taxes, insurance and HOA dues; and subtracting these items from your rental income to figure out your shortage or positive cash-flow.  Repairs, assessments, and other things go wrong from time to time.  Make sure you’re in a stable position where you are able to absorb the unexpected should it arise.
Step 3:  Determine the Cash-Flow of the Property & ROI (Return on Investment)

Determining whether the investment property you are buying will generate a positive or negative cash-flow is an important step in evaluating whether a particular property represents a good investment for you.

Determine Market Rent

  • Ask your Realtor to show you MLS listings/closed rentals for similar properties to see what they are renting for and how strong the rental market currently is.

    • Pay attention to the amount of comparable inventory

    • Pay attention to the length of time properties are listed prior to entering a rental contract

    • Look at trends, is inventory tightening and prices increasing or decreasing over time.

  • Put an Ad in craigslist or other online site to get a feel for prices and interest.

  • Do a walk-through of the property.  What is the condition like?  How easy will it be to rent or will you need to invest money?

  • Order an Appraisal with a “Rent Schedule”.

    • A “Rent Schedule” is performed by an appraiser to provide you with an independent analysis of how the current rental market is performing and what comparable properties are renting for.  This can be a good cross-check on the research you have performed on your own or with your Realtor.

Determine The Total Monthly Payment

  • Mortgage Payment

  • Taxes

  • Insurance (Be sure to get a quote for Renter’s Insurance)

  • HOA Dues

  • Add a cushion for incidentals such as electricity, cable, etc.

Determine The Net Monthly Cash-Flow

  • [Monthly Rent] – [Total Monthly Payment] = Net Cash-Flow

  • Positive cash-flow means after all your expenses the property is generating income each month.

  • Negative cash-flow means that your monthly expenses are greater than the income being generated.

Calculate your Return on your Initial Investment – ROI

  • You can calculate the Annual Return On Investment through the following formula:

    • [Net Monthly Income] X 12 months = Annual Income

    • [Down Payment] + [Closing Costs] + [Renovations/Upgrades] = Total Initial Investment

    • ROI = [Annual Income] /  [Total Initial Investment]  X 100%

Step 4:  Get Advice

Speak with friends, family and trusted advisors who have experience with rental real estate.  If you are looking to purchase in an area or state you are not familiar with, enlist the help of local professionals: Realtor, Attorney, & Mortgage Banker whom are able to make sure you get accurate #s to base your cash-flow and return on investment assumptions on.  Errors in your assumptions of:

  • Market trends, comparables, closed/pending rents, sales and listings

  • Seller vs. Buyer & State Specific closing costs

  • Down Payment Requirement

  • Interest Rate

  • Total Monthly Payment.

  • Estimation of cash-to-close

Errors in calculating these items can profoundly affect your calculations and change the outlook as to whether a property is a good investment opportunity or not. Experienced & Knowledgeable local advisors can help.