When you’re starting out, it can seem like there are almost as many ways to finance the purchase of a rental property as there are types of properties. And, thanks to the dizzying array of financing options available to real estate investors, that’s not far from the truth. If you think finding your first rental property seems challenging, financing it is even more so. The housing market has been recovering slowly but steadily since 2009 and as a result, banks have become much more cautious when it comes to loaning money for real estate deals. As a result, getting financing for that first rental property can be a challenge. But don’t despair! There are several financial options available to real estate investors at just about any budget level. Let’s take a closer look at some of your financing options for that first rental property (and beyond).
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If you have enough cash or equity in your current home to cover the down payment and closing costs for your first rental property, then an equity loan might be the best financing option for you. Equity loans are essentially a second mortgage on your primary residence. Lenders will allow you to take out a second mortgage for as much as 100% of the value of your house. So if you own a home worth $200,000 and you want to finance the entire purchase price of a rental property worth $200,000, you could take out a second mortgage for the full amount. The advantage to taking out an equity loan is that you don’t have to make any payments on it while you’re living in the home. You repay the loan when you sell the house or refinance the mortgage.
For many real estate investors, debt financing is the most common way to obtain financing for a rental property. This is usually in the form of a mortgage loan, which is a type of loan where you pledge the rental property as collateral for the loan. You can get a mortgage loan from a commercial lender like a bank or credit union or from a private individual. The key difference between these two loan types is that a commercial lender will likely require you to obtain private mortgage insurance (PMI) while a private individual often won’t.
Equity-based loans are a type of debt financing that allows investors to borrow against their own assets instead of a mortgage on someone else’s property. This is a common financing option for real estate investors looking to buy rental properties. One of the most common equity-based loan products is the hard money loan. These loans are short-term (usually 6-12 months), high-interest and not guaranteed. Hard money loans are a great option for investors who need a quick turnaround on their investment. However, they should be repaid as quickly as possible to avoid compounding interest charges and ballooning loan amounts.
Tax liens are a type of financing that real estate investors can use to buy rental properties at a steep discount. In most cases, tax liens allow you to buy a rental property at auction for a fraction of the typical value of the property. Once the owner of the property defaults on the taxes and other liens against the property are satisfied, you have the right to redeem the property at full value.
As you can see, there are many different types of financing options for first-time real estate investors. The trick to choosing the right financing option is to understand your own needs and situation and to do your homework to find the best financing option for your individual situation. When you’ve chosen the right financing option, it’s important to understand the terms and conditions of that loan. Make sure you know how much the loan is for, how long the loan will last and how much you’ll have to pay back each month. Then, when the loan is paid off, you’ll be ready to move on to your next rental property!
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