Financing Basics for First-Time Rental Property Owners

Have you been thinking about becoming a landlord, but wondering if now is the right time to purchase a rental property? You are certainly not alone. Real estate is one of Americans’ favorite investments. Plus, with current low-interest rates and the trend of millennials choosing to rent instead of own, you may want to consider taking the plunge sooner rather than later.

Having a rental property in your portfolio has plenty of perks (including a steady, passive income). Still, you need to do your research first and understand options to make sure it makes financial sense for your situation. Rental property financing is not as straightforward as purchasing a primary residence. Therefore, in this article, we will discuss some of the financing basics of investing in real estate to consider, which can be especially helpful if you are a first-time rental property owner.

Make a Large Down Payment

Mortgage insurance will not cover your investment property. So, for a traditional loan, you will need to put down at least 20-25% to get favorable financing according to Quicken Loans. A substantial down payment gives the bank more security, and it also demonstrates your commitment. Additionally, the bank will review your credit and debt-to-income ratio when making their decision on how much down payment is necessary, and if you will even qualify for a traditional loan.    

Evaluate Loan Options

Big bank’ traditional loans probably are the type of financing you are most familiar with, but if you can’t qualify, there are other options available to finance your rental property. Smaller, local (or community) banks sometimes have more flexibility in their requirements. They are usually not as conservative as the big banks, and they like to invest locally and value building relationships with their investors. Another idea is investing in a multi-family property that you can live in to take advantage of primary residence financing.   

Rental Property Owners 1

Ask the Seller to Consider Financing

If you can’t get a loan for your rental property from a bank, another option is to ask the seller if they would consider financing the loan themselves. The seller will extend credit to cover the purchase price of the property (minus the down payment), and you’ll sign a promissory note agreeing to make your payments. Interest rates will likely be higher than you’d get from a bank, but the down payment should be more flexible. Plus, you can close your deal quickly since you don’t have to go through the hassle of the traditional banking process to get your loan application approved. Remember, if you chose to explore this option, be sure when you approach the owner that you have a game plan in place. The seller must have confidence in your ability to repay the loan.      

Gather a Small Group of Investors Together

Although it would be nice to own your rental property outright all on your own, that is not feasible for most people. As an alternative to going it alone, you can gather a small group of investors to buy the property together. This option keeps you all from having to take out a loan, and it allows you to start generating cash flow sooner. Although you will have to share your profits, it does avoid the risk of a foreclosure on your rental property. It can be a great way to get your feet wet as a landlord without shouldering all the risk. To make things even easier, your group can hire a property management company, so you don’t have to deal with tenant issues.    

Making the right choice when it comes to financing your first rental property can help set you up for success. You don’t want to rush into deciding, and you should always consider your short-term and long-term goals to figure out what kind of financing makes the most sense.

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Should You Invest in Single or Multi-Family Rental Property?

Choosing the right investment property is a very personal endeavor—and one that should not be taken lightly. Is it better to go with a single-family property or is a multi-family rental a better option? It is probably the most common question that long-term buy and hold investors ask.

And there is no straightforward, easy answer.

When you are looking for the right place to invest your hard-earned money, you have to carefully consider all the choices available to you. There are advantages and disadvantages to each. Because of this, each investor should approach the matter systematically weighing the benefits based on their own needs, portfolio, and financial goals.

Single-Family vs. Multi-Family Rentals

Single-family properties are not only stand-alone homes. They can also include condos and townhomes as well. A single unit is purchased or owned, and there is just one tenant (individual or family) living in it. By contrast, a multi-family rental is a residential property consisting of multiple units that are purchased or owned together. One tenant or family lives in each unit, but because there are various units, there are also multiple families in a single structure or property.

Single-Family vs. Multi-Family Rentals

Management of each type of property is often dramatically different. Often investors will hire a property management company to handle most issues, including maintenance, rent collection, tenant issues, and property rental. The investor would need to consider financing, financial goals, and cash flow. However, selecting the right property for your portfolio could prove to be quite lucrative and work to your advantage.

Advantages of A Single-Family Property

When you have multiple families living under one roof, there are bound to be conflicts. Single-family properties remove the tenant-tenant conflict issue because each unit is separate. Maintenance is a very important aspect of any property. A well-maintained property will yield a higher return.

On the one hand, single-family properties are often easier to maintain because there are usually no common areas. However, maintenance on multi-family properties allows you to make extensive repairs in a single blow, such as repairing the roof. Contrast repairing the roof on multiple single-family properties to repairing the roof on a multi-family property where the repair covers several units at once.

From a financial standpoint, investing in single-family properties allows you to diversify your portfolio across various neighborhoods, cities, or real estate markets. The liquidity of single-family homes is much higher than a multi-family property.

Advantages of A Multi-Family Property

For the most part, multi-family properties are, overall, easier to manage. All the units are under one roof which means, maintenance, repairs, and renovations can be done at a single site in one shot instead of having to travel to multiple units that may not even be in the same city. For instance, painting one multi-family property is less expensive and time-consuming than painting several units located in various parts of the city or state.

Advantages of A Multi-Family Property

Rental income is typically higher for multi-family properties simply because there are several units under a single roof. Instead of collecting rent on one or two single-family units, you collect rent from 10 or 20 units, give or take a few depending on the size of the property. That can be a significant boost to your financial profile. This also offers some protection against the risk of not getting any income for a month or even several months.

Should You Consider Investing in Real Estate?

You have to weigh the pros and cons of each property while examining your own financial goals to determine which type of real estate investment is right for you. Several areas to consider:

  • What type of financing are you able to get? Or do you have savings that you want to invest? If so, how much can you afford for a down payment? What can you afford in monthly payments even if it takes some time before you receive rental payments from tenants?
  • How much rental income do you want to receive each month? Can you manage financially if you don’t receive rent for a month or more?
  • Do you plan to maintain the property or properties yourself, or will you hire an individual or company? What about managing the properties?
  • Do you plan to sell the property at some point, or will you buy and hold?

Investing in single-family or multi-family homes can be quite rewarding for your long-term financial goals if you take the time to choose your property wisely.

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