As a new real estate investor, learning how to finance rental property deals is critical to getting started and growing your portfolio. There are several options for financing rentals, each with their own pros and cons that must be evaluated based on your own financial situation and investment goals. To determine the right financing for your needs, there are a few things you need to understand.
Down payment refers to the amount of your own cash you put down towards a property purchase. The more you can put down as a down payment, the lower the mortgage amount and payments will be. However, a larger down payment also means having less cash on hand for emergencies and future opportunities. For beginners, focus on down payments of at least 3-20% of the purchase price of a deal. You can put as little as 3% down for an FHA loan or up to 20%+ for a conventional loan.
Interest rate refers to the cost of borrowing money to finance a mortgage. Lower interest rates mean paying less interest overall and lower monthly payments. Interest rates are determined by the overall economy and inflation, as well as your credit score and down payment amount. For rentals, lower and longer-term interest rates are usually best, like 15-30 year mortgages. Locking in a low, fixed-rate mortgage provides stability, even if interest rates rise over time.
Mortgage type refers to secured loans from banks (like conventional loans) or government-backed loans (like FHA loans). Conventional loans typically require larger down payments and better credit, but often have lower interest rates. FHA loans allow down payments as low as 3.5% and are available to those with poorer credit, but usually at higher interest rates. Commercial loans are also used for larger multifamily properties. Evaluate what you qualify for to determine the best option for your situation.
Leverage refers to financing a portion of a property’s purchase price rather than paying all cash. Using financing, or leverage, allows you to keep more cash on hand while still acquiring the investment property. The higher your leverage, the more of the costs are financed rather than paid in cash. Seeking moderate leverage, around 50-80% LTV ratios is typical for real estate investing and provides the benefits of financing without excessive risk.
Equity buildup refers to building wealth as your down payment, mortgage payments, property value appreciation and equity accumulate over time. Especially with larger down payments and lower LTV ratios, equity buildup can often exceed inflation and provide substantial gains to support future financial goals. Rental income and equity gain are the two primary ways real estate builds wealth for investors. Monitoring the rate of equity buildup regularly is important to ensuring you stay on track to meet investment objectives.
In summary, to determine the best financing options for rental properties, evaluate factors like your available cash for down payments, interest rates, mortgage types based on credit and down payment amounts, appropriate leverage levels relative to your risk tolerance, and the potential for equity buildup over time. Weigh the pros and cons of each option to choose financing that allows you to acquire the deals you want, with reasonable payments, costs and risks, while still building wealth through rental income and equity gain as rapidly as possible. With experience, financing rental properties can become second nature as an investor, helping to achieve important financial goals and build substantial real estate portfolios.