How to Purchase Your First Investment Property
If you’re thinking of purchasing your first rental property, there are several things to consider before diving in headfirst. Purchasing rental properties is a great way to create passive income, but it can take some time to get started.
You’ll need to research the market for potential investments and make sure you have enough cash on hand to cover the down payment and closing costs. Not all rental properties are created equal, so it’s important to make sure your tenants are reliable and that you have contingency plans in place if they aren’t.
A good way to ensure this is by researching your local zoning laws and city ordinances before signing any contracts or making any offers on properties. With these tips and tricks, you’ll have the information you need to make the process as smooth as possible when purchasing your first investment property.
Is an Investment Property Right for You?
Investing in real estate isn’t for the faint of heart. You have to consider the mortgage and the operating costs, but you also have to think about the tenants, who can either make or break your investment. If you manage to get stuck with bad tenants who don’t pay rent on time, your returns aren’t just reduced – they’re nonexistent.
Sure, there’s a level of risk involved with owning an investment property, but that’s also what makes it so exciting! If you had invested in the stock market, your returns would be pretty small. But with a bigger gamble also comes the opportunity for a bigger reward, and this is especially true for investment properties.
In 2016, the average gross yield for rental investors was 9.4%, a slight decrease from previous years but still significant. For some context, the average annual return on the Dow Jones over the last 10 years has been 4.8%. That’s nothing to write home about. But there are so many factors at play with the stock market – you can’t control what’s happening in China or Saudi Arabia and so on – it’s hard to predict how your stocks will perform. With an investment property, though, small changes such as a new door or some minor improvements to the kitchen can help attract good tenants at higher monthly rents; it’s not just about riding an existing wave but creating one of your own. It’s a great choice for that investor who wants a more hands-on opportunity.
Getting a Mortgage for an Investment Property
If you’re thinking of buying a property, the first thing to do is to look at a mortgage calculator to get an idea of what kind of loan you qualify for and what kind of monthly payments you can expect. Then get preapproved so that you know how much money you have to spend on your new home. Make sure that you tell your Home Loan Expert that you’re interested in an investment property, which has different rules than a primary residence.
Be Sure to Get Pre-Approved First!
The biggest pitfall of home buyers is searching for a property before securing financing. Let’s say you find the perfect rental property, but by the time you get preapproved for a mortgage, another buyer has already placed a bid on it.
It would be heartbreaking to spend months looking at houses at one price range only to learn that you qualify for less than what you thought you did. Get preapproved now and have the ability to jump on a good deal at a moment’s notice. Another problem with searching before being preapproved is that you don’t know how much money you qualify for.
Down Payment and Credit Score – Everything you Need to Know
For a fixed-rate mortgage, a credit score of 620 is required on a single-unit investment property. A 20% down payment is required as well. If you have a credit score of 720 or above, a 15% down payment is required for a single-unit investment property.
For an adjustable rate mortgage, 620 is the minimum credit score and will require at least 15% down on a single-family investment property. If you’re interested in purchasing a multi-unit property, reach out to a Home Loan Expert to discuss the requirements and options.
Other Requirements You Should Know About
Other than the down payment, requirements for a rental property are similar to those of a mortgage for a primary residence. You’ll still need to prove income by providing your mortgage company with two years of tax returns, two years of W-2s and two months’ worth of bank statements.
Also, you’ll need six months’ worth of mortgage payments in reserve as a safety net in case you experience financial trouble.
What Makes a Good Investment Property…Good?
You should look for a few specific things when scanning neighborhoods for your first rental. You want a house that requires low maintenance, has limited vacancies and allows you to have a good rent-to-value ratio.
Is a Fixer Upper Right for You?
If the ad says the property needs a lot of TLC (tender loving care), move on to the next house. I’ve fallen for this one myself once, and wound up with an amazing deal on a house that was missing interior walls, required new plumbing throughout and had a basement that flooded on a semi-monthly basis. There are few worse feelings than realizing that your cash cow is actually a money pit.
The exception to this rule is if you’re knowledgeable about home repairs. If you have extensive handyman skills (or know someone who does), you may be able to deal with these extensive repairs better than I did. But as a general rule, it’s going to be less of a headache to just purchase a house that’s already in workable condition. And they’re out there—so keep looking!
If you don’t have paying tenants, your investment property isn’t doing much for you. You want to make sure that your property is attractive not just to any tenant—but to good tenants who pay on time and don’t shove their Cosmo magazines down the toilet (speaking from experience). Depending on your location, some places just tend to have lower vacancy rates than others.
You can do some research on the neighborhood you’re looking at, but when it comes right down to it, spend some time driving around the streets near your potential property. Simply looking at the level of care given to the houses in the surrounding area can give you a good idea of which houses are vacant and which are not.
What is the 1% Rule?
New investors often ask themselves, “How much should I charge in rent?” Seasoned investors sometimes use the 1% rule, which states that the rent each month should be at least 1% of the purchase price. For instance, if you purchased a house for $100,000, you would need to charge – at the very least – $1,000 for rent. This is not always true for investors and some will settle for a slightly lower return.
To make sure that a potential property can receive that kind of return, see if you can get rental estimates for similar area properties (for instance: using Zillow or Rentometer). You may be able to charge slightly more or less than what’s listed, but it does give you a ballpark number.
Do You Really Want to Be a Landlord?
As you buy more investment properties, it’s important to consider your ability to manage them. It’s a tough job being a landlord—tougher than most people think—and I’ve seen many investors become overwhelmed by the time it takes to be a good landlord.
Fun fact: Be on the lookout for these kinds of landlords. They sometimes burn out under the weight of their landlording duties and sell their whole portfolio at once. It’s usually a good time to swoop in and buy, but remember that not everyone is cut out to be a landlord. It’s an intense and time-consuming line of work, especially if you already have a day job. For this reason, I highly recommend getting a management company to help you out with this work.
Sure, you’re probably spending 9% to 11% of your rent on this service, but they’ll take care of the tenants’ needs and collect the rent. And in the unfortunate event that a tenant needs to be evicted, they’ll help handle that process as well. Time is often more important than money—it gives you the freedom to pursue additional investments.
When purchasing your first investment property, the biggest factor to consider is location. Research housing prices and neighborhoods, then begin saving for a down payment. Once you’re ready to dive head first into the real estate game, talk to a mortgage agent about getting pre approval in place so you know what you can afford.
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