The Guide That Makes Funding Your Rental Income Property Deal Simple

The Guide That Makes Funding Your Rental Income Property Deal Simple

Do you want to start investing in rental income property?

With the real estate market in the US worth $156.2 billion it’s easy to see why people want a piece of that pie. But it’s a huge step to take, and it’s best to know what to expect before sinking hundreds of thousands of dollars.

That’s where we come in! Keep reading for this guide on how to invest in rental property the right way.

Decide If This Is Actually The Right Investment

Being a landlord is a great way to bring in a passive income, but it’s no easy task. There is a lot of hard work to get started if you want to be a successful entrepreneur in an investment property. You’ll need to master:

  • Choosing the right property
  • Prepping the unit for rental
  • Finding great tenants
  • Managing ongoing maintenance

And that’s only a few items on your to-do list. Are you competent with DIY? Can you unclog a toilet or patch up drywall? If not, you need to know who you can call and have a trusty handyman.

Or, you might want to hire a property manager to take on all the stress of managing the property. But this will cost you, and rental investors with only 1-2 properties often manage and do the repairs.

Of course, this will change as your portfolio grows. The work needed will be too much to do yourself so you’ll need a trusty team behind you. This includes contractors, handymen, cleaners, and a property manager.

Pay Down Personal Debt

Carrying debt to a savvy investor isn’t always a bad thing, but the average investor should avoid it. This debt includes:

  • Unpaid medical bills
  • Student loans
  • Children in college you fund
  • Credit card debt

If any of these apply, it might not be the right time to buy a rental property. Instead, work on reducing or eliminating that debt hanging over your head.

It’s only not necessary to do this if the income return on your real estate is greater than your debt cost. Give yourself room to breathe, you don’t want to be in a situation where you can’t pay off debt payments.

Secure At Least A 20% Down Payment

In general, you’ll need a larger down payment for a rental than an owner-occupied property. They’ll also have a more stringent approval rating on the mortgage available.

The 3-10% you used for your own home won’t cut it here. At the very least, you’re looking at a 20% down payment. This is because you can’t get mortgage insurance on rental properties.

Don’t despair at that figure though. If you have a good credit history, you might be able to get that downpayment from your bank. This would come in the form of a personal loan in most cases.

Pick The Right Location

The worst thing you could do is end up stuck with a rental property in a declining area. You want somewhere stable, or up and coming to ensure you’re getting a return for your money. A city or an area with a growing population are good starting points.

When choosing a rental property, look into the local housing market. Look for things like:

  • Decent school districts
  • Low property taxes
  • Great local amenities like shops and restaurants
  • Access to outdoor activities like parks and trails
  • Low crime rate
  • Great public transport
  • Steady or growing jobs market

With these factors in place, this will give you a larger pool of renters to choose from. You’ll set yourself up for entrepreneurial success.

Do You Buy Or Get Some Finance?

You might be wondering if it’s better to buy or finance your rental property. Well, that depends on what your investing goals are. Paying with cash will help generate a positive passive income faster.

Say you buy a rental property for $100,000. Then you factor in the rental income, depreciation, taxes, and then income taxes. You’re looking at an annual income of about $9,500 give or take. That’s a 9.5% annual return on your initial investment.

Opposed to this, fiancing could bring in a greater return at the start. Say you put down 20% on that house on a 4% mortgage interest rate. Once you take out your expenses, you’re looking at $5,580 a year for that rental property.

Your cash flow is lower, that’s true, but you’re getting a return of 27.9% on that $20,000 you paid out. That’s much higher than the 9.5% a cash buyer can expect. Weight up your goals, and find a source that works like you like hard money loans for example.

How To Get A Mortgage For Rental Property

In general, a rental mortgage is the same as an owner-occupied mortgage but there are a few differences. One thing to consider is there’s a higher rate of default on rental mortgages.

Owners who get into financially troubled waters tend to focus on their own mortgage first. Due to this extra risk, lenders tend to ask for a higher rate of interest for these mortgages.

Then, the approval standards tend to be stricter than owner-occupier mortgages. Most lenders focus on things like:

  • Down payment
  • Debt-to-income ratio
  • Credit score

These all apply for a rental property mortgage, but your credit score will need to be extra good. Your debt to income ratio needs to be low and you’ll need a larger down payment.

On top of this, a lender will take a hard look and your income and employment history. They may even want to see you have prior experience being a landlord. This is why being a live-in landlord is often a good starting point. But here’s a general look at what lenders look for.

Credit Score

You’ll likely need at least a score of 620. If you want the best terms and interest rates, you’re looking more at a score of 740 or more.

Down Payment

For an owner-occupier mortgage, you can put down as little as 3% of the sale price. But at that low a rate, you’ll have to pay private mortgage insurance (PMI). This is for any down payment under 20%.

PMI doesn’t cover rental properties though so this isn’t an option. As such, you’re looking at a down payment of at least 15%. More common is 20% though.

DTI (Debt-to-Income Ratio)

DTI is the percentage of your income that goes towards paying your existing debts. These limits are often more flexible for owner-occupier mortgages. For rentals though, you need a DTI that sits between 36-45% to qualify.

Savings

As well as all the above, you need to prove you have at least 6 months of mortgage payments saved up in the bank. This amount should cover insurance, taxes, interest, and principle.

Watch Out For High-Interest Rates

In 2021 going into 2022 the cost of borrowing money is pretty cheap. But remember, interest rates are higher for rental mortgages.

If you do finance your property, shop around for the best interest rate you can find. You want a low mortgage payment so you’re not eating into your profits each month.

Should You Find An Investment Partner Instead?

Another option if you don’t have the cash upfront is to find a real estate partnership. It’s a great idea if this is your first rental, as partnering with someone experienced can help you learn.

At its most simple, an investment partnership means someone else helps with finance. In turn, you give them a share of the profits proportional to their investment and yours.

Don’t confuse this with an easy option as you still need to put the effort in. Communication will be key, as well as finding someone on the same page as you. Do your research, prepare a pitch and give your investor a reason to take a chance on you.

How Can You Find An Investment Partnership?

If this option appeals to you, don’t worry you don’t need to be a Wall Street whizz to find a partner. First, reach out to your family, friends, or work contacts.

You can also find a local real estate investment group, or use a crowdfunding campaign. Another good tip is to look on social media for groups that focus on real estate investors.

Work Out Your Margins

Large investment firms will buy up distressed “fixer-uppers” aiming for a return of 5-7%. This is due to the fact they need to pay staff on top of other expenses.

Expenses for you will likely include:

  • Homeowner/landlord insurance
  • Property tax
  • Homeowner association fees
  • Pest control
  • Landscaping

The average person should aim for a return of 10%. Estimate your maintenance costs at 1% each year.

Don’t Spend Too Much

The pricier the home the more expensive the upkeep will likely be. It’s best to look at spending $100,000 to $200,000 on a home in an up-and-coming area.

Use your head not your heart and avoid buying the nicest home on the block. You shouldn’t buy the worst either, but you’ll get the most returns going somewhere in the middle.

Don’t Buy A Fixer-Upper

Yes, we know those bargain fixer-uppers are tempting but don’t do it if you’re new to this. For your first few properties, you want to buy those that don’t need much work.

To fix something up, you’ll need a contractor who can do quality work on a small budget. On top of this, you’ll need to use your own DIY skills to make savings.

If you can’t provide either of those things, you’ll end up paying too much for the work. Stick to looking for homes priced below the market value, which only need minor repairs done.

Prepare For Unexpected Costs

Maintenance and upkeep aren’t the only things to consider. You could have an emergency like a burst pipe or storm damage to the roof.

It’s important to put aside around 20-30% of your annual rental income to support those repairs. These are serious issues that will need fixing right away to protect you and your tenants.

Invest In Landlord Insurance

As well as homeowners insurance you want to get landlord insurance too. This will cover things like:

  • Lost rental income
  • Liability protection (against injury due to maintenance issues)
  • Property damage

One thing to watch for is most standard policies won’t cover losses while the home has tenants. Make sure you shop around and contact insurers before you buy. You want to make sure you have the right coverage.

Work Out Your Operating Expenses

You’re looking at operating expenses of between 35-80% of your total operating income. So, say you’re charging a rent of $1,500 a month, your expenses likely will be around $600, if you’re at 40%.

While planning to find a property, use a rule of 50%. If you’re charging $1,500, expect to pay out $750 in operating expenses. Anything over 50% isn’t a good starting investment if you’re new.

Work Out Your Return

For each dollar you’re putting into your investment how much are you getting back. An example is for a cash-on-cash return, stocks can offer 7.5%. Bonds might pay out 4.5%.

For your first year as a landlord aiming for 6% is a good goal to set. This might seem low but it’s a healthy starting figure, and you can expect that number to grow over time.

Know The Rental Law

As a landlord, you’ll need to abide by the landlord-tenant laws in your state and the local area. Make sure you’ve looked these up and know what your obligations are.

For example, you’ll want to know a tenant’s rights and what you need to do regarding things like:

  • Deposit holding and return
  • Lease requirements and abiding by them
  • Eviction processes and rules
  • Fair housing acts

And more. You want to know exactly what you’re up against to avoid unnecessary and costly legal action.

How To Start Your Rental Income Property Journey The Right Way

So, there you have it! Now you know how to start your rental income property journey you’re good to go.

Getting into property investment isn’t a race, you’ll need to be patient and do your research. Don’t rush and never pay the market price for a property. Start by working out your budget and getting your finances in order. Especially if you’re looking for traditional financing to fund this venture.

If you found this guide helpful be sure to check out our other articles for other useful tips and tricks!