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"Financing Real Estate Investments with Other Peoples’ Money"


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How to obtain investment property financing is one of the first things you must figure out as a new multifamily investor. Assuming you're not yet equipped to pay cash, your total acquisition costs boil down to 3 primary components:

  • The mortgage or loan (traditional bank, mortgage broker, private lender, etc.)
  • Your down payment (can be out-of-pocket or financed)
  • Your closing costs (can be out-of-pocket or financed)

THE MORTGAGE


Of course, this is the largest of your investment property financing components, and the specific type of mortgage you get may depend on the nature of the property you are buying. For a functional, fully occupied multifamily structure, a standard property mortgage will fit the bill.

A fixer upper, on the other hand, may require a different funding source, because banks do not like the added risk associated with a rehab job. Additionally, the "non-functional" nature of this type of property makes it difficult to get an accurate real estate appraisal. In fact, most times these appraisals are undervalued, which could result in a bank-mandated reduction of the loan amount, or even a voiding of the deal by the lending bank.

Although I am partial to fixer-upper projects, I did not start out this way. My first few acquisitions were of the more traditional, already-functional type, using regular bank mortgages. And unless you have access to a boatload of cash or to a private lender, you will probably have to start out the same way I did – purchasing currently occupied rental properties.

Although you'll miss out on the "fixer-upper discount," an initial focus on fully occupied properties will allow you to learn the ropes before "graduating" to the more advanced fixer-upper stuff. This will also give you time to find a private lender you can trust, which will enable you to execute the rehab strategy.


YOUR DOWN PAYMENT



The largest out of pocket expense associated with investment property financing is usually the down payment. Down payment requirements are more stringent with a traditional bank compared to a private, non-bank lender. For example, many private lenders will finance 100% of the purchase price (not to mention closing & rehab costs), especially if the term of the loan is short (like 6- or 12-months).

But if you need to go with a traditional bank mortgage, a down payment of some sort will almost always be required. The bank's down payment requirement is defined by the "loan-to-value" ratio (LTV). For example, an 80% LTV loan requires a 20% down payment.

Luckily, the days where lenders required a 20% down payment are long gone. As long as you have good credit, most mortgage brokers can hook you up with a 90% or even 95% LTV mortgage (i.e., you put down 10% or 5%, respectively).

Of course the upside compared to traditional 80% LTV loans is that you put less money down out of your own pocket, which also drives up your cash-on-cash ROI when you sell. However, high LTV mortgages do have downsides:

  • Interest rates tend to be higher
  • You may have to pay for points at closing (calculated as 1% of the mortgage amount)
  • The appraised value must be higher because there is less of an equity cushion
  • Any down payment that is less than 20% of the purchase price triggers private mortgage insurance (PMI).

Because of these issues, I would avoid straight-up high-LTV bank mortgages if at all possible. A much better investment property financing alternative is to get an 80% LTV loan, and use a secondary financing source for the 20% down payment. And luckily, you do have a few zero down options for the down payment.

Obviously if you cannot find a secondary funding source for the down payment, then you will indeed have to pursue a high LTV loan even though this is not ideal. That said, this can be viable as long as your projected rental property income is enough to cover the higher payments. Then, in a few years, you should have enough built-up equity to refinance investment property into a standard 80% LTV, 30-year fixed-rate mortgage.



CLOSING COSTS


Unfortunately, closing costs are a necessary evil in terms of investment property financing, even when using a private lender (although bank fees will usually be higher). Click for more info on closing costs.


FINAL THOUGHTS


The bottom line is that – in most cases – you'll want to get an 80% LTV fixed-rate loan using a secondary financing source to fund the 20% down payment.

This gives you the best of all worlds...you minimize your out-of-pocket expense while at the same time minimizing your largest go-forward expense item as well as your risk. This maximizes the odds that you will optimize your profit when you sell years down the road.

So, investment property financing is not overly difficult, but it does take some time to figure it all out and find the best deal. Just follow the advice on this site and do not waver. Keep moving forward. Yes, you CAN do this!



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9 Responses to Financing Real Estate Investments with Other Peoples’ Money

  1. maddoggie says:

    Does anyone have an opinion regarding the best investment property mortgage provider to go with at the moment?

  2. dwa says:

    @maddoggie: did you try bankrate.com? Whenever I need financing I always check there first.

  3. someone says:

    That’s definitely the beauty of mortgage financing. I mean, where else could you possible use other peoples’ money to acquire a money making asset? I just hope the gov’t. doesn’t screw that system up too.

  4. Ant says:

    My uncle just refinanced and he got a 4.15% rate. Unbelievable!

  5. Mali says:

    Thank you for this informative blog. I have a challenge that I’m now working on, and I have been on the look out for such information. This site has helped a lot, thanks!

  6. Brandi Johnson says:

    I’m finding that lenders are now requiring a 25% down payment for investment properties. This is before they even know my income or run my credit, so beware, fellow investors.

  7. Devinder Singh says:

    I am looking for Real Estate loan for 6 Unit Multifamily.Can I get with 10% down.

  8. Mark says:

    Qualifying for investment properties can definitely be a challenge. Some loan programs can require as little as 5-10% down for an investment property. The flip side of that is investors who are currently financing multiple properties are required to put more “skin in the game”. That comes in the form of a larger down payment. That might be the situation Brandi is running into.

    As for Devinder, typically residential financing is limited to 2-4 unit properties. Try contacting a local Commercial Real Estate Agent, they will no someone that can help you out.

  9. Grace says:

    Greetings! I’ve been following your blog for some time now and finally got the bravery to go ahead and give you a shout out from Humble Texas! Just wanted to mention keep up the good job!

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