Financing Tips for Investment Properties

Considering purchasing a rental property in Bend? Smart decision! Now is a great time to invest in this desirable and rapidly growing community. 

You already know that property has long been an investment of choice for many. It’s easy to see the benefits of property investment, from equity growth to a hedge against inflation. 

But if you’re like many investors, you probably have some questions about how to finance a rental property. After all, the process for securing single family rental loans is a bit different than getting the residential loans that you’re likely already familiar with. You may wonder about securing traditional financing, or meeting strict banking standards. 

The good news is that you’ve got options. When it comes to turning your dream of owning a rental property into reality, there are multiple pathways available. Read on for financing tips for investment properties in Bend.

Make a Large Down Payment

Let’s start with conventional loans. There’s one elephant in the room: the down payment. In order to secure single family rental loans though conventional mortgage lenders, most require a sizeable down payment. 

For a traditional lender, the required down payment will likely be at least 15 to 20 percent of the property’s value. And the higher the down payment, the better. If you can put at least 25 percent down, you may qualify for a lower interest rate. 

Of course, down payment requirements may vary depending on your credit score and other factors. But as a general rule, expect to make a down payment between 15 and 25 percent. 

Why is a larger down payment needed for investment property purchases? It’s all about risk. 

When you start with a bigger down payment, the lender considers that you’ve got “more skin in the game”… in other words, you’re taking on more risk. A larger down payment means that if the investment falls through, you’ve got more to lose, so in theory you’re less likely to default.

For lenders, this translates into more security against losing the investment they’re considering making in you. This may make you a more attractive candidate for a loan, as the bank has less to lose.

Ways to Come Up with a Down Payment

Does 20 to 25 percent down sound like a lot? For many investors, a large down payment represents a significant chunk of capital. Coming up with this much cash may require some strategizing. 

Fortunately, there are a few ways to approach the down payment issues. For instance, you may consider cross-collateralization. This approach allows you to use another asset —  such as a home, a car or a savings account — as collateral to lower your interest rate. 

Cross-collateralization can reduce the cost of borrowing money. What kinds of loans can be cross-collateralized? Possibilities include:

• Single residential property mortgages
• Multi-family property mortgages
• Credit cards
• Commercial loans
• Investment loans

Just be aware that this approach involves risk. If you default on the property investment loan, the lender can repossess and then sell the asset you used as collateral. And when assets are collateralized, defaulting on one payment can affect the other asset. 

Your 401k plan may allow you to take out a loan against your 401k savings to fund a down payment. In most cases, the loan process is relatively easy and quick. The IRS allows you to take a loan for up to 50 percent of the value of your 401k or $50,000, whichever is less. This money can be used to purchase investment property.

In many cases, you’ll have five years to pay back the loan. Interest will accrue, but it’s paid back into the retirement account. Remember: You will lose any positive gains during the life of the loan. However, you’ll also avoid any losses, depending on market conditions. 

Be aware that you’ll likely be liable for fees and early withdrawal penalties if the loan isn’t paid back on time. Your 401k is funded with pre-tax contributions, so you’ll be liable for income taxes. 

A Roth IRA may be used to pay for a down payment. Unlike a 401k, this type of retirement account is funded with after-tax contributions. That means you can withdraw funds before retirement age without penalty.

There’s one (important) caveat: You can only withdraw the principle from a Roth IRA without penalty. If you withdraw earnings, you’ll likely be on the hook for penalties and taxes. The IRS does let you withdraw up to a certain amount of principle and earnings to purchase a first home, but this exception doesn’t apply to real estate investment properties.

If you have another type of self-directed retirement account, you may be able to use funds to invest in property, then redirect revenue into the account. Be sure to talk to an advisor first to ensure you won’t be hit with early withdrawal penalties and fees that negate the benefits. 

Finally, you may consider gap funding to come up with a down payment for single family rental loans. Sometimes called a bridge loan, gap funding is a temporary solution in which an interim loan is issued to “bridge the gap” while waiting for a longer-term loan. In many cases, gap funding is associated with so-called hard money loans, or loans offered by private lenders, rather than banks.

Gap funding is, by nature, a second position loan, as it is only issued behind another loan. Thus, gap funding comes with more risk attached — and that means higher interest rates.

Some gap funding lenders also require the borrower to pay a portion of profits. Gap funding should be used judiciously. 

Work With Local Banks and Brokers

If a traditional lender isn’t offering the loan rates and terms you want,  consider working with a local bank. These smaller institutions often have more flexibility than large, national banks or lenders. 

Plus, local banks really know the regional market. They have an interest in investing locally, and may be able to offer creative ideas thanks to insider knowledge. 

The same goes for local mortgage brokers. They often have access to a larger range of lending products. Just be sure to do your due diligence and choose a reputable local broker.

Alternatives to Financing an Investment Property

What if you don’t want to finance a rental property through conventional means? Fortunately, you do have options… and there’s nothing wrong with getting creative to secure an investment property. 

If you have a substantial amount of equity in your home, you may consider a home equity loan. This type of loan is secured by your home’s equity, so you may be able to get a low interest rate and a long term, up to 30 years in some cases. (Bonus: If you’ve got good credit, your rates may be even lower.) 

A home equity line of credit (HELOC) is another option. This type of loan is also secured by equity in your home (or in other rental properties) but you can withdraw funds as needed, rather than in one large sum.

While HELOC interest rates tend to be lower than home equity loans, the rates can be variable and go up in the future. Pay close attention to the fine print.   

While not all sellers would be willing to offer seller financing, it probably doesn’t hurt to ask… at least if they own the property free and clear. In such cases, the seller transfers the property title to you, but holds a note. You make payments to them and, if you default, they keep the property.

Keep in mind that such transactions require careful legal scrutiny. You should also be prepared to pay a higher interest rate. 

Do you have a family member, friend or acquaintance who’s able and willing to lend you money for a down payment? You may consider a private loan. This type of funding is (usually) less formal than obtaining a loan through a bank or other creditor.

In most cases, expect a 6 to 12 percent interest rate, and to forgo the points. It’s always best to consult a legal professional to make sure the paperwork is correct and that all parties are protected.

A hard money loan offers another option. This type of funding is offered through a private lender and is commonly utilized by those who “fix and flip” investment properties. Often, hard money loans offer a fast way to obtain funds.

These loans may offer up to 100 percent of the property value, and are dependent more on the property’s equity, rather than the borrower’s strength. Just be prepared to pay higher interest rates (from 10 to 18 percent) and points (up to 10).

But why go it alone? Working with an investment partner just makes sense. Teaming up with a partner spreads the risk while sharing the responsibilities and the income. Working with a partner with experience in the industry and the local market can help you make smart, informed decisions that optimize your investment. 

Invest in Bend is a great partner for all property investors! We know the local market inside and out… after all, Bend is our home, so we have a vested interest in your success. Whether you’re interested in buying, selling, managing, exchanging or evaluating investment properties, Invest in Bend is here to help.