Understand the variables before you make the leap. It’s not rocket science but it can be complicated.
Buying and managing a rental property is a huge job and not everyone has a full picture of it going in. It’s an investment, yes, but it is also a test of grit, commitment, and personal pride. And there’s plenty of risk. In fact, there’s usually more risk involved with owning a rental property than investing in the stock market.
So, having said that. Are you still interested? If so, let’s take a look at the steps you’ll need to take to determine if you can afford to own a rental property.
Assuming you’re in a financial situation to take on a mortgage, cover the operating costs, keep it rented to top quality tenants, and maintain the property on a continuing basis, then let’s see what’s next.
Do you know how to find the best rental property to fit your investment profile? Perhaps you own a primary residence in which case you have a jump start on understanding the steps. However, there are some unique differences that you’ll need to consider.
One major difference is the financing. You will pay a higher interest rate on an investment property. Why? Because investment properties pose a greater risk to lenders than a primary residence. The minimum down payment for an investment property is between 15% and 25% of the purchase price.
But, as with many things, a bigger gamble also comes with the opportunity for a bigger reward, and this can be especially true for investment properties. An investment property is a great choice for an investor who wants a hands-on opportunity, And you do have more control over owning a rental property than you do investing in the stock market.
Getting a mortgage
First of all, decide how much you can afford. A helpful tool is a mortgage calculator which gives you an idea of rates and monthly payments, and then you can get preapproved to see how much money you qualify for. Make sure that you tell your real estate expert that you’re interested in buying an investment property, which has different rules than a primary residence.
Get Preapproved First
Do this first before you find your ideal investment property. You might discover that finding the property first, then waiting to get preapproved for a mortgage, is time lost, only to see another buyer grab it. Get preapproved first and have the ability to jump on a good deal when you find it. Besides, you need to know how much you qualify for before you decide on a property.
For an investment property, you will likely use an agency loan backed by Fannie Mae or Freddie Mac. In most cases, you won’t be able to get an FHA or VA loan for an investment property. The exception to this would be if you purchase a multiple-unit property and plan to live in one of the units and rent out the others. If you’re planning to go this route, you should start by talking to a Home Loan Expert.
Requirements for a Loan
The agency loans available to you will either be a fixed-rate mortgage or an adjustable rate mortgage (ARM). Both of these options have specific requirements when it comes to the down payment and credit score.
For a fixed-rate mortgage, the minimum credit score requirement on a single-unit investment property is 620, and it will require a 20% down payment. If you have a credit score of 720 or above, however, you are only required to put down 15% on a single-unit investment property.
For an adjustable rate mortgage, the minimum credit score is 620 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 to Qualify
Other than the down payment, the requirements for a rental property are somewhat similar to that of a mortgage for a primary residence. You’ll still need to follow the 2/2/2 rule: provide two years of tax returns, two years of W-2s and two months of bank statements to your mortgage company, as well as have your assets verified.
Your mortgage company will also want you to have six months of mortgage payments in reserve in order to give yourself some buffer room in the event that you go through an unexpected financial downturn.
Determine the Potential ROI for Your Rental
When looking for a great investment property, the first question you need to ask is “Can I actually make money?” If the answer is no, it’s obviously not a great investment. To see how much money your property could potentially make, you’ll need to consider the return on investment (ROI).
The ROI can be calculated by first finding the property’s net annual income. This is the rent money that’s left over after you’ve paid the taxes, insurance, property management fees, expected repairs (plan to spend 1% of the property value on this), potential vacancy periods, HOA fees (if applicable) and any utilities that aren’t going to be covered by the tenant.
To find the ROI, take the annual income and divide it by the amount you spent on the property. For example, if the net annual income is $7,500 and you spent $100,000 for the property, your ROI is 7.5%.
Use this calculation to see if each rental property is a good potential investment.
When scanning neighborhoods for your first rental, there are a few specific requirements you should be looking for. In short, you want a house that requires low maintenance, has limited vacancies and allows you to have a good rent-to-value ratio.
Avoid fixer-uppers, at least when you first start out. Unless you’re an ace handyman, you will need help and that can turn into dollars out the door.
Finding and Keeping Excellent Tenants
If you don’t keep your rental property rented, you have a problem. But sometimes finding the top quality tenants who will care for the home like their own are not so easy to find. That’s one of the many values of hiring a reputable property management team.
Use the 1% Rule
The monthly rental rate 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. Some investors will settle for a slightly lower return. Check what the property rental rates in the area and you can better gauge it.
Playing the Landlord
It’s tougher than many new investors realize to be a landlord. There are many demands and often you find that your time is at a premium. Many seasoned investors highly recommend getting a management company to manage, do maintenance, locate the best tenants, and collect the rents. Cousin James Management is a prime example of a reliable, respected property management company.
While there are many variables to consider when purchasing your first investment property, you should start by doing your research. Look at housing prices and neighborhoods and begin saving for a down payment. And when you’re ready to dive head first into the real estate game, start out by first getting preapproved for a mortgage. When you’re ready to partner with a property management company, contact us. Cousin James Management is a 25-year-old family-owned business, providing comprehensive real estate management (residential and commercial) with a focus on owners and investors who expect and appreciate a higher quality of service.