Investing in real estate is an excellent way to generate passive income, build equity, and diversify your investment portfolio. According to a recent Gallup poll, 45% of Americans believe that real estate is the best long-term investment compared to stocks (24%), gold (15%), savings accounts (9%), and bonds (4%). Purchasing an investment property and operating it as a short-term rental can give you an extra cash flow each month. If you’re looking to tap into this lucrative asset class but don’t know where to start, no worries. We’ll cover all the basics on how to finance an investment property, loan requirements, and how a vacation rental management company can help maximize your ROI. Let’s get started.
What is an investment property?
An investment property is real estate purchased to generate income, receive tax benefits, or profit from appreciation. Investment properties are not your primary residence and can be purchased individually or by a pair or group of investors. These properties are often purchased to “flip” by renovating and reselling for profit. Investment properties can also be rented out (on a long or short-term basis) to create a passive income stream.
Types of investment property loans
There are many different types of investment property loans. In order to choose the right loan for you and your investment goals, it’s crucial to understand all of your options and their requirements before contacting a mortgage lender.
In addition, keep in mind that down payments and interest rates are higher for investment properties compared to primary and second home mortgages. The reason being is that lenders view investment properties as more risky and know that if things don’t work out, the borrower will walk away from the investment and keep their primary residence.
Now, let’s break down four popular loans for investment properties so you can choose the best option and maximize your return on investment.
Conventional bank loans
A conventional bank loan is one of the most common loans among real estate investors. These loans are offered by traditional lenders like banks, credit unions, and mortgage brokers. Conventional mortgages follow the requirements set by Fannie Mae and Freddie Mac and aren’t backed by the federal government.
Conventional loans for investment properties can require up to 30% for a down payment. Mortgage lenders also consider the borrower’s credit score, income, assets, and may require up to six months of cash reserves for eligibility.
However, these requirements differ from state to state and among mortgage lenders. For that reason, be sure to research the conventional mortgage qualifications for investment properties in your local market.
Hard money loans
A hard money loan, or a fix-and-flip loan, is a great option for investors who want to renovate a property and resell it for profit in a short amount of time. This is a short-term loan that is often quicker and easier to obtain than a conventional loan. Mortgage lenders will mainly consider the property’s value and potential profitability, along with the borrower ’s income and credit score.
Interest rates for hard money loans are greater than conventional loans, and can be as high as 18%. This is because the borrower is typically asking for more than the property is worth to account for repair costs and will likely pay off the loan in a short period of time, usually 12 to 18 months.
Private money loans
Private money loans are offered by individuals, not traditional lenders. These lenders can be friends, family members, fellow real estate investors, or anyone in your network who is able and willing to loan you money for your investment property. Requirements for private money loans vary based on your relationship to the lender, but usually have lower interest rates and negotiable terms. Private money loans will usually have a contract that allows the lender to foreclose on the investment property if the borrower doesn’t make loan payments in the given timeframe.
You can use home equity to finance an investment property with a home equity loan, home equity line of credit (HELOC), or cash-out refinance. These entail using money from an asset you already own (your primary residence) to help secure your investment property. The downside to using home equity is that your primary residence is collateral if you can’t make loan payments.
A home equity loan is a lump sum from your mortgage lender that is paid back in monthly installments. Interest rates and monthly payments are fixed. Many mortgage lenders allow you to borrow up to 85% of your home’s equity.
With a HELOC, you’re using a line of credit secured by your home equity that you can borrow from and repay in monthly payments, similar to a credit card. HELOCs have a set amount you can borrow each time as needed, as long as you continue to pay it back. HELOCs have variable interest rates which can increase if the prime rate changes.
A cash-out refinance allows you to take out a new mortgage greater than the original amount. The difference between the original mortgage and the new one is paid to you in cash, which you can then use to finance an investment property.
Maximize your ROI with AvantStay
Investment properties provide a great return on investment and passive income for buyers. Now that you have a basic understanding of how to finance an investment property, plan on maximizing your ROI by operating the home as a short-term rental.
If you’re looking to secure an investment property or already have a home that you’d like to run as a short-term rental, consider working with a vacation rental management company. When you partner with AvantStay, we’ll manage your investment to give you peace of mind and maximize your income. We take care of revenue management, marketing and distribution, interior design, guest care, and more so you don’t have to lift a finger. In addition, our flexible management options let you choose what’s right for you and your home; earn guaranteed monthly rent or a monthly revenue share for maximized income.
If you’re interested in learning more about how AvantStay can maximize your return on investment, our team is ready to help. Get started with our vacation rental management experts today!