Investors are often looking for ways to create passive income. The real estate market in Richmond VA is a very viable option for creating this kind of residual income. However, one of the barriers to entry is that in order to buy real estate you are typically required to have a significant amount of capital available up front. In this blog post, we are going to go over some of the options investors have for financing their investment property purchases.
The three most common types of loans used in investment property acquisitions are Home Equity Loans, Conventional Loans, and Hard Money Loans. It is important to understand the differences between these loans, because choosing the wrong type of loan for a specific transaction can jeopardize the potential for the investment to become a profitable one.
Home Equity Loans
Especially in today’s current market conditions, most homeowners have a fairly significant amount of equity tied up in their property. You can access this equity through a Home Equity Line of Credit (HELOC) or a cash-out refinance. In most instances, a homeowner can borrow up to 80% of the equity they have in their home in order to purchase a second home. Depending on which of these equity tapping loan vehicles you decide to pursue, there may be a different list of pros and cons. A HELOC functions for all intents and purposes just like a credit card, and the monthly payments are often of the interest-only variety. This vehicle often comes with a variable rate though, which means if the prime rate it is tied to increases then your rate and payments will also increase. A cash-out refinance usually comes with a fixed rate, but the potential con is that it often extends the term of your current mortgage.
Hard Money Loans
These types of loans are usually the most beneficial when your intent is to purchase a distressed property, fix it up, and then flip the home by reselling it for a profit. The main focus of a hard money lender is how much potential profit is wrapped up in the property itself. They tend to care less about things like the credit score of the borrower or what their payment history looks like. Terms are usually very strict, and interest rates can be 18% or more. Penalties for missed payments are typically severe. However, these loans can be a great option because they are typically easier to qualify for than home equity lines or conventional loans. Another benefit is that they typically fund very quickly allowing construction to begin ASAP.
A conventional loan must conform to the standards set forth by Fannie Mae and Freddie Mac. In today’s market, conventional lenders often require a 20% down payment to be made on the property in question. However, if the property involved is an investment property, the lender will require 30% down. Things like whether or not an investor qualifies for a loan and what interest rate they will get depend on their personal credit history and credit score. A prospective borrower will be asked to prove that they can afford the monthly payments on the investment property in addition to their other monthly mortgage and credit obligations. Their debt to income ratio will be reviewed without factoring in the rental income the property will generate and a decision will be made.
As you are trying to decide on the best type of loan for your investment property, be sure to consider both the short and long-term implications of each type of loan to ensure that your venture will be as profitable as possible! As always, don’t hesitate to reach out to PMI Richmond with questions about any aspect of acquiring and managing rental property.