Are You Financially Prepared to Buy Your First Investment Property?
On paper, buying an investment property seems like a no-brainer. Someone else pays off your mortgage while providing you with a steady monthly income. Over the years, the property’s value increases, and when it’s time to sell, you get to enjoy a big lump sum payout.
But investing in an income property is not without risks. Here are six questions to ask yourself to determine whether you’re financially ready to be a landlord.
Should You Pay Off Other Debt First?
Owning an investment or rental property may yield you a steady monthly income. But it also means higher monthly expenses. You’ll have a second mortgage as well as new insurance and tax bills. Then there’s the upkeep and maintenance that comes with any property purchase. (We’ll talk more about that in a minute.)
To ensure you’re ready to make such a big commitment, take an honest look at your current and future financial needs. Is it smarter to use the down payment you would make on an investment property to pay off high-interest credit card bills? According to Investopedia, that money may also be better spent paying off medical bills, starting a college fund for your teenage children, or paying off student loans.
How Much Down Payment Can You Afford?
In order to secure traditional financing for your investment property, you’ll need cash. Lots of cash. Why? Because traditional mortgage insurance isn’t available for investment properties.
Be prepared to put down at least 20% of the home’s value on signing day. To secure even better interest rates, aim for a 25% or higher down payment.
Is Your Credit Score in Check?
When it comes to borrowing money, the math is usually pretty simple: The higher your credit score, the lower your interest rates. Borrowers with a credit score of 800 or higher are generally offered the best financing.
If your score isn’t that high, don’t stress. But do be prepared to spend more if you go with a traditional loan to fund your investment property. Loan applicants with a credit score of 740 or lower will likely face higher interest rates and lender fees, which means a bigger down payment and higher monthly payments. You may find that a home equity investment is a smarter choice. Typically, you’ll need a 630 or greater credit score, but because it is an investment, you won’t have to worry about interest at all.
How much will improving your credit score save you each month? Find out more here.
How Big Is Your Emergency Fund?
Remember those upkeep and maintenance costs mentioned earlier? In addition to your 20% (minimum) down payment, you should also have thousands of dollars in cash ready to cover unexpected maintenance and repairs.
Investment properties also have additional risks beyond a leaky water heater or busted air conditioner. That emergency fund needs to cover the mortgage between tenants. You also want to be prepared for renters who can’t pay their bills as well as potentially higher property taxes. Some states only offer a tax exemption on your primary residence, and others charge increased rates for rental properties.
Are You Looking for a Quick Return?
If so, then you may want to invest elsewhere. Investment properties are all about the long game. HGTV estimates it will take at least five to 10 years to see a return on your investment.
Can You Handle Fluctuations in Income?
Tenants come and go. And when they go, you are still responsible for the home’s monthly mortgage, tax, and insurance payments. If the thought of pulling those funds from your bank account fills you with fear, you may want to put your landlord ambitions on hold while you build your savings.
In addition to having money on hand to cover repairs, you also want to be able to comfortably cover the home’s monthly expenses while the repairs are being made.
Funding Your Investment Property
Homeowners who are ready to take the leap have the option of tapping their largest asset—their home—to fund the purchase of an investment property.
When it comes to drawing from your home’s equity to grow and diversify your portfolio, you have plenty of options.
The Hometap Guide to Tapping Into Your Home’s Equity: Your Options + How They Compare.
However, remember that traditional options like home equity loans will come with monthly payments and interest. As an alternative to working with a lender, some homeowners have found Home Equity Investment products like Hometap a smart way to fund their investment property dreams.
With no debt, interest, or monthly payment, a Hometap Investment can offer you cash today in exchange for a share in your home's future value. In 2018, homeowners saw their home equity increase an average of $15,000. Tapping into that equity today allows you to diversify your portfolio with additional real estate and reap the rewards of appreciation.
Take our 5-minute quiz to see if a home equity investment is a good fit for you.
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The opinions expressed in this post are for informational purposes only. To determine the best financing for your personal circumstances and goals, consult with a licensed advisor.