A Second Home As An Investment
Are you thinking about investing in real estate to rent out or use as a vacation home for other travelers? It can turn into a reliable source of income. But how do you know if you’re ready to become a landlord?
We’ve created a crash course on everything you need to know before you get a loan for your first investment property and start making money.
Investment Property Definition
An investment property is real estate purchased to generate income (i.e., earn a return on the investment) through rental income or appreciation. Investment properties are typically purchased by a single investor or a pair or group of investors together.
3 Signs You’re Ready to Buy an Investment Property
First, know that the buying process is different for an investment property compared to a primary home. Before you invest in property, make sure you meet the following qualifications.
- You’re Financially Stable
Investment properties require a much higher financial stability level than primary homes, especially if you plan to rent the home to tenants. Most mortgage lenders require borrowers to have at least a 15% down payment for investment properties, which is usually not required when you buy your first home. In addition to a higher down payment, investment property owners who move tenants in must also have their homes cleared by inspectors in many states.
Make sure you have enough money in your budget to cover the initial home purchase costs (like your down payment, inspection and closing costs) as well as ongoing maintenance and repairs. As a landlord or rental property owner, you must complete essential repairs in a timely manner, which can mean expensive emergency plumbing and HVAC repairs. Some states allow tenants to withhold their rent payments if you don’t fix broken home utilities on time.
Make sure you budget more money than you think you need for regular and emergency home repairs.
Investment property expenses don’t just begin when tenants move in or when you assume responsibility for the property’s current residents. You also need to budget money for advertising and credit checks to make sure you take in the best tenants possible. A great set of tenants are an asset for your property, while bad tenants can increase your expenses dramatically.
- The Return on Investment (ROI) Is There
Real estate investors often see positive cash flow with their investment properties in today’s market, but the savviest investors calculate their approximate return on investment (ROI) rates before they purchase a property. To calculate your ROI on potential property investments, follow these steps.
- Estimate your annual rental Search for similar properties that are currently up for rent. Find an average monthly rent for the type of property that you’re interested in and multiply that rent price by 12 for a year’s worth of income.
- Calculate your net operating income. After you estimate your annual potential rental income, calculate your net operating income. Your net operating income is equal to your annual rental estimate minus your annual operating expenses. Your operating expenses are the total amount of money that it takes to maintain your property every year. Some expenses include insurance, property taxes, maintenance and homeowners association Do not include your mortgage or interest in your net operating expense calculation. Subtract your operating expenses from your annual rent estimation to find your net operating income.
- Find your ROI. Next, divide your net operating income by the total value of your mortgage to find your total return on investment (ROI).
For example, let’s say you buy a property worth $200,000 that you can rent out for $1,000 a month. Your total potential income is $1,000 x 12 months for a total of $12,000. Let’s also assume that the property costs about $500 a month in maintenance fees and taxes.
- $500 x 12 = estimated operating expenses of $6,000.
- Subtract your operating expenses from your total rent potential: $12,000 – $6,000 =
$6,000 of net operating income.
- Divide your net operating income by the total value of your mortgage: $6,000-;-
$200,000 = 0.03, which makes this property’s ROI 3%.
If you buy a property in a solid area and you know that you can rent to reliable tenants, a 3% ROI is great. However, if the property is in an area known for short-term tenants, a 3% ROI may not be worth your time and effort.
- You Have Time to Manage It
Investment property management still takes a lot of time. You have to put up advertisements for your space, interview potential tenants, run background checks on tenants, make sure that
tenants pay their rent on time, perform maintenance on your property and make timely repairs if something in the home breaks down. You also must do all of this while working around your tenant’s “right to privacy,” a legal standard that prevents you from dropping by unannounced without at least 24 hours of warning in most states.
Before you decide to buy an investment property, make sure you have plenty of time to maintain and monitor your space.
Things To Consider Before Buying An Investment Property
Time, down payments, and returns are just a few pieces of the investment property puzzle. Here are some other considerations to think about before you invest.
What Are The Housing Market Trends?
You want to choose a property that rises in value over time. But how can you tell which areas will become the next best places to invest in real estate? The only way is to watch an area’s housing market indicators and rental trends over time and compare the direction of previous property prices and taxes to where they are now. A home purchase is a major investment, so don’t be afraid to take plenty of time to do your research and analyze market trends to find the perfect area before you dive into a loan.
Should You Buy With A Partner?
A partner might seem like a great idea -you can pool your money, split maintenance costs and requirements and combine your home repair skills to save money on professional contracting costs. However, buying with a partner also splits your potential profits in half and puts you in the position of sharing legal liability with another person.
For example, if your tenants tell your partner about a pest problem and your partner doesn’t fix the issue in a timely manner, your tenants may sue both of you because you are both landlords and you are both equally responsible for providing a habitable environment.
You should also remember that if something goes wrong with your partner and you split the cost of the home equally, you’re both equally legal owners of a single property. Make sure that the person you choose is trustworthy, responsible, and proactive when it comes to maintenance if you decide to go in on a rental property with someone else.
How Much Will Property Taxes Be?
Property taxes are taxes that homeowners pay to support their community and local government. Property taxes fund fire departments, public schools, libraries, and other local projects. The amount you pay in property taxes is directly related to the value of your home. If your home is worth more money, you pay more, and vice versa.
Local governments set their own property tax rates, so the specific amount you pay in property taxes depends on your house’s location. Speak with a local real estate agent or mortgage lender to calculate how much a certain house will require in property taxes. No estimate is going to be perfect because every homeowner qualifies for different levels of exemption as well.
Should You Hire A Property Management Company?
You need to decide whether you want to handle property repairs, tenant management, and maintenance yourself or if you’ll hire a property management company to manage the daily maintenance on your behalf.
Property management companies take both scheduled and emergency repair calls and check up on your property with both drive-bys and scheduled visits to make sure that tenants respect your space. They can also collect rent on your behalf. Some property management companies also offer tenant placement services and eviction processing for an additional fee. In exchange, the property management company takes a percentage of your monthly rent. If you live far away from your property or you don’t have the home repair skills to fix your own property, hiring a property management company may be a great choice.
Applying For Investment Property Loans: How to Prepare
Mortgages and loans for investment properties such as a non-owner-occupied mortgage work a little differently than those for personal homes.
Investment Property Loan Requirements
If you have a mortgage for your primary residence, you probably know that most mortgage lenders no longer require a 20% down payment to get a loan. Lenders are stingier with loans for investment properties, however, because the risks of foreclosure and default are higher.
Most fixed-rate mortgages require at least a 15% down payment with a 680 qualifying credit score for a one-unit investment property. Your credit score should be at or above 620 if you’re applying through Rocket Mortgage®. Lenders want you to put down 25% with a 620 or higher interest rate on two- to four-unit investment properties.
It’s a good idea to get preapproved for a mortgage before you start searching for homes so you know how much home you can afford.
A preapproval is different from a prequalification. A prequalification only tells you how much money you might be eligible for – it’s not as strong. A preapproval requires your financial information so the mortgage company can provide a solution that’s customized for you. While prequalification only looks at your credit and your inputted estimate for income and assets, preapproval involves a hard credit pull and proof of income and assets.
When you apply for a mortgage, you also must provide some basic personal information. In most instances, your mortgage lender will require you to provide two years of tax returns, two years of W-2s, and two months of bank statements to prove that you have enough money to cover your monthly payments.
The Bottom Line: Get on The Path To Owning An Investment Property
Are you ready to take advantage of the benefits of real estate investing? If so, it’s time to research properties in your area. There are other ways to consider whether you’re ready: Assess your financial stability and return on investment for a particular property and decide whether you have time to manage a property. You’ll also need to consider the housing market, property taxes, and whether you’d want to hire a property management company.