For many investors, the real estate market represents a dynamic and exciting arena where hard work and a small amount of luck can yield tremendous profits. Historically, real estate has been one of the most reliable investment platforms in the United States. Although seasoned investors have the ability to buy and sell numerous properties as part of larger tactical strategies, those who are new to the profession may struggle to accrue the funds needed for the down payment on their first investment property. Fortunately, it is possible to borrow the down payment for an investment property, although finding advantageous borrowing terms is an absolute must.
TL;DR (Too Long; Didn't Read)
Borrowing the funds you need for a down payment on an investment property is possible, although it may require some work on your part. HELOCs and bank loans are some of the most common forms of borrowing that property investors will seek out.
Defining an Investment Property
In order to gain a thorough understanding of the borrowing options available for real estate investors, it is first necessary to accurately define investment property. An investment property is any real estate purchase intended exclusively to generate a profitable return on the purchase price. This return can come from a variety of methods, ranging from a tenant's rent payments to the eventual sale of the property at a higher price than the investor initially paid for it. As long as the property is creating income used to make considerable progress toward paying off any mortgage loans and eventually generating a profit for the investor, chances are the investment strategy is a good one.
In some situations, an investor or investment group will undertake in-depth studies to assess what the best use of a property may be. For example, in situations where a property has received dual zoning as a residential and commercial area, the investor has a degree of freedom when it comes to designating its intended function. Using historical data and current metrics related to the neighborhood and local economy, the investor(s) will determine what they think will generate the largest possible return on investment.
Three Forms of Investment Properties
Investment properties are commonly grouped into three categories, those being residential, commercial and mixed-use properties. When an investment property is classified as a residential property, it will likely be used as a rental. Residential investment properties can be homes, apartments, condominiums and other types of habitable structures.
Commercial properties are yet another viable platform for investors. A commercial investment property could range in size from a small storefront to large, corporate-owned apartment buildings.
Mixed-used properties are often multi-purpose structures that house commercial enterprises as well as residential units. These types of structures are common in larger urban areas. Even though this type of property may initially present a more complex logistical structure than exclusively residential or commercial investment properties, they are bought and sold just like any other investment property.
Preparing Your Down Payment
Investors who may be seeking investment property down payment assistance have a variety of tools at their disposal. Although it may present an unacceptable degree of risk for some, a home equity line of credit, or HELOC, is one of the most common tools that investors use to gather the money they need to make their down payment on an investment property. When an investor takes out a HELOC, they are essentially leveraging a percentage of their primary residence, derived from the amount they have already paid into their mortgage, and using this sum of money as the basis for a new loan.
So, if an investor has built up $75,000 of equity in their primary residence, they will likely be able to borrow a similar amount as part of their HELOC. After being approved for the HELOC, the investor will receive a revolving line of credit that they can access using a credit card paired exclusively with these funds.
HELOCs and Draw Periods
Investors will typically be granted a period of five to 10 years in which they can withdraw funds from their HELOC. This duration of time is commonly referred to as the draw period. During this period, investors will not be required to make payments on the principal balance of their loan, although they will be required to pay down the interest that is accruing.
Once the draw period comes to a close, the repayment period begins. Generally, investors will be granted between 10 and 20 years to pay back the money they have borrowed. Interest rates assigned to the HELOC are usually variable, meaning that the interest rate could increase once the repayment period begins. These details should be discussed at length with the lender prior to the loan being initiated.
Risks Associated With HELOCs
Although there are numerous benefits associated to HELOCs, there are also substantial risks associated with this form of borrowing. In the event that an investment property fails to generate the type of profits that had been anticipated, investors will still be responsible for paying back the funds they borrowed through the HELOC. If they are unable to manage this debt, they could default on their HELOC, which can lead to potentially devastating consequences. Since the collateral on these loans is the equity, or ownership, of your primary residence, defaulting on the HELOC will likely result in foreclosure and the loss of your primary residence.
Some investors fail to consider that a HELOC will act as an additional monthly expense on top of their regular mortgage. With that in mind, the financial implications of this loan should be explored at length before moving ahead with this type of borrowing.
Investment Property Down Payment Assistance
A conventional bank loan could also be a viable means for securing the funds needed to make a down payment on an investment property. Given the fact that private mortgage insurance typically does not exist for investment properties, potential borrowers will be held to a much higher standard than those seeking mortgages for their primary residences.
Not only is a high credit score an absolute must, but investors will often be required to demonstrate that they already have the funds needed to cover six months' worth of the expenses generated by the investment property. The loan to value ratio for the property must also be relatively low. If these parameters are met, it is quite likely that a borrower will qualify for a bank loan on their investment property.
As a general rule, investors should consult with their bank representative to determine what specific financial profile could result in the best interest rate possible on this type of bank loan. As always, investors can expect better terms on investment property loans with 10 percent down rather than investment property loans with no money down.
Ryan Cockerham is a nationally recognized author specializing in all things innovation, business and creativity. His work has served the business, nonprofit and political community.