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How to buy your first investment property

Buying your first rental property is one of the biggest investments and decisions that you can ever make. However, investing in real estate is one of the most proven, and in a lot of cases, the safest ways to build long-term wealth. 

By creating a portfolio of cash-flowing rental properties, you can create a passive income stream that will provide you with years of financial security. But before you get too far ahead thinking about owning multiple doors, first, how do you buy your first rental property?

In this article, we are going to cover all of the basics of buying your first rental property and show you different tips and tricks to get started.

Is buying a rental property the right thing for you?

The first step is to sit down and ask yourself whether or not buying a rental property is the right thing for you. There are a lot of different things to consider before making this decision, and you must understand all of the pros and cons before moving forward.

 

Some of the things that you should take into consideration are:

  • Are you prepared to be a landlord?
  • Do you have the time and energy to manage a rental property?
  • Do you have the financial resources to buy a rental property?
  • Are you comfortable with the risks associated with owning a rental property?

Many people believe that being a real estate investor is as easy as buying a rental property and putting a tenant in. But the truth is, there’s a lot more to it than that.

For instance, what if your tenant loses his or her job and stops paying rent? Are you prepared to seek legal action by preparing an eviction? Do you know the eviction laws in your state? Or what if your tenant doesn’t take care of your property or if something breaks that you need to contract someone and have it fixed? Are you OK with your tenant calling you in the middle of the night for a plumbing issue?

These are just a few things that you need to think about before embarking yourself on the road to buying your first rental property.

Often, real estate investing “gurus” label real estate as a means to get rich with passive income, and it’s true, it can happen, but you must understand that for your rental property to cash flow, you have to put some work into your business.

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How to get a mortgage to buy your first rental property?

Buying a rental property will require a bigger investment than purchasing an owner-occupied home. Because investment properties carry more risk to the lenders, you can expect higher requirements for down payments and interest rates. 

However, as far as getting financing is concerned, there are multiple routes. 

Let’s dive into each one of them:

Buying your first rental with a conventional loan

Conventional loans are the most popular home buying programs available in the market. They are loans that are backed or purchased by government-sponsored entities like Fannie Mae and Freddie Mac as well as private institutions.

These loans comply with government guidelines and the financing is offered through lending institutions. You may already be familiar with a conventional loan as it is a popular mortgage for owner-occupied properties.

What is the minimum down payment you need to buy your first rental property for a conventional loan?

Most lenders require a minimum down payment of 20%  but the truth is, some options allow you to purchase with a minimum of 15% down. However,  condominiums and multi-family homes from 2-4 units, require as much as a 25% down payment.

In addition to the down payment, lenders will require you to have as many as 6 months of PITI reserves.

PITI stands for principal, interest, taxes, and insurance. This means that you will be required to have 6 months’ worth of your housing expense in the bank. 

For example, if the total monthly payment of your rental property is $2,500/month, you will need to have $15,000 in reserves ($2,500 x 6 months).

How much should you save to buy your first rental property?

Let’s run through an example of how much you will need for a down payment and reserves for a $300,000 investment home, assuming a 6.5% interest rate.

 

Purchase Price: $300,000

Down Payment: 20% or $60,000

Starting Loan Amount: $240,000

Interest Rate: 6.5% – 30 Years Fixed

P&I: $1,516.96

Homeowners Insurance: $100.00/month

Property Taxes: $250.00/month

 

Total Monthly Payment: $1,866.96

 

Six months of reserves: $11,201.78 ($1,866 x 6 months).

 

Down payment + Reserves: $71,201.78

One thing to remember is that reserves are not an additional fee or more money that you need to bring to closing but rather, are required by the lender to protect you in case of an emergency.

The lender only requires you to have this money at the time of closing in any of your asset accounts

Buying your first rental property with a Non-QM loan

A Non-QM loan is a loan option for borrowers who may not fit into the strict guidelines of a conventional loan. A Non-QM loan still follows responsible lending standards but offers more flexible solutions for certain types of borrowers. This type of loan is perfect for self-employed individuals or anyone who doesn’t fit into the conventional mold.

 

To qualify for a Non-QM loan to buy your first rental property, you must meet the following requirements:

 

Down payment: The minimum down payment is 20% for single-family homes. However, the minimum down payment for condominiums and multi-family properties is 25%.

 

Some very popular Non-QM loans include: Bank Statement Loans, Asset Depletion Loans, P&L Loans, 1099 Income-Only Loans and DSCR Loans.

 

To qualify for a Non-QM loan to buy your first rental property, you must meet the following requirements:

 

Bank Statement Loans

A bank statement loan is a mortgage program for self-employed individuals or business owners who cannot show their income taxes to qualify.

This loan is perfect for business owners in the gig economy or those who are 1099 contractors who have a lot of deposits in their bank accounts.

Asset Depletion Loans

An asset depletion loan is a mortgage program for borrowers who may not have a steady income but have a large number of liquid assets.

This type of loan is perfect for retirees or anyone who doesn’t have a regular income but has money saved up in the bank. Asset Depletion Loans require borrowers to have the ability to cover the loan amount in their asset accounts.

P&L Loans

A P&L loan is a mortgage program for self-employed individuals or business owners who cannot show their income taxes to qualify.

It can be a perfect for business owners who have a lot of expenses and may not be able to show a profit on their taxes. P&L loans use the cash flow of the business to qualify the borrower. The P&L must be prepared by the borrower’s CPA.

1099 Income Loans

A 1099 income-only loan is a mortgage program for self-employed individuals or business owners who cannot show their income taxes to qualify.

This loan is a great solution for contractors and gig workers who receive a 1099 from either one or various contracting jobs.

DSCR Loans

A DSCR loan is a mortgage program for borrowers who are looking to buy income-producing rental properties.

It is the solution for real estate investors who are looking to purchase a property and rent it out. The DSCR loan uses the income of the property to qualify the borrower.

Are interest rates higher on rental properties?

Yes, interest rates for rental properties are higher than owner-occupied or second homes. This is because lenders view rentals as being riskier.

 

If a tenant stops making rent payments, the landlord may have difficulty finding new tenants, leading to a loss of income. As a result, lenders often charge higher interest rates on rental properties to offset this risk.

 

The market changes daily and rates for investment properties are not publically posted but typically, rates can be anywhere between 1 to 1.5% higher than owner-occupied properties.

 

What is the best property to buy for a first-time investor?

When it comes to investing in rental properties, there are many different options to choose from. For those just starting, it’s important to carefully consider all of the different types of properties available and decide which one is right for you.

 

The easiest type of property for many first-time investors is the tried and true, single-family home. Single-family homes are usually fairly easy to finance and manage, making them a popular choice for investors.

 

Another common type of rental property is multi-family homes. In residential real estate, multifamily homes are 2-4 unit homes such as a duplex, triplex, or quads. These types of properties offer the potential for higher returns, as you can rent out multiple units.

 

Other types of investment properties are condominiums and townhomes. These are often popular choices for investors because they can offer the amenities and features of a single-family home without the hassle of yard work and maintenance.

 

However, it’s important to keep in mind that condominiums and townhomes are maintained by homeowners associations, which have HOA fees that can eat into your profits or rules that could limit your ability to rent out the units. Before purchasing a home in an association, be sure to carefully review the HOA rules and bylaws.

 

What makes a good ROI for your first rental property?

The answer to this question depends on several factors, including the type of property you’re investing in and the location.

 

For example, a duplex in a high-rent area is likely to have a higher ROI than a single-family home in a small town. The same is true for an investment condo versus a townhome.

 

It’s also important to consider the costs associated with owning and managing a rental property. These costs can include things like mortgage payments, insurance, property taxes, HOA fees, and repairs and maintenance.

 

In general, you can expect a good ROI if your rental property is able to generate enough income to cover all of your expenses and still leave you with a profit.

ROI is relatively easy to calculate using the following formula:

ROI = Annual Returns / Cost of Investment

 

ROI is calculated by taking the rate of return and dividing it by the amount invested. For example, if an investment generates annual returns of $25,000 and a cost of $300,000, the ROI is 8.34%.

 

ROI = $25,000 / $300,000= 8.34%

 

The 1% and 2% rule

The 1 percent and 2 percent rules can help you analyze properties to see if they’re worth investing in. By doing some simple math, investors can weed out rental properties that aren’t good deals. 

The 1 percent rule in real estate is a way to calculate if the monthly rental income earned from the property is worth more than, or at least equal one percent of the purchase price.

Monthly Rental Income ≥ One Percent of Purchase Price

If the property rents for $3,000 per month, after a quick calculation, you know that the purchase price should be around $300,000.

Remember that the value of a property is not because of how much a property can be rented out but rather, of what the market dictates.

Is now a good time to buy your first rental property?

There’s no simple answer to the question of whether or not now is the right time to buy your first rental property.

A variety of factors – from the current state of the housing market to your financial situation – can affect whether or not it’s a good idea to invest in a rental property at any given moment. 

However, if you’re carefully weighing all of the potential risks and rewards, there are a few general things to keep in mind that can help you decide whether or not now is the right time for you to buy a rental property.

First, consider the state of the housing market in your area. If prices are rising and properties are in high demand, it may be a good time to buy. On the other hand, if prices are stagnant or falling, you may want to wait and see how the market develops before making a purchase.

But don’t let a falling housing market keep you away from purchasing your first rental property. This may be an excellent time to pick up a good deal from someone motivated in selling.

Next, think about your financial situation. Do you have enough saved up for a down payment? Do you have a stable income that can cover future repairs and maintenance costs?

If so, you may be in a good position to buy a property now. However, if you’re still working on getting your finances in order, it may be better to wait until you’re more prepared.

Ultimately, only you can decide whether or not now is the right time to buy your first rental property. By considering all of the relevant factors and taking your unique circumstances into account, you can make an informed decision that’s best for you.

Wrapping it all up

It’s important to do your research and weigh all of the pros and cons before making any decisions about purchasing your first rental property. By taking the time to think things through and carefully consider all of your options, you can help ensure that you make the best decision possible for your unique financial situation.

 

Doing your research and finding out the financials of your first real estate deal are the first steps you need to consider when getting started. Andes Mortgage offers competitive interest rates and has experience in helping people buy their first rental property. You can apply online or call one of our representatives to get started.

 

Start your home purchase journey

Get answers to your questions and save thousands on your home loan by comparing different programs and interest rates. 

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