Real estate investment is not only a proven way to generate steady and passive income, but you can also use it to diversify your investment portfolio and build equity over time. However, the process of investing in real estate or investment properties often turns complex, especially when an investor requires to borrow loans to finance a property.
Financing investment property is an expensive affair, and investors often decide to seek help in the form of loans or mortgages from financial institutions like banks or mortgage brokers. One of the biggest challenges, an investor needs to overcome is arranging money to clear the down payment.
The down payment can be a confusing and challenging part of the process, and you must have a clear idea about this hurdle. In this blog, we will talk about everything you need to know about the investment property down payment and the best way to prepare for it.
Everything You Need to Know About Investment Property Down Payment
Before you think about how to clear the hurdle of the down payment for investment property loans or mortgages, you must come with a clear understanding of what is the down payment and why your lender asks for it.
In straightforward terms, down payment is a security deposit a lender requires as collateral for the loans you have obtained. The percentage of down payment depends on the type of loans you have applied for, the kind of property you have, your credit score, loan history and other factors.
Lenders feel insecure when they deal with investment properties, as there are huge chances for the borrowers to turn defaulter for a property, which they do not use. Hence, If you opt for traditional mortgages for investment properties, you have to arrange cash reserves for a down payment along with excellent credit score and loan history.
For example, if you are planning to purchase an investment property worth $100,000, you have to pay 20% of the value of the targeted property. However, traditional mortgages or loans for primary homes are different than loans for investment properties in terms of guidelines and criteria. Here are some takeaways you need to keep in mind before applying for loans or mortgages.
- Since mortgage insurance is irrelevant to investment property’s loans, your lender will ask you to come up with a minimum 20% of the current value of the target property, as the down payment
- The more you will deposit as down payment, the more opportunities you will get to lower your interest rate. Also, if you can pay more as down payment, you will be able to reduce your monthly payment
- Your credit score and loan history can play a significant role here. Investors with the worst credit score and loan history will find it challenging to qualify for investment property loans.
- Guidelines and criteria for investment property loans can vary from one lender to another.
Best Ways to Prepare for Investment Property Down Payment
If you are planning to purchase an investment property with the assistance of banks or mortgage brokers, you have to prepare to deposit a percentage of money in the form of down payment. Although you can hardly find any way to hedge the factor, you can lessen the percentage of down payment and make it an acceptable option. Here are some ways to get prepared for investment property down payment.
Your Credit Score Impacts Down Payment
Your credit score is going to be a significant factor, as it will determine the category you will fall into the process. An excellent credit score can benefit you in many ways. From lower interest to the minimum down payment, you can enjoy many relaxations with a better credit score.
For example, if you want to reduce the percentage of your down payment below 25%, you have to come with more than 700 or higher credit score. Since financing an investment property is an expensive affair, every investor wants to pay as a minimum down payment as possible.
However, you can secure it as less as 15% by coming with a better credit score. If you come with a 720 credit score or more, your lender may agree to reduce the percentage of the down payment as low as 15%.
Role of Debt-to-Income Ration
The debt-to-income ratio or DTI is another crucial factor you need to take care of when seeking a reduction in the percentage of down payment. If you come with 35% or less DTI and less than 650 points as credit score and apply for investment property loans or mortgages, you may have to pay a 25% down payment.
Also, if you come with 40%-45% DTI, you will need more than 650 points as a credit score to qualify for the same 25% down payment. However, if your credit score is 700 or more, you can be eligible for less than 25% down payment. Hence, we can say that there are ways to decrease the percentage of down payment.
Follow House Hacking Method
The basic concept of house hacking is that investing in multifamily property and use one unit, while the rest one can use for income. If you do not have a multi-unit property, you can spend some money to add additional spaces to rent out.
However, whether you already own a multifamily property or you have a reconfigured property, if you live in that house, you can be eligible for a low down payment. Loans or mortgages for owner-occupied properties are flexible, and you can get investor-friendly loan terms from your lender. Along with lower down payment, you can also qualify for lower interest rates and minimum monthly payments.
One of the crucial factors in this option is that you have to reside in one of the units in the property for at least a year after obtaining the loan or private mortgage.
Borrowing the Down Payment Using Alternatives
You cannot request the banks or mortgage brokers to sanction another loan for investment property down payment. It is better to try other alternatives and sources to borrow the amount you need to pay as a down payment.
You can apply for a personal loan or borrow the money from any private source. There are some ways through which you can raise funds to arrange the down payment for investment property loans.
You can also opt for a line of credit or home equity loans, as these types of loans are supported by the equity available in your current primary property. You can get this type of loan with low-interest rates and affordable monthly payments.
Personal loans are also a viable option for investors seeking an alternative to arranging money for the investment property down payment. Personal loans are one of the most popular loan options, and you can obtain up to $100,000 through this option. If you come with an excellent credit score, your interest rates for the personal loan can be less than investment property mortgages.
However, before seeking help from any reliable source, make sure that you have an excellent record of repayment. Before sealing any deal, never forget to learn about the terms and conditions, including interest rates and repayment procedures.
These are some of the convenient ways to manage or reduce the percentage of the down payment for investment property loans or mortgages. However, before you think about paying less as down payment, make sure you are ready for the drawbacks. Paying more as a down payment is always beneficial for the investors. If you are investing in rental property, the increased down payment will allow you to enjoy some perks. Higher down payment means higher equity, and there can be a sharp reduction in the interest rates and monthly payment. However, in some cases, investors find it tough to arrange the down payment and seek financial assistance from other sources to obtain investment property loans or mortgages. To learn more about available options for investment property down payment, you can consult financial experts or reliable mortgages brokers.