How to Finance Your Investment Property Using Little or None of Your Cash
A lot of the information online about financing an investment property is just long lists with ways you can buy a property with no money down. Most of the methods will not be successful for new investors because they are either wrong for today’s market conditions or they require skills that new investors don’t possess.
I want to present to you real doable ways that you can use to get started in real estate investing, ways that will work for 99 percent of new investors.
Let’s look at why you should buy with little or no down even if you have cash
In the last week’s cash flow video, I showed you how the cash-on-cash rate return on investment is improved dramatically if you use other people’s money. This strategy is not without risk. Many investors have lost their entire portfolios because they used leverage without keeping cash reserves and without having financial discipline.
Leverage speeds up your wealth-building but can also magnify your losses.
Why leverage is so important?
With leverage, even a small percentage appreciation can increase your Internal Rate of Investment and cash-on-cash return substantially.
Here is an example: If you purchase a $200,000 property with a $7,000 downpayment, with an appreciation of 4%, your equity in ten years will be worth approximately $118,000, which is an 85% Internal Rate of Investment.
Let’s look at the cash-on-cash return.
If you buy the $200,000 property with a 20% downpayment and your Net Operating Income is $18,000, your cash-on-cash return will be 33%.
On the same property, if your downpayment is 3.5% and everything else is the same, your cash-on-cash return will be 131%.
Using Leverage wisely, having adequate cash reserves, and living below your means will accelerate your wealth-building.
How do you minimize your downpayment?
The easiest and safest way is by using owner-occupant financing.
Many loan programs offer from 0% to 5% downpayment. Some lenders will even give you the money to rehab the property, all with a low-interest rate and high LTV loan.
The credit scores required for these loans are lower than those required for conventional loans.
While this is not available for all investors, if this is your first investment property, take advantage of the low or no downpayment loans insured by the government.
These loans are available for owners who plan to live in their property for at least 12 mos. Also, if you live in the property for at least 2 years, the IRS allows you to exclude $250,000 of capital gains on real estate if you’re single and $500000 if you are married.
How to maximize this strategy and make the most of the owner-occupied mortgages?
Why not take advantage of these loans and buy a fourplex?
You can live in one of the units and rent the rest. This way you will have a primary residence as well as three additional rental units.
Begin building wealth by selecting from the loan programs that suits your need the best.
Types of Low-Down-Payment Mortgages
FHA – Loans insured through the Federal Housing Administration
The Federal Housing Administration offers low downpayment loans. FHA insures these loans which makes them attractive to lenders thus the low downpayment requirement.
There is a mistaken belief that these loans are for low-income homebuyers. As long as the property is below the current FHA price you can get an FHA loan. Each county and type of property has a different limit (link to HUD mortgage limit search page).
For example, the limit for an SFH in Alameda County, CA is $765,600, while the limit for SFH in Hillsborough County, FL is $331,760. Don’t forget that you can finance a four-family home and the limit for that is higher. For example in Hillsborough county, the limit for a four-family home is $638,100.
The FHA loans are easier to qualify for but have extra costs in the form of mortgage insurance.
If you found a property that will be a perfect rental but needs a lot of work, you can use FHA (203)K for both the purchase and the rehab of the property.
The rehab has to cost more than $5,000 and can be as extensive as a full rebuild as long as the foundation remains in place.
Here are some of the improvements you can make with this type of loan.
- structural alterations and reconstruction
- modernization and improvements to the home’s function
- elimination of health and safety hazards
- changes that improve the appearance and eliminate obsolescence
- reconditioning or replacing plumbing; installing a well and/or septic system
- adding or replacing roofing, gutters, and downspouts
- adding or replacing floors and/or floor treatments
- major landscape work and site improvements
- enhancing accessibility for a disabled person
- making energy conservation improvements
Locate a lender specializing in these loans. You can search Rentce’s directory. We have several lenders listed, who actively originate this type of loan.
Are you a veteran with eligible active military service?
Consider applying for a VA loan. These are the benefits:
- No downpayment
- Easy qualifying
- Closing costs can be paid for the veterans
- Buy up to four units
- The loan is assumable
- No mortgage insurance
Find a lender who is experienced in handling VA loans. They know what’s required for approval and will guide you through the paperwork.
The other lesser know loan is the USDA loan. They offer financing with no down payment, reduced mortgage insurance, and below-market mortgage rates.
USDA loans are mortgages insured by the U.S. Department of Agriculture as part of its Rural Development Guaranteed Housing Loan program. USDA loans have income restrictions and are generally available only in suburban, rural areas.
And finally, even FannieMae and Freddie Mac have loans that are available with as little as 5% down. They are a little tougher to qualify for and better for borrowers with higher credit. Their loan limits are higher than FHA loans.
It doesn’t matter if you currently own a property or rent, consider financing your investment property with a no or low downpayment owner-occupied loans.
Here is our Q&A video on this topic
Transcript from the Q&A video
No Downpayment Options Q&A
Do you know what is the income eligibility for a USDA loan?
I think it’s 118% of the median household income. In Hillsborough county that $56,000 so you can’t be making more than $66,000.
You have to check if the location of the property you are considering qualifies as well. Go to the USDA website, they have a map.
How do I reduce my closing costs?
- Increase the sales price and ask the seller to contribute to your closing costs. FHA allows up to 6% contribution towards closing costs.
- Anyone participating in the sale can contribute towards closing costs, realtors, builders, lenders.
- Ask your lender to include the closing costs in the loan – this is available for FHA and VA loans but it increases your monthly payments.
What if I don’t want to live on the property for a year?
Unfortunately, you can’t take advantage of the owner-occupant loans.
I will talk about this in the next week’s video but some suggestions are:
- Find a private lender to finance your downpayment and give them a promissory note. Private lenders are your friends, your mom, anyone who likes you and knows you well. Show them how you are going to use the money and when they will get it back.
- Seller financing – although in this market this will be a hard sell.
- Find JV partner to finance downpayment and rehab and give equity
- Buy the property subject to the existing mortgage.
- Buy the property at 50% of ARV, get a hard money loan for 65% and use the extra money to fund the rehab, refinance.
Watch next week’s video for more options.
Can I take a loan from my 401K for the downpayment? I’ve heard I am allowed to do so without penalty because of Covid.
I am not sure what’s involved in that. I will discuss this with an accountant. I think you have to show that you are impacted in some way.
Can you be gifted money for a downpayment in an FHA?
Yes, from family for the most part. But also your employer, charitable organization, and government agencies that provide homeownership assistance.
My friend would like to live with me if I purchased a house and is willing to pay his rent upfront to help cover any downpayment or closing costs. Would a lender allow this?
The money for downpayment has to come from a verified and approved source. Your relationship with your friend has to be verified and the gift money cannot be repaid. It probably is possible, talk to your lender.
I have stumbled over a good opportunity that is listed for 150k. I have the ability to get 65% financing yet lack a downpayment. Do hard money lenders do smaller amounts around 53K?
Hard money lenders generally don’t do second mortgages. However, if this is a great deal, they may lend you the whole amount.
Check our hard money lender directory. I will include a link in the description.
This is not a question about downpayment but qualifying?
If someone has had a bankruptcy, do they have to wait 7 years to get a mortgage?
Conventional loans and FHA have different rules about this. Also, different types of bankruptcies are treated differently. FHA and VA I think have 2 years waiting period after the discharge of the bankruptcy and I think conventional loans have 4.