Financing and Buying an Investment Property

  • July 19, 2023
  •   •  
  • 4 min. read time
modern corner apartment complex with blue colored windows and light leaks

Investing in income property can be a crucial step toward achieving financial independence and building wealth for future generations. Whether your aim is to generate rental income, take advantage of tax benefits, or both, owning an investment property can expedite the accomplishment of your long-term goals.

However, financing and acquiring an investment property require careful planning and consideration. It’s important to understand the various types of investment properties available to you. But before delving into those details, let’s explore why purchasing an investment property can be a wise decision:


  1. Rental income: By renting out your property, you can earn a steady stream of cash flow and passive income.

  2. Appreciation: Real estate investments have the potential to increase in value over time, allowing you to build equity and enhance your overall investment. Making improvements to your property can further boost its value and enable you to command higher rental rates.

  3. Diversification: Adding an investment property to your portfolio helps spread out risk and reduces the overall volatility of your investments.

  4. Tax benefits: Real estate investments offer several tax advantages, such as deductions for mortgage loan interest, operating expenses, property taxes, insurance, and depreciation.

  5. Inflation hedge: Investment properties, including most residential homes, tend to hold their value and often appreciate over time, providing a hedge against inflation.


How to Finance and Buy an Investment Property


Now let’s discuss how to finance and purchase an investment property. Financing is typically the most challenging aspect of any home purchase, often involving a considerable amount of paperwork and calculations to evaluate your income, debts, and potential impact on your monthly budget. However, mortgage lenders and experts like Preferred Rate are available to guide you through the process, taking into account your specific financial situation, goals, and available options.


If you are considering investing in real estate, here are some steps to get you started:


  1. Establish clear investment goals: Define the type of property, desired location, budget, expected returns, and timeline.

  2. Assess your finances: Evaluate your credit score, calculate your savings for a down payment, and organize the necessary documents for loan pre-approval. Most mortgage lenders require a minimum credit score of 620 for investment property purchases. Preferred Rate, for instance, accepts a down payment as low as 15% for single-family investment properties and 25% for multifamily properties. It’s important to note that many lenders may also require six months’ worth of cash reserves and private mortgage insurance (PMI) if your down payment is less than 20%.

  3. Consider interest rates: Interest rates for investment properties are generally higher than those for primary residences due to the perceived higher risk for lenders when the property is not owner-occupied.

  4. Understand loan-to-value (LTV) ratio: Investment properties often have stricter LTV requirements, meaning you may need more equity or a larger down payment to meet these requirements. Preferred Rate offers up to 80% LTV.

  5. Analyze your debt-to-income (DTI) ratio: Lenders will examine your DTI ratio, which compares your monthly debt obligations to your monthly income. For investment properties, there might be more stringent DTI requirements, although lenders usually consider rental income when calculating this ratio.

  6. Compare financing options: Many loan options available for primary residences can also be used for investment properties, including conventional loans, FHA loans, VA loans, and jumbo loans.

  7. Do the math: Calculate the potential return on investment (ROI) by factoring in rental income, expenses, mortgage payments, and vacancy rates. Additionally, consider the long-term mortgage payments, which can extend up to 40 years if financed through Preferred Rate. It’s essential to ensure you can handle tenant turnover, regular maintenance, updates, and both expected and unexpected repairs.

  8. Consider maintenance and property management: Determine whether you want to hire a property manager to handle tenant screening, rent collection, and property maintenance. While property managers can be beneficial, remember to account for their cost in your monthly budget.


Types of Investment Properties 


Next, let’s explore the different types of investment properties available:


  1. Single-family homes: These properties are ideal for securing long-term tenants and, depending on local laws and homeowners’ association (HOA) regulations, can also be used for short-term rentals.

  2. Multifamily properties: These properties consist of two to four units or even entire apartment buildings, allowing you to accommodate multiple renters and collect higher monthly rent payments.

  3. Condominiums: Purchasing a unit in a condominium complex provides the opportunity to rent out the property. However, it’s crucial to understand the building’s bylaws and restrictions.


A Little Info on Airbnb


Before investing in real estate with the intention of renting it out on platforms like Airbnb, it’s essential to familiarize yourself with local regulations governing short-term rentals. Cities often have specific rules, permits, or limitations for Airbnb rentals. Complying with legal requirements and understanding any potential restrictions in your desired location can help you avoid legal complications or unexpected issues.


Consider properties with features that appeal to travelers, such as proximity to attractions, adequate space, desirable amenities, and a welcoming atmosphere. Evaluate the property’s layout, number of bedrooms, parking availability, and outdoor spaces to offer a unique and comfortable experience for guests. While owning an Airbnb can be profitable, it’s crucial to consider the long-term sustainability of your property. Look for areas with economic stability, diverse tourism sources, and growth potential. Anticipate market changes or regulatory updates that could impact your business and evaluate your ability to adapt.


Second Home vs. Investment Property


It’s important to note the distinction between a second home and an investment property. While an investment property can be your second home, there are significant differences between the two. Financial requirements, financing options, cash flow potential, and tax benefits vary depending on whether the property is classified as a second home or an investment property. A second home is primarily intended for personal use, such as a vacation home, and typically needs to be located at least 50 miles away from your primary residence. Renting out a second home is generally limited to a maximum of two weeks per year.


Although investment property purchases involve financial requirements, obtaining a mortgage loan for an investment property can be made easier with the assistance of professionals like Preferred Rate. We can guide you through the guidelines, options, and strategies to position yourself for the best chance of success. Reach out to a mortgage advisor at Preferred Rate to learn more about your investment property financing options.