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May Q&A: Available now
This month, the Making Sense team answers client questions related to trade policy developments and their impacts on key economic issues.
Without a doubt, smart financing can help you become a successful property investor. When you buy a home, you typically apply for a mortgage—but that might not be the best choice if you're investing in real estate.
Overextending yourself with several large loans, combined with the costs of maintaining a rental property or multiple properties, can add up. Ongoing repairs, long-term vacancies and late-paying tenants are just a few of the challenges property investors face. If you fall behind, or become overleveraged, you might have difficulty securing credit in the future.
Generally, loans for rental properties are viewed as higher-risk than a mortgage on your primary home. Banks may not consider income from rental properties when reviewing loan applications. Instead, you'll need to show that you have adequate income and savings to support the new mortgage. As an investor, you should also expect your interest rate to be higher than the rate for a primary home loan.
Your long-term objectives should be considered when choosing between loan options. A longer-term loan with a lower monthly payment may increase your cash flow, but you'll pay more in interest over the life of the loan. A shorter-term loan increases your payment, but you'll build equity faster and pay less in interest.
When starting out, you may choose to finance a rental property similarly to a primary home with a mortgage loan. For serious, long-term investors, additional options are worth considering. Some of the alternatives include the following:
Before you purchase an investment property, consider using one or more of the following strategies to avoid becoming overleveraged:
Increasing your cash down gives you more equity from the get-go and allows you to keep your debt-load manageable. A higher down payment may also be more attractive to sellers.
You may be tempted to use the income from your rentals for personal spending. However, in the early years, your focus should be on building equity, not generating excess cash flow. The more equity you build, the less you'll owe to others. If you find yourself with excess cash, it's a good idea to pay down or pay off some of your loans—or save the cash to invest in another property, if a good deal comes along.
When you're first starting out as an investor, chances are you may not qualify for the best interest rates. As you build your portfolio and show steady income from your properties, you may be able to restructure or refinance some of your loans and find better terms.
An experienced investor will investigate the average rent charged for a property, along with maintenance costs and expected renovation expenses. Combined with financing costs, this data allows you to analyze the profitability of a specific investment. You'll need to understand the costs of bringing the property into a habitable condition compared to how much a tenant will be willing to pay to live there.
When you're scouring the market and not finding what you want, sitting back may be the best alternative. Rather than overpay for a rental, you may want to look at your existing portfolio and focus on increasing property management revenue. This strategy will help ensure you're able to weather the ups and downs of the market without being forced to buy a property that might not give you the return you need.
Investing in residential rental properties can provide a supplemental income stream to carry you into retirement. Understanding your risk tolerance and risk capacity will help determine the right timing and type of real estate investment that works best for you. Aim to structure your financing to reduce your leverage, which can help you achieve long-term success as you grow your portfolio.
This material is for informational purposes only and is not intended to be an offer, specific investment strategy, recommendation or solicitation to purchase or sell any security or insurance product, and should not be construed as legal, tax or accounting advice. Please consult with your legal or tax advisor regarding the particular facts and circumstances of your situation prior to making any financial decision. While we believe that the information presented is from reliable sources, we do not represent, warrant or guarantee that it is accurate or complete.
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