Day 31 – Financing Investment Properties

Article number 31 needed to be helpful, impactful and relevant. What’s more relevant to landlords than financing investment properties?

My self appointed goal of writing a daily article for a month (go figure I picked a month with 31 days) is coming to a close, so let’s wrap this up with a bang.

Hopefully you’ve found the articles helpful and informative, I’ve received emails, and even a call from someone who’ve commented they haven’t been able to keep up, but have them stockpiled to go through as they are enjoying them.

So finish this up I’m going to talk about financing your properties as this has come up a few times with several landlords over the last month. It’s led to a a consulting call where I walked through ideas for one landlord to expand, to a referral for another new landlord to a local mortgage broker who was able to help him put financing in place and it’s helped provide answers to others at just the right time.

If you’ve enjoyed these leave me a comment, if you have questions or ideas for upcoming articles, again leave me a comment or send me an email and in the meantime I’ll try to come up with more articles and information to help us all become better, more educated landlords.

Onto financing!

Financing Investment Properties

Financing investment properties tends to be a challenge right from the start.

The rules and regulations seem to change and adapt as often as the wind changes making expanding and growing an ongoing challenge.

It seems every time I end up consulting with a landlord and explaining how we did things when we started I need to preface it with, “This is how it used to work.”

Understanding that the rules keep changing is one of the first steps. Being able to adapt as they change is a highly ranked number two!

Getting a loan for a rental property is simply not as easy as getting a mortgage for your home, so you need to prepare differently.

Downpayments For Investment Properties

This tends to be the biggest hurdle for new landlords or those expanding their rental portfolio.

Unlike residential mortgages where you may only require five or ten percent of the purchase price (or zero down when I started!!), for investment properties lenders typically want 20% or more before they even look at you.

And you have to prove you actually have the money by being able to show it’s been available for ninety days or longer!

Yep, it’s not enough that you have the money, you need to be able to show you’ve had it for awhile and that it’s liquid enough you can use it for the purchase.

Now you don’t actually need to liquidate it, but you have to show you have access to it which is an important distinction.

We kept a $100,000 investment portfolio active for the first five years of being a landlord just to show proof of funds.

We typically had money in our accounts that would cover all the downpayments for upcoming purchases, but due to the ever changing hurdles around investment financing it was just simpler to be able to show proof of downpayment from a stable ongoing source over and over and over.

Rules like having the money in your account for ninety days could often backfire as we would use the money in our accounts for flips, renovation projects etc and it would bounce up and down like a golf ball on cement.

So being able to consistently prove downpayments became a major concern, hence the investment account.

You need to think this through as you expand, or start out, and be able to prove consistent funds for purchasing and you should go over this with a mortgage broker to confirm it’s acceptable.

Even if you’re using Joint Venture Partners or other partners to help you fund purchases you’ll need to show there’s actually money on the table, or close to the table, somewhere. So be prepared.

Interest Rates For Investment Property Mortgages

This too is a moving target. For your personal mortgage you may be getting offers of super low rates, special offers and even incentives that it’s crazy not to accept them. After all, who can’t use a new toaster!

With an investment mortgage those offers seem to disappear and the more properties in your portfolio, the fewer options for even basic rental financing seem to be available.

Your interest rates will be higher almost immediately and as you add properties to your portfolio they not only continue to get higher, but the number of lenders who will deal with you will dwindle.

That great lender who was so excited to sign your first investment property usually has a cap on the number of loans or mortgages they will provide a single individual. It might be as low as a single property, or it could be five or even eight but there is a number.

If you’re not aware of this, out of nowhere you’ll hit that number without warning and suddenly find your current lender doesn’t want to play anymore and that there are fewer and less attractive options available than before.

If you know this will be a problem you can talk with your broker, or your bank, in advance so you are prepared for when you have to shift lenders.

As we got into double digit numbers of properties and kept growing past fifteen, twenty and upwards the number of lenders who would finance kept drying up. And along the way we’d see interest rates going up full percentage points plus additional “setup fees” added to the mix costing us even more money.

You’d think as you build up wealth and equity the lenders would become happier and happier with you, but in their inverse thinking the bigger you became the bigger risk they were involved with if you fail.

This is why many Real Estate investors transition from single family home style of investing to larger buildings. In the case of apartments or commercial buildings financing becomes about the building not you.

So be aware of potential higher interest rates and how it will affect your cash flow as you grow.

Debt Servicing

Debt servicing is fancy talk for the ability to pay your bills.

The majority of mortgage underwriters (the folks at the lenders who do all the sophisticated math to determine whether you qualify to have their money) use debt servicing as an indicator of whether you are good with paying money back and aren’t to heavily indebted.

The more indebted you are, the less money you will have to pay back the lender which for some reason they seem to think is a problem…

The challenge with debt servicing is how various lenders calculate this, often with their own in-house rules.

You might think having a $100,000 line of credit or HELOC would show you have adequate reserves in case of emergencies. At one point some lenders were talking about looking at this as an opportunity for you to spend $100,000 and calculate your debt servicing as if you had to pay that interest off every month, even when the balance is zero!

Imagine how that could have affected your ability to pay your debts. It certainly would lower your capability to make a mortgage payment which could affect your ability to borrow.

You constantly have to stay aware of rules changes and how your debt servicing can affect your ability to purchase that next property.

Another challenge they bring to the table is calculating cash flow or rental income. For their protection and to lower risk, many lenders will only take a portion of your actual net cash flow as income.

You may cash flow $1,000 a month from a property after all your expenses, but the lender may only count 50% or even 25% under their rules significantly lowering your debt servicing capabilities.

Understanding your debt servicing and the challenges associated with it are key to being able to expand past a handful of properties.

Working With The Financing System

You need to work with the finance system and within the rules if your goals are to move forward with a larger portfolio.

Sure there are options to get around some of the hurdles, like House Hacking and working with partners, who provide financing or simply moving to commercial mortgages, but a lot of it will come to preparation.

You’ll need to have good solid documentation (hmmm, just like you need documentation for your tenants, this documentation thing seems to be ongoing with Real Estate), good record keeping and a good hand to guide you.

You’ll need to check your credit scores fairly regularly (Equifax provides a free once a year credit check and there are many paid services that can monitor your credit for you on a daily basis). You’ll need to stay on top of your expenses and bills.

You might need to pass on that new vehicle if you intend to buy a new property in the new future as that extra monthly payment may affect your debt servicing. You might need to make smarter decisions about what you’re buying or financing going froward. You may need to focus on paying down a credit card or two as well just to make everything balance.

And you need to expect hurdles and change.

Owning investment property isn’t easy. If it was easy, everyone would do it.

That’s why those select individuals, like you, who make the sacrifices, who take the extra steps to learn and move forward and who are willing to strive for their goals ultimately get the benefit from it.

Financing investment properties is rarely easy, but it’s an important part so understanding what you need to do, understanding what you need to get prepared and moving forward through it are what will help you succeed.

So good luck with your Real Estate investing and your financing!

Did this help you understand financing rental properties a bit more? Was there more info you would like to have read about or that needs further explaining? Have a financing story to share? Leave us a comment!