Buying a rental property is a common yet one of the great way to build wealth and passive income. But what's the best way to purchase the property? That depends on your financial situation and goals. Below are a few ways you can finance a rental property, along with some ways to identify and buy a rental property.
Rental Property Financing Options
One of the most common ways to purchase property is with cash. Why? Because you don't have to worry about mortgage payments, interest rates, qualifying for a loan, or any closing costs. You buy it in cash, and that's it.
Getting a mortgage is the most common way for investors to buy investment properties, especially when buying a home for personal use. The process involves applying for a loan and then making payments until it's paid off. Once you're free of the debt, you can rent your property and make money from it.
Getting an FHA loan
If you're looking to buy a rental property, an FHA loan or another mortgage with a low credit score and/or cash down is likely your best bet.
FHA loans are mortgages approved by the federal housing association that has been around since 1934. They're easier to get than conventional mortgages because they require lower down payments (a minimum of 3.5 percent) and lower credit scores (as low as 580). This makes them ideal if you are a first-time homebuyer or can't afford much of a down payment on your own. Plus, unlike other types of mortgages, FHA loans don't require private mortgage insurance (PMI), making it less costly.
Selling financing might be a good option if you don't have enough cash for your down payment and closing costs. Seller financing is when the seller loans you the money to buy it instead of you getting a mortgage from a lender.
Seller financing helps you get into real estate investing with as little as 8% to 10% down on their purchase price. You will then make monthly payments directly to the seller until you've paid off their loan in full, at which point they own the property free and clear. This means that the seller will collect rent from you or other tenants.
The benefits of getting financing from the seller are that:
· You can buy a property with zero money down because all or part of your down payment will be made via an owner-financed loan.
· You could potentially get approved for a larger loan than if you tried to get traditional financing from a bank, especially if the market value of your home is near its assessed value. This is called being underwater.
· If things go wrong with your rental business plan or finances, there's less risk of losing both time and money since this type of deal requires little or no closing cost on your part and short balloon payment, at least three to five years.
The drawback is the interest rate with seller financing tends to be lower than with most traditional mortgages.
Through an IRA
You'll need to create a self-directed IRA account to buy a rental property through an IRA.
Once you have your account, you can invest in real estate in your account. You'll be able to purchase single-family homes, multi-family properties, or commercial buildings like retail stores, but nothing out of real estate investment. You can also set up an LLC that owns the rental property and use this as your vehicle for purchasing real estate investments using your IRA account.
This is one of the most beneficial ways to start investing in real estate because it gives you access to potentially lucrative tax deductions while protecting you against loss if the market turns south during any given year.
If you don't have the money to buy a house and you're not interested in renting out your own home, then you might be interested in buying a rental property through wholesaling.
Wholesale is a process by which an investor finds buyers for other people's properties to make money off the transaction.
The first step in wholesaling is finding someone with an available property that isn't selling for some reason, maybe the price is too high, or it needs work. Once you find such a property, you arrange to buy it from the owner at an agreed-upon price. Then you turn around and sell it on behalf of your client to another investor or landlord who might be willing to pay more than what you paid for it and then pocket the extra cash for yourself.
You won't need any special license or training. However, it's important to remember that when you're wholesaling real estate, you will represent the seller in their negotiations with potential buyers, so make sure you know what you're doing.
Use a lease option to purchase
A lease option is a contract between the owner and the buyer that gives you, as a buyer, the right to buy the property at some point in the future.
You'll need to make sure that your lease option contract includes all of these key points:
· A specific purchase price for when you decide to buy it.
· The time until your option expires (usually one or two years).
· Whether there's a penalty for canceling at any time before closing on the sale date (no penalties are common).
Where to Find Rental Properties to Buy
Real Estate Sites
Sites like Realtor and Zillow are great ways to learn about local real estate and find homes for sale. Zillow also has a lot of information about properties, making it a good place to start looking for rental properties.
· You can search for homes by city, neighborhood, or price range.
· You'll see pictures, floor plans, and features of each property on their website, so you have an idea of what the house looks like before you visit it in person.
· These sites allow you to filter listings based on price point, bedrooms/bathrooms, square footage, etc.
It's hard to find the right one when you're looking to buy a rental property. You could use a real estate agent, but that can cost a lot of money and take a long time. Instead, try going off-market.
Off-market properties are homes that aren't listed on the open market. They're usually owned by people selling them directly, but they don't want to list them with an agent.
To find these properties, start by looking for ads in the newspaper or wholesalers, which will often have listings for off-market properties. If you find one that looks promising and wants to learn more about it, send an email asking if you can set up a meeting with the seller or owner at their home or office. As a buyer, you have to network with the right people who can help you find a good deal on a home that's not listed for sale.
Other ways to find these properties include direct mail, word of mouth, builders, public records, and contractors.
The market for off-market deals is a lot like the stock market. You need to be able to predict when there will be a dip or a spike in the price of properties, and you need to know what kind of property you want.
Related Reading: Can You Avoid Paying Capital Gains Tax on a Rental Property?
Working with a real estate agent
Working with a real estate agent can be a great way to find your ideal rental property. When you work with an agent, they're usually able to show you a wide variety of options in your chosen area. They know about current listings and can help you negotiate with sellers.
The benefits of working with a real estate agent include:
- Can show you properties that meet your criteria
- Know about current listings and can help negotiate prices
- Have contacts with other agents who may be able to show you additional properties that aren't listed yet
- Help you find financing, if necessary.
- Real estate agents often know who the best property managers are and will be able to recommend them to you. They'll probably have a good relationship with those property managers, which means they'll have more leverage when negotiating rent prices or terms of the agreement.
Cold calling is a strategy that many investors use to find off-market deals. Cold calling involves contacting sellers directly rather than working with an agent who will represent you.
You can start cold calling by printing out a list of properties that have come up for sale in your area recently and then making phone calls to each one. You can also try calling old clients or friends and asking them if they know anyone interested in selling their property. Another way is asking real estate agents if they have any listings you might be interested in.
Some investors prefer emailing their prospects instead of speaking with them over the phone since it's easier to exchange information via email than over the phone. You could even try using social media sites like Facebook or Twitter as another way to connect with sellers directly without having to call them up directly.
Google Maps is a great and fast way to find houses for sale. You can use the satellite view to see what the house looks like and the street view to see what the neighborhood looks like.
Google Maps also lets you look up specific real estate listings, so it's a good idea to do some research on any property before you decide whether or not it's right for you.
Protect Your Rental Property with Landlord insurance
Property owners are not required to have a landlord insurance policy to rent out their property. Though landlord insurance is not mandatory, we recommend that property owners seriously consider purchasing a policy in order to cover damages that come up from being a rental property owner.
Benefits to having landlord insurance
When you have landlord insurance, liability insurance will be automatically included in your policy. This means you will be protected from legal fees and medical expenses in the event that a tenant or a guest is injured at your rental property due to a covered loss and comes after you for damages. Instead of you having to pay out of pocket for these expenses, your liability coverage will cover the costs. The amount your insurance company will cover will depend on the amount of coverage you chose to have when you purchased the policy.
Rental Property Coverage
This type of coverage protects the property itself from covered losses and helps protect your insurable interests. For example, if your property is destroyed by a fire or tornado, or suffers significant water damage from burst pipes, your landlord insurance covers the replacement costs necessary to fix the property. The amount of coverage will depend on your insurance policy and the amount of property damage the building suffers.
Note: Sometimes people are confused with replacement costs and functional replacement costs. Functional replacement costs are when the damaged property/item is replaced with an alternative that functions the same but is of lower quality.
Related Reading: The Ultimate Guide to Financing a Rental Property
Rental Income Protection
Most landlord insurance policies also provide coverage in the case that a rental property is made uninhabitable due to a covered loss. For example, if you own an apartment building with multiple rental units and the majority of them are made uninhabitable due a fire, your insurance will cover not only the replacement cost for those units, but will also cover your loss of income for that period of time.
Additional Coverage Options
If you're in an area where you're concerned about break-ins or vandalism, or you're building out a new property and want coverage for that, landlord insurance has the option to add these types of coverage to your policy.
Whether you're a full-time or part-time landlord, your landlord insurance will be considered tax deductible, because it is a business expense.
How Much Can You Expect to Pay for Landlord Insurance?
The only way to know what you can expect to pay for landlord coverage is to request a formal quote. Your location, the type of property the risks present, and more factors all play a role in the costs. Landlord insurance is typically based on risks present, as well as the value of replacing your policy or the amount of coverage you want to purchase, in the case of liability protection. A general rule of thumb is that landlord insurance costs 20-25% more than traditional homeowners insurance.
Get a quote with Steadily in minutes to determine what the best level of insurance coverage is for your needs.
We're sure that now you have a better understanding of the different methods of buying a rental property. With this information, you can make more informed decisions about how to buy your rental property and start investing in real estate. It's important to weigh your options and how each one will affect you personally before investing.