I couldn't agree with them more. Owning investment homes has been a part of my financial plan for 10+ years. It has provided my family with a higher net worth than we would have had otherwise and, if all goes according to plan, it should let me retire in my late 50's with a steady stream of rental income to cover our expenses so that I can spend my days reading great books and kayaking on the creek behind our home. Ahhhh.....
But I digress. Owning rental homes is a good option for you to consider. Before progressing too far though, there are some things that you need to know....
You Gotta Have Some MoneyWhen you're buying a home to live in, the financing terms are pretty flexible. FHA will let you buy with 3.5% down and USDA with 0% down. If your income is within the right range, you could even qualify for down payment help from the state. If the seller is willing to cover your closing costs, you could potentially buy a home to live in right now with no personal investment from your savings.
Not so with an investment property. If you're using the traditional structure where you get a mortgage from a bank for the purchase, you typically need 20% of the price down with an investment property (ie, $10k down on $50k purchase, $20k down on $100k purchase, etc.). Unfortunately, many first time investors don't have that much available.
If you can find a home that you like that is a Homepath home, the down payment needed drops to 10%. Homepath homes are homes that have been foreclosed on by Fannie Mae. You can find eligible ones here: http://www.homepath.com/.
This 10% is still more than many first time investors have in liquid funds, though. The only other real option, then, is to try buying with non-traditional financing. Sometimes a seller will act as the bank for you (called a land contract sale or lease option). Other times, you can find a partner who has the liquid money ready to invest.
These scenarios can be hard to find though. Most investors will need to wait to purchase their first investment property until they have saved the money needed for that 10% or 20% down payment.
Your Bills Need To Be LowerAnother thing that gets in the way for many first time investors is that their current bills are too high to qualify for the new mortgage. When a bank is reviewing your finances for the mortgage approval on the investment property, they will add up your current bills (mortgage on primary home, car payments, student loans, credit cards, etc.) and then add the mortgage payment for the investment property to that amount. Once they have that total, they will divide it by your gross monthly income. Ideally, all of those monthly payments including the new mortgage should total less than 36% of your monthly gross income. You may be approved up to 43% if your credit is good and you have strong savings, but 36% is the target.
The bank typically won't give you any credit for the expected rental income on the home you are buying because you are new to the investment game, so your current income has to be high enough or your current bills have to be low enough to fit the new mortgage in as-is. If the space isn't there, you may need to reduce your bills or increase your income before qualifying for this mortgage.
Your Savings Needs To Be HigherThe last hurdle most investors face is that their savings aren't high enough to be approved. Many would-be investors already have a mortgage on the home they live in. When the bank is looking to approve them for the new mortgage for the investment property, they are going to want the buyer to have six month's worth of mortgage payments for both their current home and the new home set aside in savings.
This six months is in addition to the down payment money needed, which makes a hard savings target even harder to hit. The good news on this is that these savings can be held in a retirement account. If you have a 401k or IRA that has a larger balance, that investment can often be used to meet the requirement for savings. If you don't though, you may need to save this six months of reserves before jumping into the investment property pool.
The Bottom LineSo what's the bottom line to all of this? Many people want to invest in real estate, and they should. It can be a great way to build current income and long-term wealth. It's not an easy market to get into though. By understanding the lender's requirements in terms of down payment, debt load and savings, you will be better equipped to plan for your future and step into this arena when the timing is right for you.
Lori Hiscock is a Sr. Loan Officer at Ruoff Home Mortgage‘s South Bend office. One of Michiana’s top mortgage loan officers, Lori started her lending career in 1995 after obtaining her bachelor’s degree in Finance from Western Michigan University. You can connect with Lori Hiscock or apply online here.