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It Is Time To Buy an Investment Property

September 26, 2014

holdinghouseThere are many great benefits in buying a rental property in today’s market.  Home prices are still affordable.  The most important decision in picking an investment property is to study the high demand areas and find a home near local businesses, a popular commuting area, or even a vacation spot.  You may also want to find one that is close to schools and a home that has easy access to the freeway. Of course, it is best to study the numbers and make sure your investment property will provide additional income to offset your expenses.  Remember the tenant will be paying down the mortgage while you are building equity. This is a great way to build your retirement savings without having to go and work a second jom.  Let’s look at the numbers:

Example: If you have $10,000 to invest in a property, you can then use leverage and borrow $90,000 from a bank. By combining your money with the bank loaned money, you are now able to buy a $100,000 asset. We will assume that each year, for 10 years, your investment property will appreciate by 5%. Here is where the ability to leverage benefits you. The appreciation is on the entire $100,000 asset, not only the $10,000 of your own money.

Example: $1,100 (monthly rent) – $700 (monthly PITI mortgage payment) = $400 – $110 (for maintenance and vacancy issues = $290 (your monthly passive income from the rental property)

The additional tax benefits will help to decrease your taxable income/taxes due by itemizing the mortgage interest, property taxes and depreciation of the home

Example: If you receive $3,480 in rental income for the year ($290 each month x 12 months). If you made this money at a regular job or in the stock market, you would lose a significant portion of it to pay income taxes. However, by owning a rental property, you can offset the $3,480 income with the depreciation expense for your property, then being able to reduce or eliminate the amount of taxes you have to pay on this rental income.

It is best to put 25% down to get the best rate available.  Instead of borrowing from your savings consider do a cash out refinance of your current property while rates are still very low.  Make sure to compare at least three lenders truth in lending disclosure to ensure you are getting the best offer and save the most money. Your best friend John may not be giving you the best deal after all and usually doesn’t.

Most lenders require 45-50% debt to income ratio to qualify and remember you can use proposed rents from the subject property to qualify.  Check with your lender, because some may require 2 years landlord experience while others do not.  You will be required to have 6 months of PITIA in liquid reserves after your down payment for each rental you already may own and the subject property.  If the home is in a flood zone you will be required to purchase flood insurance.  The minimum deductible required for homeowners insurance is usually $1000 and a year must be paid upfront at closing.

If you are planning to rent out your current home you will be required to do a drive by appraisal to show that you have 30% conventional financing to omit that payment.  You will also be required to provide a lease agreement and proof of deposit made into your account from proposed tenant with most lenders.

The maximum seller credit allowed for an investment purchase is 2%.  You will have to come up with the remainder of the closing costs besides the down payment.  The funds must be seasoned in an account for 60 days and cash deposits are not allowed.  The lender will require you to provide copies of cancelled checks (front and back) for all deposits not related to payroll and a written explanation for what each one was for.

It is best to pay off or pay down any credit cards about 90 days prior to applying for your home loan. Every 20 pts can equal .20% in interest savings.  Make sure there are no open disputes on your credit report or you may be required to settle/pay or resolve each one.  Conventional financing requires that 4 years has passed from a bankruptcy and the following for a short sale, pre-foreclosure, foreclosure:

  • 2 years – 80% maximum LTV ratios(1)
  • 4 years – 90% maximum LTV ratios(1)
  • 7 years – LTV ratios per the Eligibility Matrix

Lastly, it can take up to 30 days to close your loan.  Happy House Hunting!

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