Buying a home and living in it is not quite the same as purchasing real estate strictly for investment purposes. Investments typically pay dividends, or must be sold for a profit, so as long as you are living in your home, it isn’t necessarily making you any money.
It’s important to understand the differences between an investment property and personal home buying before investing in a house you won’t be living in. Investing in a rental property or house-flipping involves a different set of financial steps than you may be used to.
Likewise, getting a loan for an investment property and financing a real estate project like this is done differently than a standard mortgage, but can be a way to invest in real estate if you’re willing to do the work.
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What Is an Investment Property?
An investment property is a piece of property you would purchase for the sole purpose of generating income. There are a few different types of investment properties. However, the two main types of investment properties, where you’ll be financing it yourself, are flipping houses or buying a rental property.
By comparison, investing in a REIT or a private equity real estate fund involves indirectly investing in properties through a fund, not unlike buying stocks. Though your personal home is an investment of sorts, it’s not an investment in the same way that an income-generating rental property like a rental is. If your home appreciates in value before you sell it, you might feel it was a good investment, but its primary value until that point is providing you with a place to live.
Why Your Home Isn’t an Investment
An investment property is different than homebuying because it’s property purchased for the sole purpose of earning profit from it. Not only that, but you can’t count on property values always rising, so your home won’t always rise in value.
For investment properties, the economics work differently. Homeownership is expensive and doesn’t generate cash flow. Though it is an asset that can appreciate, it’s not an investment per se. It’s especially not an investment in the same way that an investment property is.
Investing in House-Flipping
House-flipping is buying a home that could use some renovations, but has a lot of investment potential. After completing those renovations, a house-flipper would sell the home for a profit. A house-flipping investment is different than traditional home buying due to the short timeline and renovation costs. It involves buying a property that could use some renovations.
However, buying the right property involves watching the market and looking into the area so that the return on the investment is worth the process. Buy the house, fix it up, and sell it for more than you invested in order to make a profit. There are many ways to start investing in real estate, and house-flipping is one of the most active ways to do that. So be prepared to do the legwork.
Investing in Rental Property
Buying a rental property is buying a home and renting it out in order to generate income in the form of rental payments. Unlike house-flipping, investing in a rental property doesn’t have the short timeline, but it does come with different expenses, some of which can be a surprise. The goal here is to get income from tenants that outweigh property management, insurance, mortgage costs, etc.
Unlike house-flipping, investing in a rental property offers a more predictable income that it should generate. There are also quite a few more tax advantages.
Investment Property Mortgage Basics
Financing an investment property is similar to financing your home, but has some distinguishing differences. The process is a lot harder than purchasing an owner-occupied home. Lenders prefer a better credit score, a better debt-to-income ratio, and more documentation of income. Not only that, but the down payment required and mortgage rates applied tend to be different as well.
Down Payment for Investment Property
Because investment properties don’t qualify for mortgage insurance, your down payment will be higher than it would be for a normal mortgage. Your down payment will have to be around 20 to 25 percent to qualify for a better interest rate. However, if your rental property is your vacation home that you rent out sometimes, a higher down payment may not apply to you.
Investment Property Mortgage Rates
In the same way that the down payment will be higher, your mortgage rates will be as well. The simple fact is that lenders charge more for non-owner occupied residences. Lenders don’t like to take risks, and a second (or third, or fourth, etc.) property will go into default before your actual home will go in a financial crisis. This is why down payments and mortgage rates are higher.
However, remember that the higher your down payment, the lower your mortgage rate.
Hard Money Loans
Hard money loans are a specific type of asset-based loan financing where a borrower receives funds secured by a real property. Hard money loans are great investment property loans for those looking for a financing option that makes sense for them. Though a conventional mortgage may make more sense for a rental investment property, a hard money loan may be perfect for home-flipping.
For one, hard money loans offer faster approval as well as funding. For a traditional mortgage, it’s not an overnight process to close on a property. This is great for home-flippers looking to buy a property quickly to beat the competition. They are also easier to qualify for in terms of credit score, other mortgages, or your investing track record.
Most hard money loans are short-term, which makes them unhelpful for rental property investors but incredibly helpful for home-flippers who can’t exactly get a one year mortgage. A hard money loan term can be between one and five years.
However, they do have some requirements. One would be collateral (property value), the other would be the high interest rate of around nine to 14 percent. And finally, there are upfront fees. Despite the drawbacks, house-flippers can still find a lot of use in these hard money loans. Though it’s still important to remember the downsides.
In the world of real estate finance, there are plenty of ways to invest. Some involve a lot of capital, some involve more work in terms of direct financing, and others are more removed from the process. In these terms, investment properties are great because they can be a realistic way for someone to invest in a property that is within their means. Though the financing process is a little more involved and more expensive than traditional home buying, it’s similar enough that investors can feel confident in learning about the process.
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