So you wanna be a landlord? Or maybe just develop property? For this post, we will only deal with 1-4 family dwelling financing as the topic is entirely too big to cover in a quick reading.
Landlords today sometimes have a bad rap. There is a feeling floating around out there that it is shameful to be the property owner and letting it out to people – those tenants are apparently paying the property owners mortgage, as if the property owner is some kind of leach. But are they really? So, party A has saved enough to buy property and party B needs a place to live and agrees in a contract to a monthly amount of rent. Doesn’t that equal grownups making a business deal where both win? No one is forcing a person to agree to the rent. One needs housing and the other has space. The rent hopefully offsets the actual costs. With rents on the higher end and since they rarely go back down once up, being on the landlord side of things right now seems like a good gig if you can get it. More about getting it in a minute.
Before you start throwing your popcorn at me for saying that being a landlord isn’t as sketch as the rumors say, I will fully acknowledge there are slumlords out there, maybe at least one just around the corner. What do I mean by that? It’s the owner who has either failed to screen tenants and ends up with a meth lab in the living room and aren’t paying enough attention to see it and evict them. Or worse than that, simply doesn’t keep their property in good repair. I’ve known a few in my years in this business. When they go to unload the properties you walk through and wonder how could someone live in that place and realize that just a month before someone WAS a tenant there! There are also the landlords that pull dirty tricks like giant rent hikes with minimal notice, ignore mold and hazards or any other odd thing. Noted. Realty? – the sketch exist in every industry and despite the reputation, most landlords and management companies aren’t. Like everything there are always a few bad apples that seem to get the notoriety and taint the picture. So my admonition – if you are going to do this, don’t be that person!
How to do it right? I’m certain more experienced people can chime in on this, but having owned property for rentals and worked with many investors over the years, here is what I have seen that works well. One of my most successful investors for years was a realtor who represented a builder and would always go in and buy a couple of his properties in each new subdivision. He told me that the advantage of this was twofold. 1) Everything is new and there is less to babysit in terms of maintenance 2) He typically turned them in a few years before things started to become too worn. Other investors buy and fix up first. You get more rent from a pretty home and you have less trouble when things like the furnace and plumbing have already been replaced. It also provides a nice home for someone else to enjoy. If you turn it in a few years, your property should also pass inspection well and like the higher rent, a clean property sells better and faster. It doesn’t hurt to factor in some basic services like regular yard maintenance. Have a regular handy person who knows your property and can be called on at a moment’s notice to handle surprises. I once got a call from a tenant who said she opened her front door and it fell off! Handyman was dispatched and fixed it in short order! This also means your business as a landlord is supporting yet another part of the economy of gig workers and others whose livelihood depends on these types of regular jobs.
What does it take to finance and purchase a rental property? Much of it follows the same criteria as financing your residence. Though there are some programs out now that will not require as much from you aside from a down payment, a comparable rent schedule or rental agreement and a reasonable credit score. The shorter list of documentation will of course have the trade off of a higher rate. Investment property in general has higher rates than what you get for your primary or secondary residence. A word of caution here. Sometimes people think they should just buy a home and say they are going to live in it and then decide not to. Reality is that this is committing fraud. When you sign loan documents for a primary residence it asks if you intend to live in it. You are attesting that it is or is not your intent. Fraud carries fines and sometimes jail time. If you do live in it and then turn it into a rental, plan on at least a one year stay. Some sources say 6 months, but read the fine print in your loan documents.
Financing your 1-4 family investment property:
The standard way: Put 20-30% down, use conventional financing and qualify through traditional means. This works well if you have a stash of funds or equity you can pull out of another property, a decent credit score and stable, adequate income. This generally offers the best rates and fees on a fixed rate loan up to 30 years. Note that the rates are higher than if you purchasing a home to live in.
DSCR: Debt Service Coverage Ratio (DSCR) does a ratio on the amount of rent to monthly payment cost. The advantage with this program is you may often get in with as little as 20% down or if you are doing a cash out refinance take up to 75% of the value and they are more patient with credit events. Additionally you won’t have to prove your income if the property cash flows because it is truly a collateral loan basing the risk on the expected performance of the property. You can close the loan in the name of a company and you can own as many properties as you want. The bugaboo here is that the rate is higher and often carries a prepayment penalty for a determined number of years. Those prepayment penalties generally can be removed in exchange for a small increase in rate.
Other Non-QM products: These are somewhat like the old sub-prime products but really better. They include things like no ratio, income based on 12 or 24 months of bank statements or 1099 income. Like DSCR they also have options for interest only for a period of time, various terms, ARM’s and prepayment penalties up to five years that can be bought out for a price.
That’s the quick and dirty skinny on what it takes to purchase an investment property in the 1-4 family category. If you are kicking this tire around the block and live in Oregon or Washington, please reach out. Happy to give you information and help you start the process.
Have helped buyers of all types and financial levels and worked on 1000's of loans.
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