Investments in real estate can be an excellent way to diversify your portfolio and hedge against inflation. However, the current tight credit market has made real estate investments more difficult.
The Consumer Finance Protection Bureau (CPFB) enacted new rules to regulate mortgage lending at the beginning of 2014 in response to the housing crisis and subsequent Dodd-Frank legislation.
If you are planning to buy real estate as a rental investment or a rehab-flipping project, you will find that previous options such as 100% financing are virtually impossible to receive, and FHA loans with lower down payments now have lower maximum loan amounts – varying by area, and in some cases significantly.
If you are thinking even bigger, with some form of commercial development, be prepared to have more than the old standard of 20% down payment available, even with a solid history and steady income.
How do you find financing in this environment of tight credit? It is not easy, but it is possible.
- Verify Your Credit – Make sure your credit score and credit history are in good shape before you begin. Address any glitches in your credit scores before you start your financing search.
- Outline your Plan – You are going to have to convince a bank to approve your financing, so construct a positive view that shows the bank a solid return and secure repayment path – but be aware of the weak points in your plan and be prepared to address them. If you cannot look at your project objectively, find someone knowledgeable in real estate to review it for you.
- Find a Support Team – Consider whether it is worth paying a mortgage broker for assistance. They may well pay dividends over and above the cost of their services – but take the time to thoroughly research the broker first. It is also wise to have an accountant who can help guide you through the tax aspects of investments.
- Try Local Financing – Local banks have a greater understanding of the real estate market of the area and have a vested interest in helping the local economy. If you are proposing a viable project, a local bank is more likely to work with you as opposed to throwing up roadblocks.
The key word is viable. Banks are not going to accept poor terms for them simply because you are local.
- Be Realistic on Down Payment – Mortgage insurance is generally not available for investment properties, so you need significant down payment money – 25% and above is not an uncommon request. You can use alternate paths such as home equity lines of credit (HELOCs) to lower your down payment, but in this environment, you are more likely to be rejected if you do.
Consider sizing your rental home/commercial project to the amount of down payment you have available, or look for partners or co-investors if you simply cannot come up with suitable down money.
If you are looking at a long-term rental strategy, consider going the owner-occupant (OO) path. Buy the property as your personal residence and then, after living there for at least twelve months as required, you can move to a different home and rent out the OO home. This way, you may be able to apply lower down payments.
- Consider Owner Financing – There are many motivated sellers out there, and you may find one willing to assist with financing. Take time to work out your intended owner-financing terms before presenting them to the bank.
- Keep Cash Reserves – Remember that real estate is not liquid and it is dangerous to tie up too many of your assets in a long-term investment without other ready funds at your disposal in case of emergency. Banks are not likely to approve your loan without several months of reserve funds.
Do not be too dependent on rental income for liquidity, especially in the initial stages.
If liquidity is a concern, think about investing in a REIT (Real Estate Investment Trust) instead. REITs are basically a form of mutual funds that uses investor-pooled funds to invest in real estate. They are not as liquid as stocks, but are more so than direct purchases and can accommodate smaller investment amounts.
Funding properties through alternate paths such as peer-to-peer lending may work for you if you strike out with the banks. However, be prepared for even more scrutiny when strangers are providing loans – and if you do not receive much scrutiny at all, be highly suspicious.
With a well-outlined plan, you can diversify your portfolio through real-estate purchases and obtain financing that does not put you at risk. We hope that you can take advantage of today’s excellent interest rates – but if it is too dangerous to do so now, set your long-term plan and prepare to execute it.