Financing Washington DC Investment Property
It's not as straightforward as an owner-occupied mortgage, my newbs.
Financing Your DC Investment Property
Section: Investor Intel
Author: Susan Isaacs, Washington DC Real Estate Strategist
Financing Options For Washington DC Investment Property
There are various methods of financing investment property, from self-financing to hard money loans. Which is right for you? That’s a discussion between you, your money manager and lenders. But going in, you should know which options exist, and their potential pitfalls. Read on!
Types Of Financing
Hard Money Loan
Hard money lenders underwrite their loans based on the property value instead of the borrower qualifications mortgage brokers require.
Cons:
Lower loan-to-value ratio
Higher interest rates due to lender risk
Can prohibit owner-occupied residences due to property rules/regulations
DSCR Loan
Debt Service Coverage Ratio loans allow you to qualify based on the property’s cash flow rather than your income & tax returns.
The debt service coverage ratio is a ratio of a property’s annual gross rental income & annual mortgage debt, including principal, interest, taxes, insurance +HOA. Lenders don’t consider management, maintenance, utility, vacancy rate, or repair costs in the calculation, but you’ll want to.
Cons:
Down payment can range from 20% – 25% + lender and service fees ranging from 0.5% – 1% of the loan. DSCR mortgage rates are typically 1% – 2% higher than those of traditional loans.
Seller Financing
The homeowner finances the purchase for the buyer and sets the loan terms. No funds pass to the buyer, instead the seller extends the borrower credit equal to the purchase price of the property, then the buyer makes monthly payments of principal and interest until the note is paid in full.
Cons:
Higher interest rates,
Potential balloon payment at the end of 5 to 10 years
Risk of seller default
Cash-Out Refi
A cash-out refinance pays off the initial mortgage, ‘refunding’ home equity to the borrower and establishing a new, higher value mortgage.
Commonly used as leverage for BRRRR.
Cons:
Required percentage of equity to qualify
Higher payments must be considered
Property taxes will increase
Less flexibility for a sale if needed
Risk of negative equity if market tanks
FHA 203K
FHA 203k loan investment property loans are restricted to the purchase of a multi-unit property in which the investor resides. This type of loan is not viable for fix-and-flips or building a large portfolio of investment properties. Buy and renovate, construct, or convert a 2-4 unit multifamily property and occupy one unit as your primary residence for at least a year.
Rent a home you still own with an FHA mortgage if:
You occupied for 12 months
You moved for an acceptable reason (work relocation, upsizing)
Pros: Lower interest rate
Cons: Living adjacent to tenants, likely one-time loan use & fees:
Upfront MIP of 1.75% + annual fees of 0.35 of outstanding principal.
Private Money
Aside from friends, and family, private money loans can be sourced through local real estate investment networking. Find networking groups and events in DC Metro via BiggerPockets.com.
Terms and interest rates on private money loans can vary significantly, from extremely favorable to predatory, so know the laws, variables and your own value as a borrower.
Security usually consists of a legal contract that allows the lender to foreclose on the property in the event of default. Tread carefully and consult an experienced real estate attorney.
Cons:
Risk of default
HELOC
A revolving line of credit is drawn on your investment property, with a typical draw period of 5-10 years. Minimum payments are made to cover the cost of interest, which you only pay on the amount drawn.
HELOCs are typically offered with a variable rate, so timing is important. The interest rate may start low, but rise with the benchmark rate. This an also work in the reverse, meaning your rate may lower. Monthly payments rise and fall with the rate, which is usually lower than a home equity loan, credit cards or a personal loan.
Cons:
Interest may not be tax deductible
Variable rate depends on benchmark
Home Equity Loan
A home equity loan is a lump sum loan against the equity in a property. An investor might choose to leverage another property in order to purchase a new property.
Home Equity Loans are typically offered with a fixed interest rate, meaning the payment is the same each month. The home equity loan payment is made in addition to a primary mortgage payment.
Cons:
If property value declines, you may be in a negative equity position
Blanket Mortgage
A blanket mortgage funds the purchase of multiple real estate properties inclusively, with a single monthly payment and interest rate. Valuable if the loan offers exceptional terms. With a single mortgage, your portfolio and mortgage payments are simpler to manage, and multiple lending fees are avoided.
Properties can typically be extracted from the blanket for sale or refinance. Check for a release clause. The remaining properties are still covered by the blanket loan.
Cons:
The properties are used as collateral for one another. If you default on the blanket loan, they all may be lost to foreclosure.
Cash
The simplest way to finance property is to pay cash. This can put the investor in an advantageous negotiation position, allows waiver of contingencies, lowers settlement costs and facilitates a fast close so work on improvements or rental advertisement can begin quickly.
There’s no risk of foreclosure with a cash purchase, and owners experience less stress when it’s vacant due to low overhead.
Cash vs Financing
Why Finance
Leveraging real estate financing allows investors to claim 100% of the cash flow, tax benefits + appreciation in property value with a small down payment, typically 20% of the purchase price.
Other benefits include:
Deduct interest & reduce taxable net income
Potential risk reduction through diversification of investment capital across several properties vs a single property
Increased returns on the amount of cash invested by using financing
Investors using 30-year, fixed-rate mortgages can lock in advatageous interest rates to hedge against future rate increases.
Why Pay Cash
Paying cash for investment property can produce higher cash flow since there is no monthly mortgage payment.
To determine your potential ROI, calculate the Cash-on-Cash Return:
Determine your annual pre-tax cash flow: (gross scheduled rent + other income) – (vacancy + operating expenses + annual mortgage annual mortgage payments). Then, divide pre-tax cash flow by total cash invested = CoC.
Understand The SAFE Act
What Is The SAFE Act?
The Secure and Fair Enforcement for Mortgage Licensing Act (SAFE Act) of 2008 is a federal law that sets minimum standards for mortgage loan originators (MLOs) to protect consumers and reduce fraud. It requires MLOs to register with the Nationwide Mortgage Licensing System and Registry (NMLSR), receive a unique identifier, undergo background checks and credit checks, and complete specific pre-licensing and annual continuing education courses.
The SAFE Act also applies to private lending and seller financing. The Act is designed to enhance consumer protection and reduce fraud by encouraging states to establish minimum standards for the licensing and registration of state-licensed mortgage loan originators.
The Act defines “loan originator” as “an individual who (I) takes a residential mortgage loan application; and (II) offers or negotiates terms of a residential mortgage loan for compensation or gain.” Section 1503(3)(B), entitled “Other Definitions Relating to Loan Originator” provides “For purposes of this subsection, an individual `assists a consumer in obtaining or applying to obtain a residential mortgage loan’ by, among other things, advising on loan terms (including rates, fees, other costs), preparing loan packages, or collecting information on behalf of the consumer with regard to a residential mortgage loan.
Read The Series
The DC Real Estate Investment Compass
These articles were originally published in my Tools section at realestateinthedistrict.com. Now they live here—on DC Real Estate Channel.
Zuzu Notes
Timing and planning your house hack often involves scaling. Many property owners initially begin with a basement rental in the home they occupy, later lease the upper floor, then expand to other methods. Or simply repeat!
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