How To Finance Washington DC Investment Property
It's not as straightforward as an owner-occupied mortgage, my newbs.
Financing Your DC Investment Property
Section: Market Decoder
Author: Susan Isaacs, Washington DC Real Estate Strategist
Types Of Financing
There are various methods of financing investment property, from self-financing to hard money loans. Which is right for you? Thatâs a discussion between you, your money manager and lenders. But going in, you should know which options exist, and their potential pitfalls. Read on!
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 propertyâs cash flow rather than your income & tax returns.
The debt service coverage ratio is a ratio of a propertyâs annual gross rental income & annual mortgage debt, including principal, interest, taxes, insurance +HOA. Lenders donât consider management, maintenance, utility, vacancy rate, or repair costs in the calculation, but youâll want to.
Cons:
Down payment can range from 20% â 25% + lender and service fees ranging from 0.5% â 1% of the loan. DSCR mortgage rates are typically 1% â 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, ârefundingâ 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
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.
Thereâs no risk of foreclosure with a cash purchase, and owners experience less stress when itâs 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) â (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 âloan originatorâ as âan individual who (I) takes a residential mortgage loan application; and (II) offers or negotiates terms of a residential mortgage loan for compensation or gain.â Section 1503(3)(B), entitled âOther Definitions Relating to Loan Originatorâ provides âFor purposes of this subsection, an individual `assists a consumer in obtaining or applying to obtain a residential mortgage loanâ 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.
This page is a supplement to my House Hacking series.
Read the series:
The DC Real Estate Investment Compass
House Hacking
Buy And Hold (can be a house hack)
BRRRR (a type of Buy And Hold)
Fix And Flip
Multifamily
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!
Start With The Basics
Whether youâre investing in DC real estate as a side hustle or full-time business, understanding the local real estate market and fundamentals is key.
How I Help
Guidance and education
Off-market opportunities
Skill, experience and resources
Assembling A Team
Having a team of professionals in place will ease acquisition and management of your investment portfolio.
Your Realtor, lenders, property manager, contractors and vendors functioning as a team can identify opportunities, speed transitions, address issues, and increase profitability.
These articles were originally published in my Tools section at realestateinthedistrict.com. Now they live hereâon DC Real Estate Channel.