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One of the biggest obstacles that would-be real estate investors need to overcome before buying their first property is saving up enough money for a down payment. But how much is enough? Unfortunately, there's no perfect answer to this question.
For example, down payment requirements on conventional loans can be different than commercial loans. And the down payment requirements for a vacation rental can be different than for an investment property.
With that in mind, here's a guide to help you determine how much money you'll need to put down when buying your next investment property. It should also help you analyze all the options at your disposal to find the one that works best for you.
Conventional mortgages: 10% to 25% of the purchase price
A conventional mortgage is one that a lender makes to you and is dependent on your credit, income, and other debts. If a conventional mortgage is below certain lending limits and conforms to Fannie Mae or Freddie Mac's standards, it's known as a conforming loan. If it exceeds these limits, it's known as a jumbo loan.
Here are some rules of thumb on down payment requirements for conventional mortgages.
If you finance the property as an investment property, you'll typically need at least 20% down. Fannie Mae's minimum lending standards allow single-family investment property loans with as little as 15% down, but this jumps to 25% for multifamily properties. And keep in mind that these are the minimum standards. Many lenders use more restrictive requirements when originating investment property mortgages.
Another option is to finance an investment property as a second home. This option is only available if you plan to use the property yourself at least some of the time and you're planning to buy a single-unit property (a house or condo). The down payment requirement is only 10% if you choose to pursue this route.
Of course, these are just Fannie Mae's standards, but most conventional lenders (even on jumbo loans) use similar requirements. You'll generally need strong qualifications to get the minimum down payment, which could mean high credit, a strong debt-to-income ratio, and several months' worth of expenses in liquid reserves.
Check out our thorough discussion of financing an investment property to learn more about the ins and outs of investment property mortgages.
Just because you might be able to put less than 20% down on an investment property in many cases doesn't make it a great idea. You'll need to pay mortgage insurance until your loan-to-value (LTV) ratio drops below 80%. This can put serious pressure on the property's cash flow, so be sure the numbers still work.
FHA loans: House-hack your way to a 3.5%-down investment property mortgage
You can read our extensive discussion on house hacking, but the general idea is buying a multifamily property, living in one unit, and renting out the others.
With conventional mortgages, down payment requirements aren't favorable on multi-unit properties as you can see in the last section. However, there are some great options if you're planning to live in the property. FHA loans are especially convenient.
While FHA mortgages have higher fees than conventional loans, they only require a 3.5% down payment for most borrowers. This includes loans made for multifamily properties. So an ambitious homebuyer could, for example, buy a triplex for $300,000 with just $10,500 down and have a place for themselves to live as well as two rentable units to start their portfolio.
There are a bunch of companies that specialize in originating loans to investors. Many of them offer both fix-and-flip (short-term) and buy-and-hold (long-term) loans. We're focusing on the latter.
You may see these companies referred to as commercial lenders or asset-based lenders because they base their decisions more on the underlying property's potential rental income than the borrower's personal financial qualifications.
These can be great tools if you can't get a conventional mortgage. For example, if your personal debt-to-income (DTI) ratio is too high to justify a conventional loan, an asset-based lender could be the best answer. This could also be a good option if you want to buy through an LLC or other entity. I've used a commercial lender to finance a property I planned to own as a partnership with other investors.
Commercial lenders typically want at least 20% down, as there's no mortgage insurance available for these types of loans. Depending on the nature of the property, your credit qualifications, and other factors, you may be asked to put 25% or 30% down.
Alternatives if you don't have enough for a down payment
It's generally a smart idea to put at least 20% down when buying an investment property. Of course, there are a few exceptions. House-hacking is one of them. Vacation homes that you could reasonably afford without any rental income are another. However, in general, the more money you finance, the less margin of safety you'll have.
There are a few ways you could raise the funds for a down payment on an investment property if you don't have 20% of the purchase price sitting around. Just to name a few options that could be smart ideas in the right circumstances:
- Home equity loan or line of credit (HELOC): This can be a decent way to fund some or all of an investment property purchase. Because they're backed by the equity in your home, creditworthy borrowers can get this type of financing with relatively low interest rates and fees.
- Personal loans: The personal loan industry has become huge over the past few years and you can get unsecured loans for up to $100,000 in some cases. Plus, borrowers with top-notch credit scores may be able to get interest rates comparable to investment property mortgages.
- 401k loans: I'm generally not a big fan of this option, but it could be a smart move in some cases. 401k loans are cheap as far as interest rates go (typically prime rate plus 1%). And since you're technically borrowing money from yourself, the interest is being paid back to you, not a bank.
The bottom line
As you can see, the down payment requirements for an investment property depend on several factors. Unless you're planning on house hacking or a property you're going to use some of the time (like a vacation rental), you should plan on at least 20% down.
Some conventional lenders will originate single-family rental property loans with 15% down, but it's generally not worth the added expense of mortgage insurance to get a small reduction in the down payment.
As a final thought, it's also important to realize that the down payment isn't the only expense you'll have to worry about when buying a property. There are also closing costs, which tend to run anywhere from 1% to 3% of the purchase price, as well as liquid reserve requirements, which depend on the lender. Be sure to take these into account as well when determining whether you have enough to buy an investment property.
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