You’ve probably heard that real estate has created more wealth than any other investment vehicle. You’ve maintained good credit, put away some savings, and now you’re seeing the values go up in your area and are itching to take advantage of the current market. But how much cash will you really need? Are you priced out of the market? Will you miss out by the time you’ve got what it takes? Well, that depends . . .
There’s an endless back-and-forth between real estate investors and lenders.
Those of us looking to buy property want to put as little cash into the deal as possible, so we can get in the game sooner, earn higher returns, and buy more properties.
Lenders, however, want investors to put in as much cash as possible in order to reduce their own risk.
So where does that leave you? You might be saving up to buy your first rental property and with property values rising every month are put off by how long it is taking to have the down payment you need.
That’s where we come in. In this article, I’m going to share a few ways that you can reduce the cash you need to buy your next investment property so you don’t miss out.
Typical Cash Needed for Real Estate Investment
Lenders will typically require 20% of the purchase price as a down payment. This is the same whether you go to a bank, big name finance company, or a mortgage broker for a loan.
Some lenders even require 25-30% (which doesn’t make a lot of sense for most investors as you could be buying two properties instead of one with the same amount of cash down).
In addition to the down payment, they generally want you to have 3 months’ worth of payments available in cash reserves, or 6 months’ worth if they are more conservative (which is why you should always shop around). But, they’ll require less if you’re buying your second and third house.
Lastly, there will be closing costs to cover, which are generally 3% of the purchase price.
So for a quick example, let’s say you want to buy a $100,000 rental property. You’re going to need:
- 20% down ($20,000)
- 3 months of payments in reserves (which can vary wildly, but let’s say $3,000)
- 3% closing costs ($3,000)
That means you’ll need $26,000 in cash (which is probably more than you thought).
The reason lenders require this is because you’re more likely to default on an investment property than you are on your primary residence. This is why you can’t do it with 3% down like you can with your own home. Higher risk means higher requirements.
With all that said, let’s move on to 7 ways you can reduce the cash you’ll need to close on your next investment property. The sooner you do, the sooner your money can go to work for you.
Idea #1: Lower Money-Down Loans
Some lenders are different, and have programs that don’t require tying up so much capital. One option through Fannie Mae only requires 15% down with a good credit score.
This alone could mean $5,000-$15,000 less, depending on the purchase price and the conditions in your market.
BUT, if you do this, you’ll have to pay for private mortgage insurance (PMI), which means less cash flow every month. When the house has appreciated some and the loan balance has become less than 80% of the new property value, you can apply to get rid of this fee.
Idea #2: Local Banks & Credit Unions
Some investors swear by credit unions and local banks, but I haven’t found their loan products to be that different, with one exception . . . the commercial side.
If you have an existing business, such as a property management company or an LLC that you flip houses in, then your business might be able to get a loan with more favorable terms or even a line of credit to finance purchases with.
Idea #3: Use a Line of Credit for a Down Payment
You can borrow the cash needed for your down payment, closing costs, and reserves as long as it’s secured by a different property than the one you’re purchasing (such as a home equity line of credit, or HELOC).
Of course, this requires that you already own property. But in an appreciating market, many homeowners are finding themselves with equity that’s sitting unused instead of being put to work.
And, unlike with other types of purchases, this cash doesn’t need to be “seasoned” and sit in your account for months in advance. You can borrow it right before closing.
If you do this, however, make sure that the property’s cash flow can sustain the payment on the line of credit. If not, keep looking!
Idea #4: Seller Financing
You might have heard about seller financing, land contracts, subject-to deals, etc. These are not easily found on the MLS or with off-market properties unless you’re actively advertising to find motivated sellers, which is a business in and of itself.
But, if you come across a seller who for whatever reason doesn’t want to list and sell their house the usual way, it’s possible to put 10% down and then make payments to the seller every month instead of qualifying for a loan and meeting the down payment requirements of a traditional lender.
Idea #5: Seller Financed Closing Costs
Unfortunately, lenders won’t let you borrow any of the closing costs. But, the seller can pay for some of them—up to 2% of the purchase price.
So, this is something you can propose to the seller when making your offer. If the market is not super hot, or if there is something less desirable about the property, they might take you up on it. It usually doesn’t hurt to ask!
If that fails, try raising your offer by 2%. Then they’ll net the same amount, and as long as the appraisal can justify the higher price you should be good to go!
Idea #6: Buy & Refinance
If you buy low enough, you’ve got options. This means more work up front, of course, looking at more properties until you find one where the buyer is willing to negotiate and sell for less than it’s worth.
But, if you’re willing to do some work, you can buy low, fix it up, and then refinance and get your money out so it’s not all tied up for years to come.
One way to do this is by paying cash, and refinance within 6 months with a new loan balance equal to or less than the acquisition cost (but not to exceed 75% of the new appraisal value).
This can help you get some of your purchase costs back, but not your renovation costs. They will still be tied up.
An easier way is to use a hard money lender to borrow purchase money and rehab costs, then pay it off when you refinance (borrowing up to 80% of the new property value).
Just make sure you confirm how quickly you can refinance. Some lenders will make you wait 1-2 years and hard money usually has a 6-month term. And if you borrow from a hard money lender more than 6 months, the interest you pay during that time might destroy the equity in the deal.
Idea #7: Buy in Less Expensive Areas
Having trouble finding properties below market value? If you’re in a hot market, then you might want to expand your search to less pricey areas.
They are often less expensive and offer higher cash flow anyway. Where you invest does not have to be the same as where you live personally.
Creativity & Hustle Make the Difference
The smartest investors know that if you do what everyone else is doing, you’ll get what everyone else is getting.
Don’t just go with the first lender you find, or look at a couple of properties before making an offer. Instead, exercise your creativity and find ways to get more of a return for every dollar invested.
These 7 ideas will help you to minimize the cash needed to get into the real estate game, and also help you to buy more properties and retire with more. If you’re willing to work at it, you can reach your investment goals much faster.
Justin is the VP of Operations & Finance. He has leveraged his passion for education, entrepreneurship, and numbers into a versatile portfolio of investments which include stocks, real estate, oil & gas, green energy, real estate lending, online and offline startups, restaurants, and more.
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