What Are You Legally Required to Disclose When Selling a Property?

If you’re currently a landlord thinking about selling a house, you may have to fill out a disclosure statement first.

Even if your state doesn’t require this form, it’s recommended that you provide it, since it can protect sellers in the long run.

Here’s how it works and what kind of information you need to provide.

Major Defects on the Property

In general, you have to disclose anything that would affect property value, which includes defects that you’re aware of.

For example, if you know the faucets leak, the roof needs to be replaced, and there are cracks in the foundation, you need to disclose these problems.

This applies whether you have seen them yourself or your tenants have pointed them out.

Similarly, if there is evidence of a termite infestation on the property, let the buyers know in the disclosure statement.

Even if you’re aware that there are lots of barking dogs nearby or construction noise, you should disclose these issues because they could affect the value of the property.

Inspection Requirements

You don’t have to get a full inspection before you sell the house. You only have to disclose the issues you know about, not look for more.

Of course, the buyers will likely hire a property inspector anyway, so they will probably unearth any problems that weren’t obvious before.

If you hire an inspector yourself, and that inspector discovers problems you didn’t know about, you will have to disclose them.

But on the upside, if your inspector doesn’t find additional problems, you will have the documentation you need if the buyer accuses you of not disclosing defects in the future.

If they’re not in the inspector’s report, it will be clear that the defects are new and, therefore, the responsibility of the new owner.

Federal Disclosure Requirements

No matter where your property is located, you need to disclose whether there is lead paint in the home. That’s because the Lead-Based Paint Hazard Reduction Act of 1992 is a federal law.

However, it only applies if your house was constructed prior to 1978.

If this is the case for your home, let the buyers know that the house might have lead-based paint, and then give them 10 days to test the paint for lead.

You should also make sure they know the dangers of lead-based paint, which can be achieved by giving them a pamphlet by the EPA called “Protect Your Family From Lead in Your Home.”

Then you need to have them sign a statement that they’re aware of whether or not the house contains lead.

Keep this signed document for at least three years as proof that you’re in compliance with this federal law.

Additional Information to Disclose

Once you have disclosed the presence of lead-based paint and general defects in the home, you should find out if there are any other disclosure rules specific to your location. That’s because they vary by state.

For example, most states don’t require you to disclose a death in the home, but the exceptions are California, South Dakota, and Alaska.

In California, you must disclose any death that took place in the home in the last three years, even if it was due to natural causes.

But sellers in South Dakota and Alaska only need to disclose murders or suicides that took place within the last year.

In New Jersey, sellers have to disclose whether the house is fit to live in.

They also have to disclose any hidden defects that they know about.

On the other hand, sellers in Georgia aren’t required to offer a disclosure form at all, but they’re still encouraged to do so.

If you’re not sure what to disclose, you can ask your real estate agent about the rules that apply to your specific situation before you sell the house.

What Are the Requirements for a Mortgage on a Rental Home?

Securing a mortgage for a rental home can be a headache.

Although these mortgages work similarly to conventional mortgages, they often have stricter qualification requirements.

Below are some you may be expected to meet.

Credit Score

Your credit score plays a significant role in determining your eligibility for a mortgage on a rental home.

The biggest influences on your credit score are your payment history and debt load – together, these two components account for 65 percent.

Lesser influences include the length of your credit history and the age and mix of your credit accounts.

Maintaining a credit score of 720 or higher can help you to qualify you for a low interest rate on your rental home mortgage. Below that, lenders may charge you a higher interest rate.

Credit Report

In addition to checking your credit score, lenders examine your credit report to gauge your readiness to repay your mortgage debt.

All lenders use information from at least one of the three national credit reporting bureaus: Equifax, TransUnion, and Experian.

If your credit report reveals that you have liens or judgments against your name, you will need to pay these off in full, or negotiate a payment plan with your creditors, before obtaining a mortgage.

Income

The maximum loan size for a rental home is linked to the income you expect to receive once your rental home is tenanted.

Lenders typically require your potential rental income to be 25-30 percent higher than your mortgage payment.

They may also request proof of your personal income and cash reserves to ensure that you have sufficient funds to cover any void periods – times when your property is untenanted or rent is not paid.

Employment History

Rental home mortgages are a serious financial commitment and lenders rely on a stable employment history to determine your ability to make your repayments on time.

Most lenders require at least two years’ verifiable work history, as well as proof that your employment is likely to continue for a minimum of three years.

Lenders verify your employment history by checking with your current and past employers and/or requesting pay stubs and tax returns.

If you are self-employed or work on commission, lenders may ask for at least two years’ worth of accounts to substantiate your employment history.

Debt to Income Ratio

Most lenders require that your debt be no more than 30 percent of your income. This is your debt-to-income (DTI) ratio. The higher your DTI ratio, the more interest you will pay on your rental home mortgage.

If your DTI ratio is too high to qualify you for a mortgage, consider paying off high interest debts to get below the required limits.

Down Payment

Rental home mortgages often require larger down payments than conventional mortgages to compensate for the risk of void periods.

Most lenders request a down payment of at least 15 percent of the loan amount. A higher down payment may be required if you are a new investor and/or you have a credit score below 620.

Understanding the requirements for a mortgage on a rental home is an important first step in the buying process.

Knowing that you meet the requirements can boost your confidence and make it easier for you to negotiate with lenders.

What to Consider When Selling a Rental Property

For whatever reason, you have decided to sell your rental property. While this may be a sound business decision, you have a lot to consider before you begin the process or sign the final closing papers. Do it right, and you won’t have any regrets.

Informing Your Tenants

If your property is occupied, you will have to inform your tenants at some point. In multifamily units, it may not be a big deal.

Chances are pretty good your buyer will continue to maintain the property in the same way and keep the same tenants as long as they are current on their rent.

Things could be much different in a single-family dwelling where the buyers could want the home for themselves.

In this instance, you have to give your tenants an appropriate amount of notice.

A side benefit is that your tenants may be interested in buying.

If you can offer incentives, such as paying part of the closing costs, you may discover a buyer.

Otherwise, you may need to provide 60 days’ notice to be fair, even if the law in your state only requires 30 days.

Showing the Property

To sell the property, you will have to show it to prospective buyers — another good reason to let your tenants know. You need to find out what times are convenient for them and plan appointments during those times.

Unlike homeowners trying to sell their own property, your tenants may not be as cooperative because it doesn’t benefit them for you to sell.

One way around this problem is to offer them an incentive.

Perhaps you offer to deduct an amount from their rent in return for allowing a certain number of showings per month.

Include one or two open houses in the deal, and you are more likely to get full cooperation if they agree.

Make the deal even sweeter by providing an added discount if they find the buyer.

This puts both of you on the same team.

Realtor or FSBO?

You will also have to decide whether to hire a Realtor or sell the property on your own as a For Sale By Owner.

While hiring a real estate agent puts another person in the mix, it can also result in your property selling faster and for more money.

The key is to hire someone knowledgeable about investment properties.

A real estate agent should know the legal details of selling an investment property.

However, you should also talk with your lender about any ramifications of selling your rental and find out if there are any prepayment penalties or other concerns.

Legal Advice

While many home sellers use an attorney when selling their homes, it is essential for a property owner selling a rental.

Landlord and tenant laws vary by state, and you should find an attorney experienced in rental matters to ensure you don’t break any laws and end up being sued.

Selling a rental property is a major decision.

You have to consider the tenants and all the legal issues that can result.

The best way to navigate through this process if this is your first time is by working with an experience agent and lender to help you make the right choices as you sell your property.

Low Cash Options for Investing in Real Estate

Traditional real estate investments typically require a considerable upfront investment.

Mortgages for rental properties require a 20 percent down payment.

When you don’t have the cash on hand, breaking into real estate investment might take a more creative approach to financing.

Consider these options to avoid the cash requirements or obtain the financing through different avenues.

Avoid the Down Payment

One of the easiest, though not the fastest, ways to get into real estate investment without a large cash down payment involves buying a house for occupation.

Owner-occupied mortgages have options that include a zero down payment.

In addition to the low cash requirements for this type of loan, you also avoid the added cost of mortgage insurance.

Mortgages on personal properties rarely require the owner to carry mortgage insurance.

When choosing this method, keep in mind there are some restrictions, including:

  • Property must remain owner occupied for a set amount of time.
  • Longer terms may lead to slower equity.
  • Zero down loans may not be available after the first home purchase.

In most cases, loan agreements require the homeowner to live in the property for at least a year before renting out the residence.

Some require three years or more, so be sure to check on the residency requirements before selecting a lender.

Also, be aware that first-time home-buyer programs are not available on a second property.

You might still be able to find a zero down loan, but you need to be prepared to pay closing costs.

Cut Down on Closing Costs

Becoming a real estate agent is one way to significantly reduce the amount of cash you need to invest in real estate.

As an agent, you can handle the property sale and avoid paying the commission to a third party.

By removing the cost of commission to an agent, you can drop the cost of closing the sale.

Private Money Is Always an Option

If you are asset-rich and cash-poor, you might look into private lending sources.

Soft money, funds obtained from friends and family, might help you get started if you can guarantee a reasonable rate of return.

After all, a guaranteed 6 percent on a loan is often better than what someone might be earning in a CD.

Hard money, or asset-based lending, for real estate is another option.

These relatively expensive loans work in the short term by offering a 65-80 percent after-renovation value limit.

For example, if you used a hard-money loan to buy a house at $60,000 and the expected value after renovations is $120,000, you could secure financing of up to $96,000.

That loan amount will likely come with a term of a year or less, several points and a higher interest rate, but it allows you to close the deal.

Then, after the renovations, you might qualify for a refinance loan at the same loan-to-value ratio, allowing you to switch to more traditional financing without the upfront cash investment.

This is a relatively expensive way to get the money you need, but it works well when you come across a severely undervalued property, or you have the experience to do the renovation yourself.

Investing Without Assets

When you don’t have the money to invest directly, you need to either be prepared to invest time or cut into your profit margins.

There are many ways to find the funds, but these are some of the most direct. If you have the time, consider buying as a personal buyer and renting after meeting the residency requirement.

If you want to jump right in, work with private lenders to get the financing ready and dive into repairs.

Either method can help jump-start your life as a landlord with little to no out-of-pocket cash.

Benefits of a Mortgage Broker

If you’re the DIY type, you may wonder why anyone bothers using a mortgage broker when they could just talk to lenders directly.

For some people, the direct path really is the best option.

The majority of new real estate investors, however, can benefit from working with a mortgage broker.

Here are four reasons you should consider using one.

1. Using a Mortgage Broker Can Save You Time

Comparing mortgage offers is one of the most important things that you can do when buying investment property, as people often find that they can find vastly different offers from different companies.

Some lenders may decide that you don’t meet their expectations, so they don’t want to give you a mortgage at all.

Other lenders, however, may decide that you’re just what they’re looking for, so they will give you a low interest rate.

This may sound ridiculous if you haven’t worked in real estate or finance before, but it’s actually quite common because lenders use different criteria to measure how risky borrowers are.

If you don’t use a mortgage broker, then you will have to fill out applications for dozens of lenders. This takes a lot of time, especially since each company has its own set of documents.

Using a mortgage broker makes this process considerably easier.

Instead of filling out documents for several lenders, you just work with one person.

You will still have to provide plenty of documentation to prove your creditworthiness, but you will only have to do it one time.

That’s a big time-saver when you consider that most lenders will want:

  • W-2 forms from the last two years
  • A copy of your most recent federal tax return
  • Recent paycheck stubs
  • Canceled checks showing you have made rent and mortgage payments on time
  • A complete list of your assets and debts

If you own a business, then you will also need to supply loss and profit statements from your 1099 forms.

Renting property counts as owning a business, so you will need to give the lender this information if you already rent a property to tenants.

You will likely save hours of research on this issue by working with a mortgage broker.

2. Brokers May Have Access to More Loan Options

When you approach a lender, your loan officer will make certain assumptions about what you qualify for.

Even if you have a good credit history, the lender may choose to show you certain types of loans over others.

Mortgage brokers have enough experience to know what types of offers you can potentially use.

They also know what types of products lenders offer other clients. That could make it possible for you to access more loan options. They may not fit your needs, but at least you will get to consider them.

3. You’ll Likely Get Lower Interest and Other Costs

Since mortgage brokers have connections to a lot of lenders, they can often find loans with lower costs than the ones you would get by going directly to your bank. Having the option to look at more offers gives you an opportunity to lower the overall cost of borrowing money.

Lenders are also more likely to lower their interest rates and closing costs when working with brokers.

The lenders, after all, know that most mortgage brokers will work hard to find the best options for their clients.

This encourages lenders to compete with each other.

If they don’t lower their costs, then they aren’t likely to get much business from the broker.

In the long run, they can make more money by lowering interests, points and closing costs because that means the broker will get them more business.

Some real estate buyers worry that they will end up spending more money by using a mortgage broker. After all, the mortgage broker has to get paid.

However, this is unlikely to happen, especially since new regulations that went into effect in 2014 prevent brokers from making more money by selling expensive mortgages to their clients.

The new rules have also decreased the number of mortgage brokers. Considering that those brokers left the industry because they could only make good incomes by fleecing their clients, you should consider that a benefit.

4. A Mortgage Lender Can Give You Expert Advice

All investments come with some level of risk. Rental properties aren’t excluded from this.

Considering that you will likely spend $100,000 or more on your investment property, you will probably feel a little nervous about it.

Even if you know you can make money from the opportunity, it’s scary to hand such significant savings over to someone.

A mortgage lender can give you expert advice that will help you avoid common mistakes, and if nothing else, a good mortgage broker will help you feel more at ease. Sometimes, that’s all you need to move forward with an acquisition that will earn you steep profits.

Mortgage brokers aren’t right for everyone.

If you have a lot of experience in real estate and finance, then you may feel that you can do the job well on your own.

For most people, though, a broker offers experience and advice that can help them make smarter decisions when buying investment properties.

Interest Rate Outlook

Real estate investment is heavily tied to and dependent on lending interest rates, so a rate hike could unlock the door to lower property prices.

When rates go up, so do monthly mortgage payments, making it more difficult for you to find properties that will generate positive cash flow until prices correct for the new market.

When rates drop dramatically, more people buy and fewer people rent.

It can also drive up property values, as home buyers often look at the final monthly payment, not the price of the property.

With that in mind, it is crucial to keep an eye on mortgage interest rates when investing in real estate.

Recent Interest Rates

Since 30-year mortgages have the longest recorded history, you’ll want to look at this number to get an idea of what interest rates are doing and to follow trends.

In October 1981, according to Mortgage News Daily data collected on Freddie Mac, interest rates hit an all-time high of 18.45 percent. Since then, they have been on a fairly steady decline with a few peaks along the way.

In 2010, rates on a 30-year fixed mortgage dropped to 4.23 percent with fluctuations up to a little more than 5 percent the following year. After the increase, interest rates dropped again.

Where Interest Rates Are Today

Today, interest rates are almost back down to the incredibly low rates of November 2012.

Rates are holding steady at around 3.5 percent.

What is unusual is the length of time rates have remained low. For the past six years, interest rates have been at or below 5 percent, with typical rates sitting below 4 percent.

Why Have Interest Rates Stayed So Low?

The Global Financial Crisis, also known as the Credit Crunch, hit in 2007, leading to thousands of foreclosures, bankruptcies, and a long recession.

To help combat the effects of the recession, the Federal Reserve Bank responded by lowering interest rates to help spur economic growth.

With the economy in a slow but relatively steady period of recovery, these historically low interest rates may not last for long.

Low Interest Rates and the Real Estate Market

The GFC hit real estate hard. Creative lending tactics led to the issuance of many adjustable rate mortgages with balloon payments.

When homeowners failed to make the payment or refinance the loan, many lost their homes.

While this was tragic for the individual, it opened up a wealth of possibilities for real estate investment. After all, a flood of houses hitting the market depressed property values from the sudden highs seen leading up to the GFC.

Combined with low interest rates, investors had a sudden opportunity to expand their property portfolio at a time when more people needed to find rental accommodations.

At the same time, loan regulations became more strict, making it harder for lenders to find qualified buyers.

Those real estate investors with a higher credit score faced less competition for desirable properties. When fewer borrowers qualify for a mortgage loan, it reduces the number of offers per property.

Enter Government Mortgage Programs

Falling mortgage numbers spurred government action in the form of a variety of homeowner grant and tax relief programs.

First-time home buyer programs were designed to help new buyers get into a home.

Existing homeowners were offered a half dozen different programs designed to help them afford their existing mortgage or refinance to get out from under water.

Foreclosure rates are now at an eight-year low, bringing up the question of an interest rate increase.

Will Interest Rates Go Up?

Interest rates are cyclical.

Rates go down, and then they go up. The only real question is when, not if, the rates will rise.

The Federal Reserve did put through a small increase to the prime rate, but that does not directly impact mortgage rates. These are more closely tied to bond activity.

Also, as long as the Federal Reserve continues to buy up mortgage-backed securities, it is likely that mortgage rates will remain low.

Low Interest = Higher Prices

Even if the mortgage interest rates do start to rise, that may not be a bad thing for you.

If you plan on buying into real estate, a rise in rates usually translates into a drop in prices.

Buyers tend to look at the bottom line, and what they can afford on a monthly basis is limited.If rates go up and prices stay high, properties fail to sell.

Sellers may not move on the price right away, but, eventually, higher interest rates will drive down prices.

Why Higher Interest Could Mean Better Real Estate Returns

When you are buying real estate as an investment, the goal is always to buy at the lowest possible price and sell at the highest.

If high interest rates drive down property values, you could pick up some units at well below the current market value. Then, when the rates fall again, driving prices back up, you are in a prime position to sell at a significant profit.

When to Look for Rate Hikes

Experts predict that interest rates will stay fairly flat until 2019.

Increases will be phased in slowly, so if you watch the market you should see the trend.

When rates get up above 5 percent, it might be time to start looking for discounted properties.

Of course, if the market pushes back against the increase, you might see rates drop right back down.

Top 4 Things That Can Cost You Money in Real Estate Investments

Investing in real estate might be a great way to build lasting wealth, but it has its share of pitfalls.

Property is one of the single most expensive purchases you can make, giving you a lot of liquid tied up in a single investment.

When you start investing in real estate, you are taking a risk, but there are ways to minimize the risks and avoid unplanned expenses.

You want to enjoy the profits of your real estate portfolio, not spend everyday stressed about cash flow. Here are some of the most common mistakes and some tips to avoid them.

1. Underpricing Repairs

A property that comes with an asking price that’s too good to be true probably needs significant repairs.

If you can’t see the issues, it means they could be hiding behind the walls, carrying a massive price tag.

Renovating a property to rent or sell is a great way to earn equity and add value, but only if your repairs come in on-budget. An unexpected issue costs more for the repair and leaves the property vacant for a longer period of time. Underestimating repairs costs is one of the biggest mistakes new real estate investors make.

Avoid breaking the bank on repairs by:

  • Getting the property inspected by an expert. Let the inspector know you want every detail about needed repairs. Some inspectors may gloss over issues to help you line up financing, but that won’t help when you are underwater on your mortgage.
  • Don’t skimp on your contractors. There are plenty of places where you can cut costs, but the contractor you choose should not be one of them. A good contractor will do the job right the first time.
  • Research average costs of materials and repairs in your area. The more you know about the cost of repairs, the more you can negotiate the price with your contractor.
  • Expect to overshoot the estimate and build a slush fund into your budget. Even with a good inspection, you might run into surprise repairs, so have the money on-hand to cover any last minute additions to the construction plan.

2. Buying the Wrong Location

Where you buy an investment property might be even more important than what you pay or the condition of the property.

A beautiful house in an area with a 30 percent vacancy rate could sit empty for several months each year.

A more expensive property in an area with virtually no vacancy will stay tenanted, keeping your cash flow stable.

Before you pick a property, zero in on an area.

For a new landlord, you’ll probably want something that is close enough to commute to fairly regularly, and in an area that has appeal. Look for some of these signs, which indicate that you can find and keep tenants.

  • Easy access to shopping and transportation.
  • Low unemployment rates and big local employers means there should be a fairly stable source of potential renters.
  • Find something near, but not next to, a popular luxury apartment building. If an apartment complex can keep full, you should have no trouble finding tenants.
  • Check the crime rate and school statistics. These numbers can affect a tenant’s willingness to live in a particular area.
  • Track selling prices for a period of time. If sales are rapid and prices on the rise, it might be a prime time to invest. Another set of sales figures to watch for is a stable price after a drop. If prices have gone down and stabilized, the neighborhood could be ripe for another price increase. If all other signs point to revitalization, buy low, sell high definitely comes into play.

3. Failing to Check on Cash Flow

When you buy an investment property, you don’t want to have to reach into your pocket to make mortgage payments.

From day one, you should strive for positive cash flow.

Avoid operating underwater with a little investigation.

  • Look at properties near your prospective purchase. Even if total area vacancy rates are low, empty houses near your investment can make it more difficult to find tenants.
  • Track population changes. As more people move into an area, the need for housing grows. If you can catch an area at the start of a population explosion, you can rake in solid returns.
  • Check the property math before you put in an offer. Sometimes, a property that makes sense as home just doesn’t work out as an investment. You’ll want to total up all your expenses (taxes, mortgage, insurance, maintenance, etc.) and compare that number to average rental rates in the area. If the numbers don’t work, walk away.

4. Missing Compliance and Regulatory Issues

Different areas have different laws surrounding landlords and tenants.

Before you buy, make sure you understand all of the regulations that could affect your investment.

For example, Maryland has strict requirements regarding lead paint.

  • Know the safety regulations inside and out, and factor the expense of compliance into your cash flow plan.
  • Find out about licensing and leasing. The rules are different in every area, and a legal lease in New York may not be enforceable in California.
  • Adhere to livability standards. These change based on your area and may affect the number of tenants allowed to reside on the property and the amenities you must provide.

Making Real Estate Investments Profitable

Buying an investment property is exciting, but it can also be full of anxiety.

If you do your homework, stick to the numbers and obey all of the local ordinances and regulations, you could find a property that will enhance your monthly income.

Top 5 Questions to Ask Your Lender

The amount of profit you can earn from a rental property depends heavily on the terms of your loan; however, the better your loan is from the beginning, the more you can potentially earn.

Choosing the right lender is often difficult, especially for people who only recently developed an interest in becoming landlords.

Before you decide to accept a loan, make sure you ask the following five questions. They should help you choose an option that matches your needs and lets you earn more income from your rental property.

1. Which Types of Loans Do You Offer?

Keep in mind not all lenders want to work with landlords, so you might as well get this question out of the way as soon as you meet a company’s mortgage loan officer.

Some lenders also have stipulations about the types of properties they will fund and where those properties are located.

Don’t assume a lender who’s willing to lend you money to purchase a single-family home in California will also lend you money to purchase a multifamily home in Florida.

Each lender has its own concerns about giving money to landlords; make sure you ask for details that will help you choose the best company for your needs.

Ultimately, you want to work with a company willing to help you fund your investment property; otherwise, you could commit a lot of time and energy to a deal that falls through at the last moment.

2. What Down Payment Amount Do I Need?

It’s unlikely you can receive private mortgage insurance (PMI) for an investment property, so your lender will require a down payment that equals at least 20 percent of the home’s value. In some cases, lenders may ask for even larger down payments to protect themselves from risk.

From the lender’s perspective, an investment property is riskier than the house in which you live. While people obviously don’t want to lose their rental properties, their personal homes are more important emotionally and financially.

This slightly higher risk encourages lenders to ask for larger down payments, since the more money you have invested in the property, the less likely you are to walk away from it.

3. What Interest Rate Will I Pay?

Since lenders see investment properties as high-risk, landowners may have to pay a higher interest rate or more points.

Lenders usually choose one or the other, but this amount depends on your credit history and the size of your down payment.

The specific amount you pay often differs from lender to lender.

While one lender may choose to charge 2 percent more than its standard interest rate for a mortgage, another may charge twice that.

The same goes for how many points they charge.

This discrepancy makes it crucial for you to talk to several lenders before you accept a loan.

If you haven’t received offers from at least three banks, credit unions or other types of lenders, you won’t really know what your best option is.

Also, keep in mind these points will require you to pay a higher amount now while interest is paid throughout the course of the loan. If you have limited capital, you may want to choose a higher interest rate to avoid more points.

4. Do You Offer Non-Recourse Loans?

If possible you should choose a mortgage broker that offers non-recourse and recourse loans.

By taking a non-recourse loan, your home and other assets are protected from seizure even if you cannot repay your debt; instead, the lender can only seize the rental property you purchased with the mortgage.

Despite the advantages, there are some potential downsides to keep in mind before accepting a non-recourse. For instance:

  • Lenders often charge higher interest rates because non-recourse loans are riskier for them
  • Your credit score will still suffer if you fail to repay the non-recourse loan

Many landlords prefer using non-recourse loans because they want to protect their personal property from seizure.

The option you choose, however, will depend on factors such as how much investment capital you have and whether you’re willing to pay a higher interest rate.

5. Is There a Prepayment Penalty?

Some lenders include prepayment penalty clauses in their contracts to ensure they earn enough money from loans. If a lender insists on a prepayment penalty, it will charge additional fees if you try to repay the loan ahead of schedule.

This is important to know should you plan to use rent money to repay your loan as quickly as possible: By repaying ahead of schedule, you can potentially spend less money on your rental property. As long as there isn’t a prepayment penalty, you could save a lot of money to repaying the loan before the term ends.

For instance, if you use a 30-year loan with a 4 percent interest rate to borrow $100,000, you will spend a total $171,869.51 by the end of the 30th year.

If you repay the loan in 15 years, though, you will only spend $133,143.83. That option presents a saving6s of over $40,725.

A prepayment penalty will likely cost you several thousand dollars, which may affect whether you decide to pay ahead of schedule.

Lining Up Your Real Estate Financing: Cash vs. Loans

The biggest barrier to entry in real estate investment is usually the money.

Buying property requires a large chunk of bills. If you have the cash on hand, you can buy property outright. If you don’t, you must obtain a loan.

Both paths take you down the road to investment property ownership, but there are definite pros and cons to each purchasing decision.

Tax benefits, loss shelters, and liability issues are a few of the factors to consider when you are deciding how to make a property purchase.

Cutting the Tax Burden

One of the best reasons to get a loan when buying a property is the tax benefit.

Not only can you write off the property tax, you can also write off any interest you pay on the loan. Of course, if you pay cash, you avoid paying interest entirely.

The tax write-off helps reduce the cost of the loan but does not eliminate it.

Managing Investment Risk

A big part of any investment is the risk.

Typically, the riskier the investment, the more the potential payoff. In real estate, the same is true.

If you buy a property using cash, you can develop immediate cash flow. Every rental dollar you collect — minus taxes — is pure profit.

Of course, if the property sits vacant or the market drops out, you are left holding a worthless investment.

If you take out a loan to buy an investment property, you pay the bank most of the free cash coming from the property, but you don’t put your own dollars at risk.

One of the first things you learn in investing is to use someone else’s money whenever you can. That keeps your cash available for further investment opportunities.

Leveraging Your Assets and Cash

When you buy a property using cash, you limit your ability to buy additional investment properties. More of your money is tied up in the single purchase.

In the short term, you can generate more income from a property when you don’t have a mortgage.

In the long term, leveraging your holdings to close on additional properties will generate more wealth.

The more properties you own, the more rent you collect and the less a vacancy will affect your cash flow.

With the money you spend to buy one property outright, you could leverage the funds to own as many as ten investment properties.

Avoid Over-Leveraging

Using loans to buy properties allows you to buy more, but it can also encourage you to over-leverage.

Owning more properties means that you will eventually enjoy a comfortable income solely from rent, but you need to be cautious. The more mortgages you have, the more vulnerable you are to market shift.

f a property sits empty for too long, you could face foreclosure.

Before you choose to max out the number of loans available (typically 10 mortgages), you’ll want to take a serious look at your cash flow.

If every property is showing positive cash flow, and you can sustain the loans even if you face a high vacancy rate, you should be in good shape to continue expanding.

If your cash flow fluctuates and you pull money out of your pocket to pay your mortgages, it’s not the time to keep buying.

Over-leveraging and expanding too quickly are some of the risks associated with using a loan to build your property portfolio.

Quick Pros and Cons of a Cash Purchase

Buying with cash has some clear benefits and potential negatives.

Pros:

  • You own the property outright, so there is no threat of foreclosure.
  • Less pressure to keep the property occupied.
  • No mortgage loan that must be paid, even when the property is being repaired.
  • All rent collected, after taxes, is profit and can go into property maintenance.
  • Potential long-term property appreciation, increasing the value of your investment.

Cons:

  • You must have the cash in-hand to make the purchase.
  • Almost every dollar you collect is subject to income tax.
  • Reduces cash flow, which also reduces your ability to diversify and grow your portfolio.
  • Risk of property depreciation is entirely yours.

Quick Pros and Cons of a Mortgage

When you either don’t have the cash to buy outright or would simply prefer to dilute the risk, you need to understand the benefits and negatives of financing the purchase.

Pros:

  • You don’t have to have the entire purchase price in free cash.
  • The bank’s money is at risk, not your own.
  • Tenants pay off the mortgage, tying up cash flow in exchange for equity.
  • Greater financial flexibility with less of your free cash tied up in property.
  • You can deduct the interest paid on your loan, reducing your tax burden.
  • Potential property appreciation in the long-term increases the value of your investment.

Cons:

  • A big chunk of rental income goes right to the mortgage payment.
  • Foreclosure is a risk if you can’t meet the financial obligations of the mortgage.
  • Must fill vacancies as quickly as possible to avoid missing mortgage payments.
  • You pay interest to make the purchase, adding to the price of the investment.
  • Risk of property depreciation that could cut into your earned equity.

Deciding Between Cash and Loan Purchases

Ultimately, both cash and financing options have clear benefits. I

f you already have a well-diversified property portfolio, you might not need to finance.

If you have enough cash on hand to buy a rental property, consider the benefits of leveraging that cash to purchase several rentals. The amount of risk will influence your decision.

If you are comfortable taking moderate risks to increase your eventual return, financing is a great option for investing in real estate.

How to Make Top Dollar on a Real Estate Investment

If you are buying property as an investment, the first priority is profit. You want to make as much money as possible, in the shortest amount of time.

With real estate, you have several options for ensuring positive returns on your investment.

You can buy, renovate, and sell; buy and rent; or buy, live and rent. Endless variations on these themes exist, and there are many more possibilities.

When you first start investing in real estate, you will probably want to start with one of these basic practices. To get the most out of your property investment, keep these things in mind.

Real Estate is NOT a Short-Term Investment

The only way to turn a quick profit on real estate is through a renovation model.

You buy a distressed home at below its market value, improve the property, and then sell it.

This model can give you some quick gains, but unless you plan to do most of the renovation work yourself, it can also be a very expensive way to turn a profit.

If you are planning on doing the rehab, you need to know what you are getting into. Rehabbing a home takes a lot of work, a big investment in time and materials, and may not go according to plan. If the renovation takes too long, you could see property prices dive, leaving you selling at a loss.

The buy, renovate, and resell business model works best for those with a lot of experience in construction and the real estate market. Plus, it only generates a one-time return. Looking at real estate as a long-term investment gives you more flexibility in how you deal with a property.

Becoming a Landlord

Renting out a property is the way to generate consistent income.

Mixed-use and multi-family dwellings are often the best way to get the most income with immediate returns. It is easiest to line up financing for owner-occupied buildings, so finding properties in which you can live and rent space makes a lot of sense.

They also offer benefits during renovation periods.

If you need to do repairs to one unit, you can still draw income from one of the other units.

As a landlord, you can get many of the same benefits as someone who renovates and resells, without the risk.

Because you plan to keep the property for several years, you do not need to rush renovations or worry about temporary price fluctuations.

Building Wealth with Property Appreciation

One of the most common ways to earn a good return on real estate is by gaining appreciation on the property.

A building you buy now might be worth considerably more in a few decades.

On top of that, you can collect rent every month, giving you income as you wait for the property value to go up.

Like with any investment, you should set some hard and fast targets before you buy.

When buying stocks, you can set up sell thresholds, and you should do the same when buying a property. Waiting too long can leave you struggling to sell after the market corrects.

Instead, commit to specific targets and act as soon as you reach them.

Expanding Your Property Portfolio

A few small units can give you a regular income, but to make real estate your primary source of income, you need a fair number of units.

That is where small apartment or office buildings come into the picture.

You’ll want something that has less than 50 units and more than five.

More units mean more income per property, and if you can buy the property outright or pay down the mortgage quickly, most of that money goes right into your pocket.

The reason why most new real estate investors don’t dive into an apartment building is due to the more complex financing requirements. Commercial lending on that scale has more limitations.

Buy Low, Sell High

Ultimately, making money on real estate comes down to the simple concept of buy low and sell high.

You want to find undervalued properties or areas you think are likely to experience a renaissance.

For example, in Maryland, the addition of the Rt. 200 toll road made property further from Washington D.C. more valuable. With quicker access to the Metro and other major highways, homes further from the city could commute in a reasonable time.

Find areas with similar construction plans in the works or new businesses coming to the area.

If you get in before the property values start to rise, you can make a real killing.

Diversify and Wait

When you are in real estate for the long haul, you have the potential to earn a lot.

Each property in your portfolio represents a significant capital asset. By renting units, you get someone else to pay the mortgage, leaving you with a valuable investment and direct income.

Don’t invest in property expecting to see rapid appreciation, and don’t spend all of your time on renovations.

To get the most money out real estate with the least stress, invest in properties that will give you positive cash flow from day one. If you do, you can rapidly expand your property portfolio and gain capital assets.