When it comes to purchasing your first home, there’s a wealth of information out there on how to build your credit, available first time home-buying programs, how to reach out to lenders, and what kind of insurance you need. But when it comes to purchasing your second home, it’s a little more unclear.
Housing prices have started rising again, but interest rates are staying relatively low — at least for the time-being. If you’re looking to buy, now is the time to do it.
Sadly, the days of quick and easy financing are now long gone. The credit market is beginning to tighten, and it’s becoming increasingly difficult to acquire loans for a second property.
However, with a little creativity and preparation, you can increase your chances of borrowing money. Whether you’ve simply outgrown your first home and are looking to upgrade, or you’re looking to invest in a rental property, these tips can help.
Include a significant down-payment
When I was looking to purchase my first home, I leaned a lot on the wisdom of my Uncle. At one point, he said to me, “Getting into the housing market is difficult. But once you’re in it, it’s easy.” He was referring to the amount of money that was required for an initial down-payment. However, once you’re actually in a home, it’s simple to upgrade. You already have equity in your home that can be rolled into another.
First-time home-buyer programs offer incentives that allow you to purchase homes with as little as 3.5% down. If you live in a rural area, you may even qualify for 0% down. The rest of the money that you didn’t put down is covered by PMI (Private Mortgage Insurance) until you’ve reached 20% loan-to-value equity. On investment properties, no such buyer programs exist.
Because of this, you’ll have to have enough cash to put down at least 20% to acquire traditional financing. To improve your chances of qualifying, however, you’re best to put down 25%. Not only will it give you better chances of qualifying for a loan, but the likelihood of getting an improved interest rate increases as well. In the long run, the lower rate will more than make up for the additional 5% you put down.
If you don’t have 20-25% to put down for an investment property, you may still qualify, but it’ll be more difficult.
Purchase with ‘A Credit’
There are a lot of factors that can play into the terms of a loan on an investment property. Some things such as specific policies from your lender, loan-to-value ratio, and your personal debt-to-income ratio. The most telling, however, is your credit score. You’ll want to check this before going to apply for a loan.
To achieve the best interest rate, you’ll want what banks refer to as “A-Credit”. This is a credit score of 740 or above. Granted, if you’re even higher than that, great! But if you’re lower than that, you may want to work on improving your credit before applying, as this can save you thousands of dollars over the life of the loan.
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Another option, if you’re below that 740 mark (and you’re too impatient to wait until it’s higher), is to pay a fee. Some lenders will give you the same interest rate as someone with a higher credit score, but by tacking on an extra charge. But since SaneCents is in the business of saving you money, not wasting it, we’d advise against it.
If neither of those options sound appealing, one last option is to simply accept a higher interest rate.
Have 3 to 6 months cash reserves
While this may be an investment on your end, banks are equally as invested in what they’ll be getting in return. Before they’re willing to lend money to you, they want to know that their investment is secure as well, and that it isn’t going to fall apart as soon as you drive away. They’re going to take a look at all of your financial statements, and they’re also going to take a peek into your bank accounts. They want to see that you have sufficient funds to weather a storm, if need be.
While three months should be considered a minimum, six months is much more ideal. Remember, this is six months of expenses, not necessarily what you’re currently living on from month-to-month.
In addition to this, as you progress into purchasing even more rental properties, lenders are going to want to see that you have reserves set aside for each individual property. I, personally, like to have $5,000 minimum per duplex, or $10,000 per four-plex. This allows me to have money set aside for monthly repairs, and a decent side-fund in case a unit goes un-rented for a couple months.
Stick with Credit Unions or private lenders
When I turned 21, I called up Wells Fargo to get approved for my first car loan. They approved me; for a 12% interest rate, and a limit of $8,000. That was with good credit, too. I quickly blew them off and went down to my local credit union. They came back and approved me for a 3.5% interest rate, and a limit of $20,000.
In defense of Wells Fargo, I didn’t have any prior credit history, so they were playing it safe. But I wasn’t about to take a loan out with an interest rate so high. I’m sure if I were to go back now, Wells would give me a better rate, but they wouldn’t be able to match a credit union.
Wells Fargo is a bank. They’re in the business of making money (aren’t we all). Just as they tried to gouge me with a car loan interest rate, they’ll do something similar on a mortgage. They’ll easily charge you a percentage point or two higher than a credit union or other lender. Seek out credit unions first to find a better deal.
Home Equity Line of Credit (HELOC)
While this isn’t my favorite option, it’s still a valuable option, and many take advantage of this. You essentially take the equity that you’ve built up in your first home, and then roll it over as the collateral on your second property. The guys over at Bigger Pockets do this all the time. They call it the “BRRRR Method“.
You may have a more difficult time finding a bank that will be willing to roll equity over into another property, and another, and another, and so forth. Prior to the crash of 2007 and sub-prime lending, this would have been easy to do. Now, banks and credit unions have more safeguards and regulations in place to not allow this. Banks also want to see that you have a more vested interest in the property. They want you to have money of your own down, rather than borrowing from yourself over and over again, essentially.
Be creative. With the above tips, you should be able to get into a second property relatively easy.