I was just wondering what type of loan most of you use when purchasing rental properties. I currently buy rehabs and use an 80% ARV loan at 6% for that purpose. But it’s one year interest-only, so I would be forced to refinance after a year. But maybe that’s not a problem? I don’t want to pay any down payments. I want to buy a bunch of rentals but don’t know how to go about the financing. Thanks.
Hi, Mr.Fancypants
I just used a 30 year conventional loan for the rental property. With an adjustable rate.
For that traditional 30 year mortgage didn’t you have to come up with a 10-20% downpayment? I want to do it totally with other people’s money?
yes. I had to do a 20% downpayment. I want to use other peoples money too. 
Often, your exit strategy determines your financing opportunity. If you are going to flip the property quickly, 100% financing at high rates will work because you plan a short holding period. When you want to get into investment rentals – property you may never sell – your financing approach may need to change somewhat and your financing has to be affordable.
You might consider going after a Subject To deal for the 100% financing, only to discover that the property won’t cash flow as a rental with the current loan in place. Your exit strategy might be to flip the property on either a Lease/Option or on a Contract For Deed. In either case you are selling the future appreciation now to collect a profit. In either case, you are selling the property.
To hold the property for a long term rental, you will probably have to refinance to get a lower mortgage payment which will result in a positive cash flow. How much you want to pay down the loan balance depends upon how much cash flow you want.
Personally, I just use conventional financing. I do my cash flow analysis based upon 80% financing to avoid PMI. If this level of financing gives me a 1.25 or higher DCR and an internal rate of return of at least 15% over an eight year holding period, then I go for it.
I once used a 90% loan and paid the PMI for two years because the property was discounted so much. I paid $49K for the property in 1999, put another $8K into the rehab, then collected a great positive cash flow until I sold the property this year for $153,500.
Running the numbers, I had a total of $21K invested in the property (purchase price, initial rehab, and other capital improvements over five years). I collected an average of $200 monthly cash flow, for about $12K over five years. I collected $100K in net sale proceeds when I sold. Seems like my return on investment averaged around 100% per year. I am not going to walk on this deal just because I am not able to do it with 100% financing.
I rarely try to do a deal with 100% financing because I have the resources to put 20% down on anything I might want to buy for my rental portfolio. I just make sure that the deals I do make good business sense when I consider all the potential to be gained from Tax Benefits, Cash Flow, and Future Appreciation.
Thanks DaveT for your helpful response. I think I understand most of it. So basically let me see if I am getting the jist of it. It seems like you’re saying it’s okay for me to use my “rehab” loans to buy rentals, but that I’ll eventually have to refinance inorder to be able to get a positive monthly cash flow. What exactly does refinancing entail. I am assuming because I buy REO’s with a lot of built in equity that refinancing means I could pull out money or get a low monthly payment? Thanks for your help and merry Christmas.
No, you took my comments out of context.
Go back to the Subject To example where you take the property subject to the existing financing (100% financing already built in) then discover that you can’t make the property cash flow under the existing mortgage terms. If you want to keep the property for long term rental use, then you might want to reduce your debt service.
Refinancing (getting a new mortgage loan to pay of the existing mortgage loan) could reduce your monthly payment enough to produce a positive rental cash flow. If not, then you will need to consider paying down the loan balance at the same time.
If you are buying REOs at a discount to market value, then conventional financing usually requires some money out of pocket as a down payment. Alternatives to using conventional financing, yet still obtaining 100% financing include a home equity line of credit on your personal residence, or a working line of credit at your bank.
Using a HELOC on your primary residence (if you can get a credit line large enough) may let you purchase with 100% financing. Also, you might accomplish the same thing with a real estate credit line. I have a working credit line with my bank that will finance up to 80% of appraised value regardless of the contract purchase price. If the property is being sold at a large enough discount, I could use my credit line for 100% financing.
The main point of my response is that 100% financing is not your goal here if you are acquiring property for your long term rental portfolio. Instead, you need to be focused on cash flow. To get the cash flow and the return on investment that meet your criteria, you may have to bring downpayment funds to the settlement table. If you purchase correctly, you will never have to take another dollar out of pocket. Your rental income will cover all your expenses, pay off your mortgage loan, and give you a little monthly income (cash flow) to contribute to a contingency reserve fund. When your fund is large enough to cover any major emergency that may come up, the cash flow can be accumulated for future acquisitions.
Along with cash flow, you get tax benefits, and can profit from future appreciation. Use 1031 exchanges to expand and/or upgrade your real estate portfolio without ever contributing another dollar out of pocket (still 100% financing). Repeat often over time to accumulate a respectable net worth.
DaveT,
Thanks for your response. It makes sense now. If you have time, could you go a little more in depth about that formula you use to determine profitability. You mentioned a 1.25 level of DCR and an IRR of 15% that you look for in the deal. Thanks.
Downloan the Cash Flow Analysis Tool available right here on this site in the Real Estate Forms section.
Positive cash flow and return on investment are just two metrics I use to tell me that a property is a candidate for my rental portfolio. DCR tells me that the net operating income is sufficient to cover vacancy and unplanned repairs. The IRR tells me if the return on the investment is good enough.
When I buy rental my goal is to never have them more then 5 years. With that said I get intrest only over 40 years . This gives me max cash flow. I allways put 20 % down so I avoid PMI. If you dont have 20 % try an 80/20 program.
All The Best
paul J. Da Costa
Mr. Fancypants,
I am from nashville as well and was wanting to know what bank you were talking about that offers 100 percent financing.
For the casual reader, the monthly payment is the same whether the interest only loan is for five years, ten years, or 40 years.
Shop for a shorter loan term to get a better rate. I have no direct knowledge but I strongly suspect that an interest only loan for five or ten years will have a lower prevailing interest rate than a 40 year loan product.
Their are a number of banks that will do 100% Country Wide Indy Mac Longbeach. Call me if you have any questions 941-716-2597
All the best
paul J. Da Costa
pdacosta,
Last time I checked with CountryWide, they would only go to 90% LTV on investment property – only 80% if the property is a condo.
Since this was a couple of years ago, has CountryWide since changed their lending guidelines for investor loans?
Yes I just did a 80/20 from CW the client had gret credit. And was a SFR
Paul J. Da Costa
Owner occupied loan, or investor loan?
Investor. Great credit and assets can get you almost anything
Thanks everyone for your helpful responses. I really appreciate it. Have a happy new year.