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.