Real estate investment is a rewarding path to building wealth. Like most new ventures, starting is usually the most challenging part. Figuring out how you’ll afford this investment is usually a top early hurdle. Securing the funds to purchase your first property is one of the biggest challenges first-time real estate investors face. Knowing where to begin can make all the difference in your success.
Read through every step to finance your first real estate investment and lay the groundwork for a successful venture.
Step 1: Assess Your Financial Readiness
Real estate financial planning begins with knowing where you stand financially. Perhaps you do have the cash at hand to make a buy. However, you won’t be alone if you need financing. Many real estate investors do rely on some financing as part of their business.
The lenders you work with will evaluate your financial health. So should you before starting. Look at:
- Credit Score: A good credit score is key to qualifying for favorable loan terms. Aim for a score of 700 or above to secure lower interest rates.
- Income Stability: Consistent income reassures lenders that you can handle monthly mortgage payments. Be prepared to show proof of steady earnings through pay stubs and tax returns.
- Down Payment: Real estate investment properties typically require a higher down payment than buying a personal home—often 20% or more.
- Cash reserves: For some loans, lenders want to see you have enough cash on hand to cover bills should the investment not meet income-generating expectations.
- Budget: Run the numbers to verify you can comfortably afford the initial down payment plus closing costs. Then, there are the ongoing monthly costs like mortgage payments, property taxes, and maintenance. For rentals, you’ll need funds to float the property when it’s vacant and for marketing.
Pro Tip: Use a mortgage calculator to estimate how much you can borrow while staying within your financial comfort zone.
Step 2: Explore Different Real Estate Financing Options
The good news is that real estate investors have multiple loan types available to assist with these purchases. The best type of loan depends on your financial situation and investment goals.
A few common ways to finance investment properties:
- Conventional Mortgages are similar to home loans but often carry stricter loan qualifications. While conventional loans have competitive rates, you’ll need excellent credit and a solid down payment.
- Rental investment loan, also called a debt service coverage ratio (DSCR) loan, evaluates the ability to repay based on the property’s net operating income.
- Investment property loans assist with single-family home and less than four-unit purchases. Most lenders consider these higher risk, so expect higher interest rate and stricter terms.
- Government-backed loans may be an option if you plan to live in one rental property unit. Think duplexes or renting the accessory dwelling unit (ADU).
- Hard money loans are short-term loans ideal for fix-and-flip investors. They have higher interest rates and shorter repayment windows but are easier to qualify for and fund quickly.
- Private lenders can offer flexible terms, making them a good option for investors who don’t meet traditional loan requirements. However, interest rates may be higher.
- Seller financing may be equally as flexible as private lending, but it usually is a short-term arrangement and has the seller holding the promissory note.
- Crowdfunding for Real Estate: Some platforms allow you to pool money with other investors to buy into real estate projects. Crowdfunding starts with minimal upfront investment but relies on the project leader to deliver returns.
- Home equity loans help some new real estate investors tap into their primary home’s equity to afford the down payment on the investment property. However, it could change your debt-to-income ratio and make qualifying for a second loan more challenging.
- Cash-out refinance: Like a home equity loan, real estate investors use existing equity to gain down payment or closing cost funds. However, this also refinances the primary home’s existing mortgage at a higher amount than the original loan balance to account for the loaned equity.
If you’re looking into commercial properties as your first real estate investment, there are targeted commercial loans to assist with your purchase.
Pro tip: Investment real estate comes with some tax benefits. Speak to a local tax professional about how to structure the sale and financing with the tax code in mind.
Step 3: Understand Loan Requirements and Terms
Part of being a real estate investor is studying the mortgage industry and watching market trends. The more you know about financing, the higher your chances of success. Over time, you’ll develop relationships with mortgage lenders who can get you the funds needed for an investment property. Walking in the door with a deep knowledge of terms and packages helps make a strong first impression.
Key factors include:
- Loan-to-Value (LTV) Ratio: Most lenders require an LTV ratio of 80% or less, meaning they won’t finance more than 80% of the property’s value.
- Debt-to-Income (DTI) Ratio: This measures your monthly debt payments compared to your monthly income. A lower DTI (typically under 43%) improves your chances of loan approval.
- Interest Rates and Repayment Terms: Interest rates for investment properties tend to run higher than those for personal homes. Compare lenders to find competitive rates and opt for terms that align with your investment strategy.
Step 4: Secure Your Financing
Be prepared with rental property financing long before you find the right purchase. Part of being an investor is moving with speed and purpose. Having your funding sources lined up helps execute the deal quickly.
- Choose the Right Lender: Whether it’s a conventional bank, private money lender, or crowdfunding platform, talk to multiple lenders to find one who understands your investment goals. Seasoned investors work with several lenders, as one may be your hard money lender while another works in conventional financing.
- Prepare the Necessary Documents: The typical loan application paperwork includes your credit history, tax returns, bank statements, proof of income, and details about the property you’re purchasing. Private loans may not want all of these, as it varies from lender to lender. For existing rental properties, you’ll ask the buyer for statements like their profit and loss and annual NOI.
- Get Pre-Approved: Pre-approval gives you a clear idea of how much you can borrow and strengthens your position when making an offer.
- Finalize Approval: Once a buyer accepts your purchase offer, the lender may do a final assessment, including home appraisal, after-renovation value estimates, or a review of its past rental income. Be diligent about providing all required documents promptly.
Step 5: Find and Purchase the Right Investment Property
Now comes the exciting part—choosing your first real estate investment! Finding investment properties at its core isn’t much different from finding the right primary residence, other than specific factors weighing more heavily.
For instance, if you want to rent a residential property long-term, you need a place in a high-demand area where people work and live. However, a short-term rental would be better near popular attractions.
Either way, focus on properties with the potential for high cash flow and ROI to ensure your investment pays off in the long run. Estimate the rate of return, looking both at the passive income and the return on investment when you sell. Always have an end game in mind before buying.
- Research the Market: Look for areas with strong rental demand, good schools, or easy access to essential amenities. Stability and growth potential help keep a rental property occupied. FIx-and-flip investors want areas with excellent home values but high demand for homes.
- Perform Due Diligence: Inspect the property thoroughly and identify any repairs or improvements needed to maximize its value. A property with a deeply discounted price has a reason for it. Check that the repairs won’t cost more than the after-repair value or beyond your budget.
- Negotiate with Financing in Mind: Work with your real estate agent to negotiate favorable terms while keeping your financing limits in check.
Start Your Real Estate Investing Career
Everyone has a beginner investor at some point. Financing your first real estate investment is absolutely doable—and totally worth it! By looking at your finances, exploring creative ways to fund your investment, and finding the right property, you’ll be on your way to starting an exciting and successful journey.
Remember, the right financing strategy can make all the difference in your real estate investment journey. Research your options and take that first step toward building future wealth.
About the Author: Preston Guyton is the founder of ez Home Search. He has been a real estate leader for over 20 years. Starting with a focus in South Carolina, he has helped coach and empower real estate professionals to achieve their full potential by meeting the needs of their local community.