Investment properties have become popular for building passive income and diversifying your investment portfolio. However, it’s important to understand that the down payment for investment property use differs from that of primary residences.
While you might have been able to purchase your home with as little as 3.5% down, investment properties typically require much more. Understanding the down payment you’ll need when buying a rental property is essential to ensure the transaction goes smoothly.
Keep reading as we dig into the investment property down payment you’ll need and some things you can do to reduce out-of-pocket costs.
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Most lenders require a down payment of 15% to 30% for an investment property. However, it’s important to understand that this number can change based on several factors, including your credit score, debt-to-income (DTI) ratio, the type of property you’re purchasing, and the loan you use.
Investment property down payment requirements are higher than those primary residences because lenders take on additional risk. If an investor loses money with a rental property, it’s much easier to walk away than with their home. However, when investors have more money tied up in an investment, the chances of them walking away drop significantly.
Although purchasing a rental property requires more cash, there are some benefits. With a lower loan-to-value (LTV) ratio, investors can have a better chance of securing a lower interest rate on their loans and paying fewer fees.
Even though the down payment for investment property use tends to be higher, there are ways to reduce your overall cost, including how much you’ll need at closing. One of the easiest ways is through house hacking.
House hacking is a great way to become a homeowner and generate rental income. When housing hacking, you’ll purchase a multifamily property, live in one of the units, and rent out the others.
One of the benefits is that house hacking can also help you avoid the hassle of using an investment property loan. Instead, you could use an FHA loan and take advantage of its reduced 3.5% down payment requirements. If you qualify for a VA loan, you could land a mortgage with no down payment at all. However, it’s important to understand that FHA loans technically aren’t available on investment properties. Instead, you’d need to live in one of the units for at least a year to qualify.
By renting out the additional units, you can generate rental income to help cover a portion of your monthly mortgage payment.
When considering financing options for rental properties, you might consider a conventional loan from a bank or credit union. Fannie Mae or Freddie Mac backs these loans, and each has a different down payment requirement.
Conventional loans through Fannie Mae are available on single-family properties with a down payment of at least 15%. Multifamily properties require a larger down payment of 25%. However, when underwriting the loan, lenders will consider more than just your down payment. They also consider your credit score, debt-to-income, and cash reserves.
| Units | Down Payment |
|---|---|
| 1 | 15% |
| 2-4 | 25% |
Many of the same requirements apply to loans backed by Freddie Mac; however, the down payment requirements are slightly different for those purchasing multifamily units. Freddie Mac loans can also offer additional flexibility with loan terms for highly qualified borrowers.
| Units | Down Payment |
|---|---|
| 1 | 15% |
| 2-4 | 30% |
Some lenders originate loans and then sell them to Fannie Mae or Freddie Mac. Other lenders, known as portfolio lenders, hold onto the loan beyond closing. Specialty lenders usually offer these loans, but traditional mortgage lenders can occasionally act as portfolio lenders.
Because these loans stay on the lender’s books, they can offer flexible underwriting terms. Instead of strict credit score or debt-to-income requirements, they can provide financing to borrowers who might not otherwise qualify.
Although lending to lower-quality borrowers carries added risk, lenders can minimize the risk by offering higher interest rates and fees.
With real estate prices still rising in much of the country, many investors find raising 15% or even 30% of their investments challenging. That means thinking strategically and finding innovative ways to raise funds or reduce the amount needed is important.
Here are a few ways to come up with a down payment for your investment property.
One of the easiest ways to access the down payment for a rental property is through the equity in your current properties. Using a home equity line of credit (HELOC), you can borrow up to 80% of the equity in your primary residence or another rental property. With housing prices up significantly over the past several years, you’re likely sitting on a significant amount of equity that you can turn into cash.
Compared to a mortgage, getting a HELOC is easy. Unfortunately, the interest rates will be higher than lenders’ offers for most new mortgages. It’s also important to understand that HELOCs act as second mortgages. Your monthly payment will be determined by how much you borrow. It’ll be due alongside your original mortgage payment. Bear in mind that defaulting on your HELOC could result in a foreclosure.
One option for obtaining a down payment for a rental property is through a private lender. This process typically involves the borrower supplying the down payment while the lender provides the remaining funds for the purchase price. However, some private lenders will loan well-qualified borrowers the entire purchase price.
One of the best ways to find a potential lender in your area is to join a real estate investing group. It’s likely that someone has used a private lender and can provide a recommendation.
Typically, when you invest in an IRA for retirement, you’re limited to stocks, bonds, mutual funds, and ETFs. However, when you use a self-directed IRA (SDIRA), you can include many other asset classes, including real estate.
When using an SDIRA, the SDIRA owns the investment property, and the cash flow pays into the account. Additionally, all expenses for the property would be paid out of the SDIRA. You wouldn’t have access to any of the profits until you started taking withdrawals after retirement.
Because of the complexities and regulations surrounding SDIRAs, a custodian is usually used to set up and maintain compliance.
Another option for financing the down payment on a rental property is to work with a group of investors. These could be friends and family or other investors in your area. By working with others, you can reduce the amount of money you need for a down payment.
Group investing could help you avoid using your money for the down payment. Instead, you could find a partner willing to use their cash for the down payment as long as you manage the day-to-day investment. In exchange, you both share the profits.
Before applying for an investment property loan, it’s important to understand what it will take to get approved. The last thing you want is to apply for a loan, go through the entire process, and get declined.
Here are a few things to know before getting started.
It is essential to ensure that the down payment for a rental property is covered, but you should also consider additional factors before investing in real estate.
Many factors can make real estate a winning or losing investment. However, one of the most significant factors is location. When purchasing an investment property, picking the ideal location can make all the difference.
Ask yourself: Is the home in a desirable neighborhood? Will it be easy to attract and maintain tenants? Are prices in the area appreciating? These are all questions you should ask before purchasing a rental property.
Depending on where you live, your state property taxes can fluctuate greatly. While states like Illinois have some of the highest property taxes, states like Colorado have some of the lowest.
Before Investing, make sure you understand how taxes will affect your investment. If you want to buy property close to you, there isn’t much you can do. However, if you don’t mind being a long-distance landlord, you can choose a state where the financials make the most sense.
If you purchase an investment property in your city, you can manage it yourself. A property management company will cut your cash flow, leaving you less cash available to improve the property or look for other deals.
Consider using a company like TurboTenant. We offer critical services like lease agreements and accounting tools, and we can also handle tenant screening, rental applications, and rent collection. Access to all the necessary property management tools can make investing in real estate more profitable and less stressful.
Investment property down payments can fluctuate based on the lender you’re using and the loan type you want. However, you should always expect to need anywhere from 15% to 30% of the total purchase price. Luckily, we covered some creative ways to reduce and, in some cases, eliminate the need for any of your own cash at closing.
The down payment required for an investment property depends on the lender and type of loan. If you’re using a conventional loan, you’ll need anywhere from 15% to 30%, depending on the number of units purchased. If you’re using an FHA loan, you could get away with a down payment of 3.5%.
You can use an FHA loan for an investment property if you live in the home for at least one year. FHA loans work great if you’re purchasing a multifamily building because you can live in one of the units and rent out the remaining.
Even though rental properties require significant cash as a down payment, there are ways to reduce the amount you need. For example, you could get a home equity line of credit to use your equity in your primary residence or another rental property. You could also partner with another investor and split the down payment.
The credit score needed will depend on the lender and the loan product. However, if you’re applying for a conventional loan for your investment property, you’ll need a credit score of at least 700. With a higher down payment, you might get away with a lower credit score.
If you’re using a FHA loan, you could use a 3.5% down payment if your credit score is at least 580. For credit scores between 500 and 579, a 10% down payment would be required.
When you purchase a rental home, there are several additional expenses you’ll need to consider besides the required down payment. Once you close, you’ll also be responsible for property taxes, maintenance, homeowners insurance, and property management.
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