Are you eyeing your next rental property deal? It’s a smart way to double down and increase your passive income, but it’s also a capital-heavy endeavor that comes with its fair share of challenges and risks.
There are a handful of ways to secure funding for your next rental purchase, but not all are created equal. The easiest and most obvious choice is to take out a loan, be that a home equity loan, conventional loan, or a hard money loan.
Take out a conventional loan
You’re probably wondering: is it better to take out a traditional loan or purchase the property with cash? The answer often boils down to your investing goals.
Sure, buying with cash can generate positive cash flow every month, but the return on investment is usually low. Take a property that’s appraised at $200,000. If you pay cash, you could earn around $19,000 annually, which translates to a 9.5 percent ROI. Taking out a conventional mortgage (4% APR), on the other hand, you can get roughly a 27.9 percent return on your investment.
Should you refinance?
If you’ve got some equity in your existing properties, you can refinance your mortgage to score some funding for your next rental property. Refinancing is a cost-effective funding option when it comes to closing costs, flexibility, and interest rates, plus you can pay it off as you see it fit.
If leveraged creatively and managed properly, refinancing can be a smart way to use your wealth to make more money. There are some downsides, though. First, you’re eating into equity in your current rental property, and refinancing rates are usually adjustable. This can make it difficult to gauge your long-term financing costs.
Consider private money
As clearly suggested by the name, this is a financing option that involves getting funds from private investors. They can be your friends, family, colleagues, or pretty much any individual willing to back your investment. This route is usually costlier than a conventional loan but offers more relaxed and flexible terms.
Take out a home equity loan (HELOC)
This type of financing allows you to use your home equity as collateral to take out a loan to finance your next rental property. The equity in question is usually tied up in your primary residence.
For instance, let’s say you have owned your home for over 15 years, all while paying off the mortgage. If the current market value of the property is $850,000 and you have paid down $400,000 in mortgage payoff, you can refinance the loan to take advantage of the $400,000 equity in it. In other words, you can tap into the $400,000 of home equity to purchase your next rental property.
Tap into your retirement accounts
If you have a fat 401(k) account, you can borrow up to half of the balance to buy your rental property. Note that not all 401(k) administrators allow members to borrow a loan, and you’ll have up to 5 years to pay it off. Borrowing against your 401(k) is the cheapest and fastest way to access a loan.
Borrowing to finance your next rental property isn’t always a viable investment move. For instance, if you have less than 10 percent equity in your current rental property, you might actually be overstretching your finances. Additionally, you should take your other must-pay into account.