How to find the money to buy a rental property
There are a number of ways in which you can come up with the money required in order to purchase an investment property. Despite what many beginner investors might think, you do not need to have a lot of your own personal savings in order to buy a rental property. Let’s look at the different ways in which you can find the money.
1) Your own personal savings
You can use your own savings in order to buy a real estate investment. This is probably the least common method that is used by real estate investors. It is not a common method used; because, generally you have to come up with a significant amount of cash in order to purchase an investment property. When I say significant, I am referring to tens of thousands of dollars. Most average income earners do not have tens of thousands of dollars saved. Furthermore, if somebody has a plan to buy more than one investment property, then by using this method, they will continually have to come up with tens of thousands of dollars of their own money.
2) Leverage the equity in your home
This is the most common method that I see being used by fellow real estate investors. This is also the method that we have used most recently to purchase our last 3 investment properties. This is a powerful method to use, because you are utilizing leverage here. If this method is used, it is recommended that a secured line of credit be used. In order for this method to work, there has to be equity in your home. Generally speaking a secure line of credit can be up to 80% of the value of your home, minus any outstanding mortgage balance. Here is an example to demonstrate. Let’s assume that you live in a house (your principal residence) and the value of your home is $400,000. You have a mortgage on your home and the balance is $250,000. Therefore, 80% of the value of your home (valued at $400,000) works out to be, $320,000.
We then take $320,000 and deduct your outstanding mortgage balance of $250,000. $320,000 minus $250,000 equals $70,000. Therefore, in this scenario, you would have approximately $70,000 that you would be able to use to purchase an investment property. With the secure line of credit, you only pay interest to the bank on whatever amount you use. Meaning, that you can be approved for the $70,000, and you can utilize the funds at your discretion when you are ready. The interest rate on a secure line of credit usually is around the bank’s prime lending rate. This method is one of the cheapest ways to borrow funds, especially if you are in a low interest rate environment.
3) Use a Vendor Take Back Mortgage
This is a fantastic way to find money in order to buy a real estate investment. Experienced real estate investors will tell you that this method was used frequently in the 1980’s, during a higher interest rate environment. Here is an example of how this method works. You purchase an investment property from a seller. Let’s call the seller, Sanjay. By the way, Sanjay is also the vendor, because the vendor and seller mean the same thing here. When you buy the house from Sanjay you ask him if he would be willing to do a vendor take back mortgage. If he agrees to this, this is in your favour.
What is a vendor take back mortgage?
A vendor take back mortgage or VTB is an arrangement where you are obtaining a mortgage from Sanjay (the vendor/seller). In essence, Sanjay has pretty much become ‘the bank’ here. You will be responsible to pay Sanjay mortgage payments, often principle and interest, or just interest on the funds that you have borrowed from him. Keep in mind however that you still need to secure a ‘first mortgage’ from a bank or major financial institution. The mortgage portion that Sanjay will be lending you often times is in the range of 10 %to 15% of the value of the home. This is good because this decreases the total amount of cash required that you have to put into the deal.
Why would Sanjay want to give you money?
There could be a variety of reasons. Perhaps Sanjay has had a difficult time selling this property in the past. As a result, he agreed to the VTB mortgage in order to make the deal work between the two of you. In addition, Sanjay may not have needed the funds from the proceeds of the sale of his home. As a result, giving you a VTB mortgage, and making a return on his investment with these funds could be something that appeals to him. As a side note, real estate investors who sell off a large portfolio of investment properties to other investors often offer VTB mortgages as a way to, a) facilitate the deal, and b) as a means of continuing to make a return on their invested capital.
4) Leverage the equity in you rental property
Once you have equity built up in at least one rental property, you can use these funds wisely in order to continue to purchase investment properties. Financing rules with investment properties differ when compared to financing rules on you principal residence (the house that you live in). As a result, I always advise that you deal with a knowledgeable mortgage broker, or bank, in order to get the proper advice. However, the good thing here is that I can tell you how you can leverage you rental property. ☺
You can either put a secure line of credit on the rental property in order to access funds, or you can re-finance your rental property in order to pull out equity from the house. I would advise you to put on a secure line of credit, as opposed to re-financing. A secure line of credit is better because you will only pay interest on the portion that you use. If you refinance the property then you have to pay on the new mortgage balance. For instance, let’s look at some new numbers. Let’s say that your investment property is worth $300,000. Your mortgage on the property is $200,000. Rules vary as to refinancing, so once again it is important to consult a good mortgage broker, or your bank. However, let’s say that you are able to refinance your investment property to 90% of the value of the property. Therefore 90% of $320,000 is $288,000. You now have to take $288,000 and subtract your mortgage balance of $200,000 in order to determine the amount of funds that you have gained. As such, $288,000 minus $200,000 equals $88,000. So this means that you have $88,000 of new funds to invest into real estate investments. However, remember that because you did a refinance here, you owe principal and interest payments on your entirely new mortgage balance of $288,000, starting from the day these funds were advanced to you. So, as you can see, a secure line of credit is a better option, as you don’t have to pay, until you use the funds.
**Please also note that I have not factored in the cost of bank appraisals or bank fees with regards to the secure line of credit or refinancing.**
5) Purchase a Rental Property with a Joint Venture Partner
This method is used by both beginning investors as well as experienced investors. This is a fantastic method to use if you are looking to buy your first rental property or your 100th rental property. With the classic joint venture partnership, you have a real estate expert, who does all of the work associated with locating, buying, and managing a rental property. In addition you have the money partner, who provides the funds required in order to purchase the real estate investment. If a real estate investor is able to master the art of joint venturing, there is no limit as to how many rental properties they would be able to purchase. However, the most important aspect of the Joint Venture Partnership is that it has to be a win-win relationship for both parties. Having a happy joint venture partner is key. If you are delivering on your promises with them and you are doing a good job, chances are that they will become an advocate for you.
Do you need help with buying your first rental property? If so, check out the REIN Live Events and REIN Home Study Courses