investment property mortgage rates | InvestingInProperties.com

Best Ways To Handle Tenants When Owning Rental Property

Saving on investment property expenses

There are many ways a property investor can save on expenses when owning rental property. A major expense trimming can be had by simply searching for the best investment property mortgage rates. After all, finding excellent terms on any investment loan can save an investor many thousands each year. In addition, locating the optimum prime properties that can be purchased under current market valuation is another huge savings. However, buying a rental property and then knowing how to choose and handle the right tenants can realize the most cost savings of all.

Set your ground rules with your tenants

I always advocate for a written lease when renting out your units. Month to month rentals are fine – however, consider at least placing it in writing. A written document, even for a month to month rental, helps solidify your expectations. It also makes it more difficult for a tenant to negotiate with you down the road. In the lease, you’ll need to include exactly what you require for your rental: the monthly rent, the day payment is due each month, the penalties for late or bounced checks, and all the negative consequences (read: the eviction process) should the tenant break any of the rules.

Stick to the rules you set

Once you break your own rules for one tenant (as a nicety – giving them a break – just this once), you’ll end up getting into a bad, costly pattern with other tenants. This could prove disastrous to your business. Tenants talk. To one another. Never show weakness (that is, being a nice guy). Once you, do they will, by human nature, start taking advantage of your largesse. Always stick to your guns. If you have not received full rent from any given tenant by the fifteenth of the month, send them written notice immediately. Don’t wait a full month (or worse, longer) before getting tough. Impose late payment fees after the fifteenth of the month.

Evictions – the nuclear bomb of owning rental property

If you have not received full payment and late fees by the end of the month, you must start eviction proceedings against a bad tenant in order to protect yourself, and minimize the damage they are doing to you. Expect eviction proceedings to last up to two months, on average, depending on your local municipality’s court schedule. If you are unfamiliar with the eviction process, you’re certainly going to need the services of a local, experienced attorney you can trust to act expeditiously on your behalf to remove the delinquent tenant. It’s always a gut-wrenching, ugly experience. And obviously, quite costly as well.

Unpaid time

Besides paying for the services of an attorney, there’s the issue of lost rent for the time period until you find a new tenant to replace the delinquent one…It’s not simply the time period that the bad tenant has not paid you. Until you get them out of your building, it’s going to be very difficult to even show the unit to prospective tenants. And many times, a bad tenant, just before they are finally evicted, will perform some form of “revenge” destruction inside your unit. A bad tenant can end up costing a property investor a tremendous amount of money.

Finding the “good” tenants

For this reason, it’s best to find only “good” tenants to avoid this scenario. Make sure you’ve properly vetted them – check their references well. Speak to their current and prior landlords, as well as their work references. Check their credit. Make sure they can afford your unit. To this end, their rent should only comprise no more than 33% of their current gross monthly income, as a general rule of thumb. If you follow these simple rules, you’ll be able to save a tremendous amount in unnecessary operating expenses. In this way you can turn each and every one of your rental buildings into a prime property.

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Investment Mortgage Loan Costs

A tighter lending market

Property investors know that a rental mortgage is harder to obtain financing for, as well as costs more, than residential home mortgages. Why? The answer is simple:

lender risk. The greater the risk, the greater the financing costs for the bank. And likewise, the lower the risk, the lesser the cost structure. Lenders always look at their worst case scenario: that is, a property going into foreclosure if the monthly mortgage is not paid in a timely fashion. It is for this exact reason that lenders assign greater risk to investment mortgage loans.

Home purchases are highly emotional to borrowers. There is a natural human affinity to stay in one’s home – one’s own personal sanctuary. And a borrower will do all he can to keep his home, even when beset with personal financial difficulties. A homeowner is thus much more likely to attempt to hold onto his home and make payments on his mortgage in a timely manner than an investor would on a rental property. Investors look at balance sheets and income statements to determine if a property is worth sinking more money into and making mortgage payments in a timely manner. It is the concept of emotionalism and ties to a home that makes home buyers a safer risk than property investors.

The extra costs with an investment property mortgage

While there are daily fluctuations in rates globally, all real estate is local – and rates will differ from region to region. However, on average, rental home mortgage rates have

traditionally cost about half a point higher in mortgage financing costs relative to the residential home mortgage marketplace. Again, this is due to the increased inherent risk associated with non-owner occupied rental properties.

There are some discreet factors that ultimately affect the rate any investor will be able to obtain on their rental property. Some of the factors include the type of rental property – ie., a single family versus a multifamily, the loan-to-value ratio (the lower the LTV, the lower the mortgage rate, and vice-versa), the borrowers credit score, and of course, the current occupancy and rental cash flow of the property. The higher the occupancy rate, the lower the costs associated with the loan. Also, know that extra points can be shaved down by accepting a slightly higher interest rate on a rental mortgage.

The basics of rental property mortgage financing

While credit markets are much tighter for investment property, some generalities hold true when choosing from different rental property investment strategies. Occupancy rates help lower overall mortgage costs for rental property. Traditionally, 75% of current rent roll on a property can be used as an income qualifier for any given rental property. Loan-to-value ratios tend to start at 70% for investment property (while it’s 80% for home loans). Lower LTV’s (eg., down to 60% or 50% even) can substantially lower overall costs of the loan, including points and interest rate). In addition, when real estate investing, an excellent credit score (above 740) will also aid in reducing overall rental property financing costs. This can greatly expand what you can borrow, helping paint a brighter financial picture for your investment opportunities.

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Investment Property Loan Financing Tips

Understanding the psychology of lender risk

The reason investment property loans are more expensive, harder to obtain, and more restrictive than loans on personal homes, is that investment property mortgages are inherently riskier than home lending. Fannie Mae and Freddie Mac charge higher rates for investor property loans, much more than for primary home loans because of these higher risk factors. It’s a simple axiom – the greater the risk, the higher the cost. Of course, the opposite axiom is likewise the same – the lower the risk, the smaller the cost. For lenders, real estate investors are inherently more dangerous as a group to make loans to than are homeowners.

Thinking like a bank thinks…

Banks have to look objectively, and ruthlessly so, at their bottom line. What’s their worst case scenario in any lending situation? Naturally, a foreclosure. And in the case of those investing in rental property who are unable to make their monthly loan payments, since they have no emotional stake in the property, they will be more likely to walk away from their loan obligations in any worst-case scenario. Much more so than any homeowner would, since homeowners are emotionally grounded to their home – which is most probably their single greatest asset. This helps explain why total mortgage costs run higher for real estate investments, as well as why investment property mortgage rates are higher than homeowner rates.

Real estate investors understand that buying a rental property is simply a game of numbers. A homebuyer views their purchase decision in much more emotional ways – deciding what emotional benefits will accrue him if he buys a particular home. Conversely, this makes it much more difficult for the homebuyer to give up “his baby” so to speak. And this single reason is what makes lenders value the homebuyer as much less risk than anyone buying rental property.

Mortgage rate differentials

Regardless of the specific area of the U.S. you may look to buy in, real estate investments will have mortgages that will generally run about half a point greater than home loans on average. In addition, many fees tend to be added to loans on investment properties – many more than home mortgages. Thus, the overall cost of any rental property mortgage will be greater as well. Some of the factors involved in the overall costs associated with an investment property loan include the borrower’s current credit score, the loan-to-value ratio for the loan, the property character (ie. – single family, duplex, multi-family, multifamily with owner-occupying one unit) and the specific mortgage program being applied (FHA, Fannie Mae, Freddie Mac or no government-insured program).

LTV’s

In many instances, when in investing in real estate, lenders set up loan-to-value (LTV) ratios at higher overall amounts than home loans. The greater the amount you put down on the rental property you’re trying to finance, the less overall risk to the lender. Most lender these days have maximum loan-to-value ratios of 70% of the purchase price, where you, the buyer, must put down at least 30%. But if you put down 40%, or even 50%, you’ll find your interest rate and overall costs of the mortgage loan will come down substantially. This is also because you are helping to substantially lessen the lenders overall risk. (After all, it’s much harder to walk away from a property you have 50% down in equity than it is if you had only 30% down.)

Using rents as income qualifiers

Traditionally, banks will allow 75% of gross rents currently in place on units in any property you’re thinking of acquiring to help offset the monthly carrying cost of the loan. Keep in mind that this applies only to actual rentals…not hypothetical “market” rents. In addition, the tenants need to already be in place. Typically, the same 75% figure can be used to offset monthly loan costs in any refinance situation for your rental property.

Credit scores

You should also remember that lenders usually require those buying rental property to have better credit scores than their homebuyer counterparts. Lenders like to see scores of at least the low to mid-700’s before extending any rental property mortgage. (That’s not to say that it’s impossible to obtain a loan if your score is in the 600’s – but it will be more difficult, and certainly, it will come with a much higher interest rate. The bank, after all, is always looking to defray their risk.)

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The Diversification Model

Safety versus reward…

When I was just starting out buying rental property, an investment opportunity came on the market that totally captured my fancy. It intrigued me so much, I came very close to acquiring it – and making a major error at a very early stage of my real estate investing career. The property was an eight unit set of townhomes, all attached, and owned by a local bank that had taken them over when the developer defaulted. The project was totally finished – nothing had to be repaired, fixed up, renovated…a truly turn-key operation among investment properties. Of course, new tenants would need to be found for it, which would take several months after a closing to gain full occupancy.

Thinking pragmatically

I negotiated directly with the bank, and they were willing to provide the loan, with investment property mortgage rates that were very beneficial for me on the property. And the numbers, which I got into a habit of crunching several times a day, every day for a few weeks, kept making more and more sense. So – why didn’t I acquire the property? Simple – it would have used up every penny I owned in available capital. Any mistake on my part in my numbers crunching meant I could potentially lose money as I was just learning about investing in rental property. And it could happen quickly – without any means to tap a “slush” fund for emergencies…not only for the townhomes, but for myself personally. In effect, I could lose everything I owned on this one set of real estate investments.

Listen to your inner self for the danger signs

I could sense the danger every day I got more and more serious about closing the deal. Ultimately, common sense prevailed. While the upside was also quite large on this grouping of townhome investment properties, and would have set me up, in theory, quite nicely moving forward, the downside, as I evaluated it was equally nerve-racking. I just didn’t have the stomach. So I backed out of the potential deal.

A self-taught lesson in fiscal restraint

This offers a good lesson – as I taught myself – in the need for diversification in any type of real estate investing. To have put all my eggs in one basket, at the beginning stages of my property investing career, would have been a very risky, and probably fool-hardy thing to do. When I applied reason to my analysis, I came away with other options, like picking and choosing smaller multifamily homes, one at a time, that were much less risky. Again – not as much reward, but no one property would sink me like this townhome project could if I was wrong in my calculations.

Basic property investment theory

Diversifying is such an integral part of investing theory, and yet when confronted directly with the prospect of a “big kill,” the notion of diversification can easily go out the window, especially when dollar signs go up in the sky in big bold letters.

In real estate, this means diversification can have many looks. You can diversify across one class of properties – for example, sticking entirely within residential real estate, and acquiring individual homes as I have done. It can also mean spreading risk out over several classes, or types of real estate investments. Owning a small office building, a retail store property and a multifamily home at one time are a good way to diversify your real estate holdings.

Eschewing the big kill mentality…

With more diversification comes lessened risk – as a downturn or a financial hit to one segment won’t totally destroy your overall holdings. It’s slow and steady financial gains that are approached as an averaging of all your different real estate holdings in the diversification model. In this way, real estate investors can protect themselves, and can be ready in the event of any downturn…Ready to acquire another, different class of investment property moving forward.

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