Investment properties are a smart and potentially lucrative choice for building wealth. I probably didn’t have to tell you that. If you are reading this blog you likely already have given it some thought for that very reason! In the simplest terms, an investment property is a property other than the buyer’s main residence. This is certainly how the lender will define it.
I have had several clients who want to buy an “Investment property” and I can tell you that my conversations with them are what prompted this blog. There are a few things I would like to bring to light about investment properties for folks thinking about going this route.
SHOW ME THE MONEY
First, let’s talk lending. Taking out a 2nd loan usually requires a higher down payment of about 25%. It may be even more than 25% if the buyer’s current income won’t cover both mortgages at the same time.
The buyer’s income will be even more important in the application process than a primary residence application.
In addition to a higher down payment, the interest rate for a second home or investment property is higher. Loan fees directly affect the final interest rate a buyer will pay. The higher the fees, the higher your rate above current mortgage rates.
Here’s an example: if your fees equal 3.375% of a loan, expect your interest rate to be 0.5 to 0.75 percent in addition to the current rate. It is always best to have a conversation with your lender and/or shop around for institutions that have special products for investment loans.
PROTECT YOUR INVESTMENT
You will need to carry regular home owner’s insurance coverage on a second home. However, it is strongly recommended to augment your home owner’s policy with an extra liability rider and/or an umbrella policy over everything that you own. Keep in mind you will have renter’s in your home and while you’d like to think you have lovely, law abiding, respectful renters, you never know… This will provide you extra protection for all the possible contingencies beyond natural disaster.
UNCLE SAM WANTS HIS SHARE
Taxes. That dreaded word. Like your primary residence you are able to claim a mortgage deduction on your taxes. You are also able to deduct anything you spend on a 2nd residence, ANYTHING. IF, and only if, you ALSO CLAIM all the income you made from your investment property. In other words, you will have to pay income tax on the rent you receive before you can write off those expenses.
Finally, don’t let your emotions get in the way. Buying a home is often a part head-part heart kind of purchase. And that certainly makes sense considering it’s where you will be spending much of your time. But leave emotions out when it comes to investing. Do your homework, research location, and negotiate the best price. After all, the lower price you pay, the more likely you can earn a higher profit.