How to Buy a Rental Property
Purchasing a rental property can be a smart way to generate extra income and grow wealth over time — but it’s not without challenges. You’ll need to weigh the time, effort and costs involved with managing the property, plus figure out how you’ll finance the property purchase. Below, we’ll cover how to buy a rental property and the factors to consider before choosing this real estate investment strategy.
- Having a good credit score and stable income can make it easier to qualify for a rental property loan.
- Understanding your real estate market is crucial to finding good investment opportunities.
- You have several financing options to buy a rental property, including a conventional mortgage or hard money loan.
How to buy a rental property in 5 steps
1. Decide the type of property you want to buy
Start by narrowing down the type of rental property you’re interested in — whether a single-family home, a duplex or a multifamily home. Each property type comes with its own set of financing options and requirements. If you’re new to real estate investing, a one-unit property may be more manageable, since it’s generally easier to qualify for a single-family mortgage than a multifamily loan.
2. Understand the rental market in your desired area
Researching the rental market is just as important as choosing the property itself, since a home’s location can significantly impact its potential return and overall appeal. Consider factors like crime rates, school ratings, rental demand and average rent prices. Generally speaking, areas with low crime and high rental demand make for better investments.
3. Figure out financing
Conventional loans are a common way to finance a rental property purchase because they generally don’t require you to live in the home. If you don’t plan on making the home your primary residence, financing can get trickier. For example, government-backed loans, such as FHA loans and VA loans, are typically only available for borrowers who plan to live in the home they’re financing.
Keep in mind that rental property loans will also generally have stricter financial requirements, like a higher minimum credit score and lower maximum debt-to-income (DTI) ratio.
You could potentially use your home equity to buy a rental property by taking out a home equity loan or home equity line of credit (HELOC). The average home equity loan offer is more than $140,000, according to LendingTree data.
Hard money loans are another financing option. Private companies and investors — instead of banks — typically offer these loans, which often have higher interest rates than traditional mortgages.
Learn more about how to choose between a HELOC and a home equity loan.
4. Find a home and make an offer
Once you’ve shopped for and chosen a lender, getting a mortgage preapproval can provide you with a more accurate estimate of what you can afford and help home sellers take you more seriously as a buyer. With a preapproval letter in tow, it’s time to find a home you like and make an offer.
5. Close on the property
As with any home sale, you’ll need to go through the closing process, which may include getting an appraisal and inspection, as well as providing the lender with any additional information it requests. Once you close on the home, you’ll receive the keys and can start looking for tenants (assuming no repairs are needed first). Congratulations, you’re officially a real estate investor!
Pros and cons of buying a rental property
Pros
- Extra income stream: Rental properties can provide passive income each month — though if you don’t hire a property manager, you’ll need to manage it yourself.
- Potential property appreciation: Property values tend to rise over time, which could mean a profit when it comes time to sell the home.
- Tax benefits: As a rental property owner, you may qualify for various tax benefits, including deductions for maintenance and property management expenses. Tax laws vary by state, so it’s important to establish a relationship with a local accountant.
Cons
- Finding tenants: Finding and screening tenants can take time, and choosing the wrong ones can lead to massive headaches, like missed rent payments and property damage.
- Maintenance and repairs: As the owner, you’re responsible for keeping the property in good condition and handling repair requests promptly. It’s important to have an emergency fund so you’re not scrambling to find the cash for unexpected repairs.
- Property taxes and insurance: You’ll still need to cover the property taxes and homeowner insurance for the property, but you can factor these expenses in when setting the rent amount.
What are the requirements to buy a rental property?
The requirements for a rental property loan vary depending on the property type, the loan type, the down payment amount and whether you plan to live in the home. Here are some general guidelines to keep in mind for conventional rental property loans:
- Minimum down payment: 15% to 25%
- Minimum credit score: 680 to 700
- Maximum DTI ratio: 45%
- Cash reserves: At least six months of mortgage payments
If you plan to buy a duplex or multifamily home and live in one of the units, you may qualify for an FHA loan with as little as 3.5% down and a 580 credit score, or 10% down with a 500 credit score. Alternatively, military service members, veterans and surviving spouses may qualify for a multifamily VA loan with no down payment, though many lenders require a minimum 620 score.
Don’t know your credit score? Get your free score on LendingTree Spring today.
Should you buy a rental property?
Here are some questions to ask yourself to help determine whether you should buy an investment property:
- Are you financially prepared (do you have enough for a down payment, property management costs, etc.)?
- Do you understand the rental market you’re investing in (rental demand, average rent, etc.)?
- Does buying an investment property align with your short- and long-term goals?
- Do you have sufficient savings for maintenance and repairs?
- Can you afford the homeowners insurance and property taxes on the property?
- Do you understand the risks and unexpected costs that can arise (losing tenants, property damage, etc.)?
Tips for buying your first rental property
- Buy a smaller property: You don’t want to bite off more than you can chew. A single-family home or duplex will be easier to manage and likely more affordable than a property with several units.
- Consider house hacking: This strategy involves renting out part of your current home, whether an extra bedroom, a finished basement or an in-law suite. House hacking allows you to lower your living costs and bring in extra income at the same time.
- Look into seller financing: Seller financing involves borrowing money from a home seller, instead of a mortgage lender, to purchase a property. These deals can be complex, and it’s crucial to understand the terms before you sign the contract.
Other ways to invest in real estate
REITs
REITs, or real estate investment trusts, are companies that own income-generating real estate and sell shares of their company to investors. Instead of buying a property yourself, you can indirectly invest in the real estate market by purchasing shares of a REIT. Many REITs are publicly traded, making them easy to buy and sell, like stocks.
House flipping
Fix-and-flip investing involves buying a property that needs renovations or repairs, fixing it up and then reselling it for a profit. Buying a fixer-upper can offer good returns, but it comes with significant risks and requires hands-on work.
Frequently asked questions
It’s possible to buy a rental property with little to no money down, but it’s more challenging. Government-backed programs, like FHA and VA loans, usually offer low down payments, but they’re difficult to qualify for. In many cases, you’ll need at least a 15% down payment to buy a rental property.
The BRRRR method stands for “buy, rehab, rent, refinance, repeat.” It’s a strategy that involves purchasing a property, making repairs, renting it out, refinancing the original loan to access the increased equity and buying more properties to repeat the process.
The 50% rule refers to a guideline that real estate investors should expect to pay 50% of a property’s gross rental income toward operating expenses.
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