Before you purchase a piece of investment property, you need to know that it is a good fit for your budget and your investment goals. Not every property that appears to be a good value is going to make a profitable investment, so you must learn to analyze and compare properties. These four tips will help you make wise investment decisions.
Your Mortgage Payment
Keeping the mortgage payment low is a primary goal when investing in the Houston real estate market, so understanding what makes your payment is important. Many factors will influence the terms of your investment loan. The loan-to-value ratio on the property, your lender’s policies and your credit score are all important.
Lenders want a solid interest rate from investors, as they are more closely scrutinizing investment borrowers. If your credit is below 740, you will start to notice changes and an increased interest rate. In order to keep the interest rate low, can pay points to “buy down” the interest rate. You will need to weigh the cost of the points with the savings you receive from a lower interest rate as you figure what is best for your situation.
Down Payment Requirements
One way to make your investment more affordable is with a large down payment. You need at least 20 percent down to secure financing for your investment property, as mortgage insurance is not an option for investment properties. If you are able to save 25 percent, you might see a better interest rate.
If you can’t come up with 20 percent, a few options exist. One is to take out a second mortgage to cover the down payment, but this practice is no longer as common as it once was, and finding a willing lender is difficult.
Another option is to finance a multi-unit home through an FHA loan. If you plan to live in one of the units and then rent out the others, you can finance for only 3.5 percent down for a property with up to four units. In Houston, you can finance up to $524,150 for a four-unit property, provided you live there, with just 3.5 percent down, and with the option for specialized down-payment assistance programs.
Capitalization Rate (Cap Rate)
A cap rate is the expected first year income yield on an investment property. It is found by creating a ratio from the property’ net operating income to its current market value. While a valuable piece of data and a good starting point in comparing investment properties, it should not be considered alone. Consider the cap rate a rough valuation of the property that is used in conjunction with other factors when making a choice.
Cash Flow
A final consideration when making an investment is the calculation of your cash flow. Cash flow is important because it is the money you make simply by owning the asset, not by selling it. Cash flow is found using the following formula:
Rental income – vacancy loss – payments – expenses = cash flow
What is a good cash flow? The answer depends largely on your goal, but if you set rent at 150 percent of the mortgage on the property, you will have a decent cash flow to cover your expenses and have some income of your own.
If you have further questions about how to analyze and evaluate rental property, investor friendly realtor Bill Edge is ready to help. Give us a call to discuss your goals for investing in the Houston Real Estate market.