We’ve already established that real estate is the ideal investment, but to make the most out of this opportunity, it helps to have some know-how about financing. Most likely you won’t buy property with cash since this doesn’t make financial sense even if you have the entire amount.
It’s far wiser to balance some key terms to maximize your profit. The first two items you need to pay attention to are the rent potential and the loan terms. Next, you need to think about your financial ability and debts accumulated so far. T
he standard metrics in the industry are the credit score, the loan-to-value ratio and the ability to repay. Always take into consideration potential money fluctuations and unknown expenses.
Any real estate investment should be money in - money out. What this means is the rent should cover all of the expenses. It's rarely a good idea to be cash-flow negative on a deal and hope for unknown appreciation.
This is no time to fall in love with a property. Old charm usually means leaking pipes and more trouble. Try to identify central properties or another type of high-value real estate, like excellent vacation locations or even potential office spaces. Look at the available amenities, look for minimal changes and try to remember the 3 Ls of real estate: location, location, location.
When you short-list a property always look at the average rent price in the area for similar places. Think about the age of the building, the resistance structure, floor space and facilities like free parking or proximity to what could be of interest to your tenants. Also look at bargains in your league and aim for the lowest required rent to be at least 10% higher than your expenses (lease, maintenance, cleaning).
Since you are getting the property on a mortgage, you will be entering a contract for at least ten years, most likely close to 30 years. That’s a long time for a commitment, and you need to ponder well about what you are getting yourself into. Think about each of the terms in your contract. Make a small investment and ask the advice of a lawyer if you are unsure about any of them.
One of the essential items of the loan will be the interest rate. This is computed by proprietary algorithms by each lender and mostly depends upon your credit score which will be discussed in the next section. One thing you need to pay attention to is if the rate is allowed to vary during the term of the contract. You should aim for a fixed arrangement, even if it can be slightly higher since it gives you predictability.
This number ranging between 300 and 850 shows your creditworthiness. The higher it is, the lower your interest rate will be. You are perceived as a less risky business. You can expect the best rates if you have scored over 760 or 740 for a 20% down payment.
Before jumping into the real estate bandwagon be sure you build up your FICO credit score as much as possible to get a head start and get the most out of your money. Check your credit report for errors to make sure the credit bureaus are not artificially downsizing your score. Learn here how to remove late payments from your credit report to get your score up even over 100 points. These are some of the most damaging items.
Loan to Value
This number measures the value of the loan compared to that of the property. It’s a matter of putting your money where your mouth is, and the minimum required by most lenders is 20%. The explanation behind this requirement is that the more money you have already put into a property the least likely you are to default the rest of the loan.
This measure, together with the FICO score enters into the algorithm used to compute your interest rate. It shows your commitment to the borrower and bringing your part in this business. Individuals with lower credit scores can get better rates if they offer higher down payments, usually around 40%.
This number represents the percentage of the income owed to different entities, like lenders, social obligations, and more. This is called the debt to income ratio.
Since you also need money for daily expenses, you will not receive a loan unless this score is below 43%. It makes sense that after all debts are paid, you get a bit more than half of your income for yourself.
It’s worth knowing that most lenders have convergent evaluation models for the same types of properties. Therefore, although you will most likely get some variation between different lenders, these will be negligible. To get the best rate, brush up your score first, reduce your debt ratio to increase your repayment ability.
Don’t neglect a down payment a bit higher than the minimum recommended. However, most importantly, make sure the property you choose is worth the trouble and will create a constant cash flow.