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Buying an investment property: What you need to know

minute read

    An investment property provides many options to a potential buyer. To see if an investment property is right for you, we’ll cover what an investment property is, what is it like to finance one, and more.

    What is an investment property?

    An investment property is a piece of real estate you or a group of people own to profit. This might mean a monthly profit from renting out your property, or a profit down the line when you eventually sell.

    It’s important to distinguish the difference between an investment property, flipping a house and a second home. Buying a fixer-upper, flipping it and selling it is usually not the same as an investment property because it yields short-term gains.

    The strategy behind an investment property is usually long term — you intend on holding onto this real estate for the long haul and it isn’t where you reside, like you would in a primary or secondary home.

    The IRS differentiates tax benefits between a second home and an investment property. There are different qualifications and tax implications for both. In some cases, you may be able to generate rental income and tax deductions for expenses in a Second Home, as long as you live there for at least 14 days a year or 10% of the total days the property is rented out. That is why an investment property is not usually somewhere you, the owner, would be living.

    Why consider an investment property

    If you have funds to invest, real estate may be a good option for you. There is no guarantee in any investment, but real estate proves to be a steady rate of return and profit.

    There can be tax benefits to owning a property and renting it out. As an investor, you may be able to treat your mortgage interest rate as an expense and deduct it from your rental profits. There is also an opportunity for depreciation deductions against the price of your home and various home improvements. These depreciations are annual income tax deductions. You can go to the IRS or contact your personal tax advisor to learn more about how your investment property might qualify.

    Common mortgages for an investment property

    It’s more common and usually more cost-efficient for people to finance a primary residence only. But if you are in the position to invest, there are a few things you can do. Keep in mind, down payments are usually higher for investment properties than primary residences. You will typically see lenders ask for a 15 to 25 percent down payment. Lenders will accept a wider range of down payments for primary residences because there is less risk.

    Getting prequalified

    Like any home, it is helpful to get prequalified for a mortgage. To be sure you're getting the best deal, talk with multiple lenders and compare their mortgage interest rates and  loan options.

    With prequalification, the loan officer will ask for information about your income, job, monthly bills, amount you have available for a down payment and possibly some other information. They will then provide you with an estimate.

    Investment loans

    There are various loan programs to consider with a real estate investment. It’s important to remain cautious about your debt, but it is good to know that there is help if you need it. Here are a few examples:

    • Conventional loans from a bank, like what you’ve probably used for primary real estate.
    • Home equity loans. Take advantage of the equity you’ve built in your primary or secondary residence to help fund an investment property. You may get up to 80 percent value of your home equity if you take out a home equity loan.
    • Find investors. You may have friends, family or colleagues in your network who are interested in a real estate investment that’d be willing to help finance.

    The safest option is always to save up money and avoid any debt, but there are cases where taking out a loan or asking for help might be worth it. Make sure to do research before committing to a strategy.

    How to find the right investment property

    There are many things you should consider when finding the right investment property for you. Here are a few things to ask yourself:

    • What does the market look like? It is important to remain up to date with real estate trends.
    • Try to make sure you’re coming in at a time that is financially sound for you. Acting on emotion is not recommended but remaining proactive and reactive to market trends is.
    • Where do you want to buy?
    • Where is smart to buy?
    • How much can you afford?
    • Do you want to invest alone or as a group?
    • How much could you charge as a rental?
    • How much do other homes cost in the area?
    • Does this area have a high rate of appreciation if you’re looking to sell?
    • What kind of attractions and job opportunities are around?
    • Is this a vacation destination? If so, how can you remain competitive with other rental properties nearby?

    If you know someone who has invested in real estate, it might be helpful to pick their brain. Knowledge is power!

    The pros and cons of an investment property

    As you can see, there are pros and cons of buying an investment property, and many of them depend on your personal circumstances.

    Potential pros of owning an investment property

    • Potential tax benefits
    • Opportunity for passive income
    • Probability of long-term appreciation
    • Could be a steady, dependable place to put a surplus of cash

    Potential cons of owning an investment property

    • Can be a challenge to finance
    • Income might ebb and flow with rental trends
    • Additional management and upkeep responsibilities
    • Potential lack of liquidity and unforeseen costs

    Investing in real estate could be a good option for you if you have the resources to do so. It can also be a bit of a challenge before you see the fruits of your labor. Speak with your Home Lending Advisor to see if owning an investment property is the right move for you.

    Have questions? Connect with a home lending expert today!

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