I always get a mortgage when buying my rentals. Why use my money when I can use the bank’s? I don’t know of any other investment vehicle where you can use other people’s money (the bank’s), have other people (your tenants) pay your debt, and you end up with an asset that hopefully you’ve paid little to nothing for. It’s a great racket!
So, let’s talk getting a mortgage on your little money maker. Before even searching for a property, if you’re going to get a mortgage on it, you need to get a pre-approval letter from a mortgage company. It does not have to be the mortgage company that you use! In fact, in my case, it rarely is. You need the letter though so that sellers know that you are serious about buying their property. In fact, some sellers won’t even let you submit an offer unless you have an attached pre-approval letter.
To get a pre-approval letter, you simply call a mortgage lender (who is more than happy to talk to you!), and provide them with some basic financial information. They run a credit check on you and normally that day, you have the magic letter that you can submit with your offer.
Like I said though, you don’t have to use the mortgage lender that gave you the letter as your mortgage lender for the property. Shop around! Get the best rates!
Just like with all my houses, with this latest purchase, I contacted not less than 5 mortgage lenders and had them compete against each other. I tell them up front that I will be contacting numerous lenders to shop for the best rates so that hopefully they’ll give me their best rate up front. If a lender wants to see another lender’s rates before quoting me, I tell them that I want their quote first. I don’t want them looking at each other’s rates before I have them all in hand. That way I know which lenders tend to have lower rates to begin with vs. those that don’t.
I then have all of them give me quotes, preferably written good faith estimates or at least quotes via email. I take the lowest quote and go to the lender with the second lowest quote and ask if that person can compete. Normally they are willing and then I go back to the first guy and ask if he can compete with the now lower quote and back and forth and back and forth until one says, “Nope, that’s too low. You should go with the other guy.” That “other guy” is my winner!
The lenders that I choose for my “competition” are referrals from other investors in my area. I also always have a credit union thrown in the mix since their rates are pretty competitive. This time around, I also went to BankRate.com, put in my house information, credit score, etc., and found a well reviewed bank with low rates. That guy called me back and smugly told me that his rate can’t be beat. Sure dude, that’s what they all say. BUT… he was right and that’s who I ended up going with.
With my last rental, because I had my lenders compete, I went from 5.25% with 2 points (meaning an up-front cost of 2% of the purchase price) to 4.875% with no points. Unfortunately the local guys were the ones that had sky-high rates. I say unfortunately because given the choice, I’d rather go with a local lender. I plan on buying more properties and with a local lender, they have more leeway to give you multiple loans whereas a lender from Timbuktu doesn’t. He or she is constrained by the big banks’ rules. Local banks don’t have those same restrictions. At some point, big banks won’t lend to you if you have too many mortgages even if all your rentals are fully occupied and making you money but the small banks will.
Another more painful way to get the best rate is to have a larger down payment available. I try to put down 25% because my rate is significantly lower with this higher down payment. In my case my rate was a quarter point lower with a 25% vs. 20% down payment. My down payment is also borrowed, more on that below, so what I put down is really not that relevant since it’s ALL borrowed; I’m just looking for the best rate.
Remember that when shopping for a mortgage for a rental, you will end up paying more than if you were shopping for your primary home because investment property rates are higher. It’s riskier for banks to lend money on investment properties since you’re more likely to skip out on your investment property mortgage, so you pay for that risk. You’ll also pay more for a condo since in the last recession, those were the first properties to default on loans. How much more you pay is up to each lender but don’t get sticker shock running mortgage numbers using rates intended for a primary home when you buy a rental, especially if it’s a condo.
As for where my down payment comes from, it is also financed from a home equity loan. That way none of “my cash” is in the transaction. I do pay off that loan ASAP and I don’t buy another property until that down payment is paid off, but that’s a personal choice. Some people buy multiple properties with 100% financing, then move on to the next and do the same. For me, that’s too risky, but to each their own.
Another way to get a better rate is to think outside the 30 year mortgage box. Thirty years is a long time to pay off a loan and if possible, I go with a 15 year mortgage. The payments are higher but the overall rate is lower and in the long run, between the lower rate and the shorter term, you’re saving a lot in interest. If you have the discipline and don’t want to be locked into a shorter term mortgage, you could always pay extra toward principal every month to get rid of that mortgage faster. But that does take discipline!
In the end, it all comes down to the numbers… Like I said in another post, I go for appreciation so I’m willing to take less cash flow per month and pump that money instead into buying down my properties’ mortgages faster.