Buying property to rent it out is a concept made popular by dozens of TV shows and successful entrepreneurs, many of whom become wealthy relatively quickly by investing in property using borrowed capital, and reinvesting profits to accumulate a large real estate portfolio as quickly as possible. While this module can be profitable, it is important to weigh the risks, calculate the potential costs, and ensure that you are getting a good deal before you sign a mortgage contract.
How Does a Buy to Rent Mortgage Work?
Buy to rent mortgages are offered by some banks to allow you to invest in property by mortgaging the property and paying it off. While terms vary depending on where you are located, these mortgages typically include higher interest rates, might require a higher down payment on the property, and will require you to pay for insurance to protect your investment and to protect your income. This means that costs are high.
Pros and Cons of Buy to Rent Mortgages
Like any other investment strategy, buy to rent mortgages have their pros and cons. Most notably, buy to rent means that you will pay more than you would if you had the capital to invest in the home directly. For example, you may be better off mortgaging your own home and using that money to purchase the investment property directly, because the interest rates and considerations on the property are significantly lower.
- Buy to Rent Mortgages often include competitive rates. A 2-point requirement on the mortgage means that you have to pay $4,000 to receive a competitive interest rate.
- Rental income is most often considerably higher than the typical mortgage fee, which means that you can use funds to reinvest, save up to pay the mortgage off more quickly, or to improve your investment property.
- If property values go up, the mortgage does not change
- Buy to Rent allows you to invest in property with very little initial capital.
- Most banks will allow you to maintain multiple investment mortgages, typically with a cap of around 8 properties.
- Interest rates are typically high
- If you don’t have tenants in the property at any point in time, you lose money for the month.
- If the rental rate is almost the same as the mortgage, you will lose money every month.
- Drops in the real estate market can leave you with a high mortgage and a low-paying rent.
Buy to Rent Mortgages as an Investment Strategy
If you’re thinking about purchasing an investment property using a mortgage, there are a few things to consider. Mortgages are a great opening investment strategy to help you accumulate a real estate portfolio, but the properties you purchase should be chosen with care.
- Property cost – How much is the mortgage? How long will it take you to pay it off?
- Rental rates – What is the average rental rate for a similar property in your area?
- Maintenance and Refurbishment – It’s almost always a good idea to set aside 10-25% of profits for reinvestment and maintenance purposes.
- Insurance – Monthly insurance can be expensive. How much does it cost in your area?
- Risks –How high is the demand for property in your area? It’s usually a good idea to calculate that your property will be empty for at least two months out of every year.
You can usually estimate that your mortgage payments should be about 60% or less of your monthly rental income in order for the property to pay off. Therefore, if you’re getting a 15 year fixed mortgage on a 3 bedroom/1 bath $449,000 home, expect rental income of $3,195 per month, you can easily check your probable monthly payments (which for a 15 year fixed would likely be over $2,500) and assume that it won’t be profitable. On the other hand, if you’re paying $300,000 for the home, you’re paying nearly $800 less for the mortgage per month, and you can very likely make a profit over 15 years.
Paying attention to your income, adjusting your calculations to account for possible disasters and rental income changes, and playing it safe can save your investment.
Property management is a large part of investing in homes, and if you don’t handle it professionally, you could be losing money. Contact SJA Property Management for more details or a free quote.