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The First Step in Buying A Rental Property

by Dawn Anastasi on April 3, 2014 · 20 comments

  
Buying a Rental Property

This is a follow up to Brandon Turner’s blog article on 8 steps to buying a rental property. The first step that Brandon mentioned is that when you’re going to buy a rental property, it’s a good idea to get pre-approved (if you know you’re going to be buying with financing rather than all cash). It doesn’t do anyone any good if you want to buy a property at $90,000 and find out you’re only pre-approved to buy up to $70,000.

However, if you’re new to the real estate you may have lots of questions running through your head just on step 1, and that’s okay. Everyone has to start somewhere.  Here are some questions that I’ve seen posted on the Bigger Pockets forums over time:

What lender do I work with? Is it better to work with a credit union, a local bank, or a national big bank?

Some people on the forums have indicated that it’s much easier/better to work with a local bank or credit union. Why? You can establish a relationship with a mortgage loan officer and become more than just a number to them. Other people have found good success with a national bank such as Wells Fargo.

Should I get multiple quotes from multiple lenders or just go with one?

If you shop around for mortgage quotes, generally all pulls within a 30 day period of time are treated like one pull, so yes, you can definitely shop around. You wouldn’t walk into a car lot and buy the first car you see, right?

Keep in mind that you generally need a 20-25% down payment in order to buy a non-owner occupied investment property. The lender wants to know that you have some “skin in the game” and that if you walk away from the property and stop paying, that you’re putting your own money at risk.

A great forum thread on finding a lender

How do I calculate my DTI ratio? What *is* a DTI ratio?

A “DTI Ratio” stands for “Debt to Income Ratio.” Some additional forum posts:

How lenders calculate the DTI ratio

Paying down a car loan to improve DTI ratio

If I have credit card debt, should I pay that off before trying to get pre-approved? What does my credit score have to be?

Jimmy Moncreif was featured on a podcast where he explained more about what lenders are looking for, and ways on getting them to say “Yes.”  I believe that if you have high-interest credit card debt, you should definitely clear that off before trying to get a pre-approval.  Credit card debt is treated as “bad” debt, being unsecured.  Using credit cards is not a bad thing, holding a balance and incurring interest at 20%+ month after month is what will work against you as a real estate investor.

What is a portfolio lender?

A portfolio lender is called that because instead of selling off your loan to Fannie Mae or Freddie Mac, they keep it in their own portfolio. These are the smaller banks and credit unions I mentioned above.

Portfolio lender questionnaire

Learn where to find portfolio lenders

Why Portfolio Lenders are important to investors

What if you find a really good deal and need financing but cannot work with a traditional lender? What other options are there?

You typically want to try traditional lenders first for buy and hold because you’re keeping the property (and thus the loan) longer term. But if you just cannot get traditional bank financing, there are other options:

a) Hard money lenders – shorter term loans; typically < 2 years. You could use those to buy a property, fix it up, and then before the end of the term, refinance with a conventional lender.

Bigger Pockets Show 009 with Ann Bellamy

Using Hard Money to Buy a House, Renovate, Rent, and Refinance

b) Private lenders – these are people you know or have networked with who are willing to lend you the money from their own pockets (or an investment IRA or 401k). A private lender could also be your parents or another relative who is only earning 1% interest in their savings account and wants to earn more money by investing in the opportunity you bring them.

Where Private Lenders are Looking for Qualified Borrowers

What are Private Lenders Looking for?

c) Peer to peer lending – Sites like Lending Club and Prosper where individual lenders chip in $25 or more to help you reach your overall loan goal.

Bigger Pockets Show 029 with Dawn Anastasi

Peer to Peer Lending

Note that all three options will more than likely cost you more than a bank loan in terms of interest and give you less of a term (think more like 5 years or less). There’s also other alternate options like buying a house on a credit card, or pulling money from an IRA or 401(k) but those are generally not recommended.

If you’ve done your homework, researched lenders, and gotten your pre-approval, then you’re on you’re well on your way!

Have you taken the first step in buying a rental property? How’d  it go?

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{ 20 comments… read them below or add one }

nalo April 3, 2014 at 11:25 am

Dawn you did an AWESOME job summing up all the very initial questions that most newbies have. Thanks for providing additional links as well. This is a great article.

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Dawn Anastasi April 3, 2014 at 12:41 pm

Thanks so much. Sometimes, “begin at the beginning” is the key.

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Naveen April 3, 2014 at 12:20 pm

Dawn,
Again, your post looks well researched and all the links & info to posts are very helpful to beginners in loan process and others too.
Thanks for all your work.
Regards,

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Abbott Mary April 3, 2014 at 12:21 pm

Great post dawn!!!

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Eric April 3, 2014 at 6:49 pm

Even more important, learn how to calculate cash flow, and how to screen tenants. You can do this while you are waiting. It makes no sense to know how to buy one, if you don’t even know how to run it, or if it is a good investment.

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Dawn Anastasi April 3, 2014 at 7:53 pm

And you can find all this information on the Bigger Pockets forums. If there’s something you don’t understand, just post a question. There are so many people on the forums just waiting to help someone new.

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Eric April 6, 2014 at 12:13 pm

Very true. In the mean time, I look for investors that haven’t figured it out…. All my purchases, in the past 5 years, 20 renters, were from failed investors.

What would seem to be common sense, for RE investors, it is not. It is nobody’s God given right to make money as a RE investor.

Many investors spend more time deciding what laundry soap to buy, that which investment property to buy…

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Jason Merchey April 3, 2014 at 7:52 pm

I was reading on a forum that there seem to be some hoops to jump through and some pitfalls to be wary of if one wanted to be a private lender. Pray tell, how does one become a private lender – is it regulated, are there licenses, etc? Or do you pretty much draw up a Note and a mortgage with the help of an attorney and write your check?

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Dawn Anastasi April 3, 2014 at 7:57 pm

On the simple side, any one can be a private lender. A family member, a friend, etc. People lend each other money all the time without paperwork, but when you’re engaging in a business transaction, its highly recommended that you engage an attorney to cover the paperwork and ensure that everything is done on the up and up.

You can lend money and record a mortgage or other instrument or you can lend money unsecured. It’s all about how much you trust the borrower and your belief that they will pay you back.

Likewise, the terms are all about what you and the borrower agree. What is the length of the loan? Is it interest-only or full amortizing? What interest rate? Is there a balloon payment? What are the penalties for a late payment or a default? These are all things you have to decide before you draw up the paperwork.

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Sharon Tzib April 4, 2014 at 9:37 am

Nice article, Dawn! Question:

“If you shop around for mortgage quotes, generally all pulls within a 30 day period of time are treated like one pull, so yes, you can definitely shop around.”

When you say “pulls,” you are referring to credit score inquiries, correct?

As a former realtor, I wouldn’t even put someone in my car if they weren’t pre-approved. If you don’t know what price range to target, you cannot look at property, figure out cash flow, or ROI’s. Look forward to Steps 2-8, where I’m sure you’ll have lots more good stuff!

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Dawn Anastasi April 4, 2014 at 9:40 am

Sharon,

Thanks so much for the comments! Yes, by “pulls” that’s what some people term “inquiries”; it’s all the same thing just different wording. There are what is known as “hard inquiries” and “soft inquiries”.

Hard inquiries do count on your credit report. Soft inquiries do not. When you apply for a loan, the credit checks that the lender does is known as a hard inquiry. So you want to try to “shop around” within a 30 day period so that it doesn’t count as multiple hard inquiries.

Too many hard inquiries actually count against you.

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Sharon Tzib April 4, 2014 at 9:47 am

Hey, Dawn. I thought so. I know how all that works, I was just trying to clarify the terminology, since I thought others may not have heard it referred to that way. Like for instance, if you check your score on http://www.creditkarma.com, that is a soft pull. But if you go buy a car, that will be a hard one. Thanks again!

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Al Williamson April 4, 2014 at 2:00 pm

Dawn,
Way to contribute Sis! So happy you’re part of the BP Community. You’re very generous with your time and giving. These types of articles take a TON of time to assemble and you’ve made the internet a better place.

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Dawn Anastasi April 4, 2014 at 2:02 pm

Thanks so much for your comments Al! It’s not just my time; don’t forget about the editors here on Bigger Pockets who take the time to help with the formatting of the articles and add snazzy graphics. It’s a TEAM effort!

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Brett April 6, 2014 at 10:55 am

Dawn, just want to say I am a huge fan of you and your style of investing. I’ve re-listened to your podcast three times (more than any other show and I’ve heard them all) and I just bookmarked this article on my phone so I never lose it. I’ve never bookmarked anything on my phone, like, EVER :)

Thanks for sharing and teaching.

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Dawn Anastasi April 6, 2014 at 6:50 pm

Wow, Brett, thanks for the comments! So great to hear that you are getting value from the podcast and the articles. Stay tuned for more articles in the future!

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Ramon Cardenas April 10, 2014 at 10:03 am

Awesome stuff! Is there any additional info anyone would recommend for the first time buyer if they are looking to live in one of the units? I will finally be purchasing my first rental building this year and the information I have found in Brandon’s posts has been invaluable.

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Dawn Anastasi April 10, 2014 at 10:27 am

Ramon,

If you are going the owner-occupied route, there are definitely some other considerations.

203(k) loan – roll your rehab costs into the loan –> can be a bit of a hassle because there are tons more paperwork, but only available to owner-occupants.

HomePath and HUD – owner occupants get first dibs on properties before investors do. Right now HomePath has a special 3.5% closing cost assistance available.

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Mehran April 13, 2014 at 9:44 am

Extremely great article Dawn! One of the first things I focused on when I started investing was to truly understand the lending aspect of things. You pretty much just gave a blueprint for everyone to do just that. I can tell I’m going to like all your blog posts :)

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Kahanu July 25, 2014 at 2:57 am

Hi Dawn, this post is very helpful.
Any suggestions on how a buy and hold RE investor planning to purchase an out of state multi unit property should go about getting financing? Would it be better to deal with a lender from the interested area of investment (out of state market) or a national lender in this case? I have considered utilizing a heloc to fund the initial investment but was wondering how to go about getting pre-approved if I tried to finance the deal.
Any tips anyone?

Reply

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