If you’re one of the lucky few who has already built a sustainable budget, saved for an emergency and are well on your way to a healthy retirement fund, it may be time to think about diversifying your financial portfolio.
Why not consider an investment property? Before plopping down a bunch of your hard-earned cash on a house, here’s what you need to know about investment properties, how to purchase one and how to save for one in the future.
Related: What is considered a good return on investment?
What is an investment property?
An investment property is a piece of real estate that you buy with the intention of earning a profit on, either in the form of rental income or future sale. The property can act as a long-term investment or a short-term one via house flipping —which is when real estate is purchased, refurbished, and sold for profit in a short amount of time.
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Who is an investment property right for?
Before you invest in a property, it’s important to determine how much you have to spend on this property upfront. If you plan on buying a rental property, it’s important you have the time to take care of it or have the means to employ someone else to maintain the property.
House flipping also requires a lot of time and resources, so plan accordingly. Also, make sure you have set aside an emergency fund for the investment property to take care of any unexpected expenses like a new roof or water heater.
How can I purchase an investment property?
Once you’ve decided you are ready to purchase an investment property, you’ll need to do a little bit of planning before you actually commit. The first thing you should do after nailing down a budget is to decide which geographic area you want to purchase the home in.
It’s often beneficial to look in neighborhoods or areas you are familiar with to limit unexpected surprises down the line. You may also want to consider neighborhoods where experts think property is likely to increase in value. Be discerning about what your budget can buy you. Will you be buying a one-bedroom downtown loft investment property or a four-bedroom beach house you can rent out in the summer?
Figure out potential investment gains
Next, check out websites like Craigslist or Hotpads to learn about how much homes in the area are currently renting for and estimate how much you’d rent a potential home for. Then, calculate your estimated expenses for the property, including loan payments, taxes, insurance and fees, along with a cushion for any necessary repairs and vacancies that may come up.
This equation — rent minus expenses — equals your passive income on the investment. The general advice is that income should be at least 1.25 times your principal investment and interest.
Don’t buy until you try
You wouldn’t buy a house sight unseen, and you should treat an investment property no differently. Once you find an investment property for sale, bring a contractor along for an appraisal before closing on any home. This way you’ll know exactly how much you’ll have to spend for repairs upon purchase. Add those costs to the primary cost of the home, taxes, and closing fees to figure out your final investment.
As with most investments, earning from your property is far from a done deal. If all goes well, the buying process will go smoothly and your investment property will generate rental income and gain in property value.
However, if housing prices plummet or your rental market becomes less desirable, your investment could end up being fairly costly. While this risk shouldn’t necessarily dissuade you from pursuing investment property, it’s important to go into the property-hunting process with caution.
Like a primary home, you’ll want to put 10% to 20% for a down payment to purchase your new investment property. It could also be worthwhile to up your down payment to 25% to help you secure a lower mortgage.
Investment property loans are treated differently by lenders than a home for a primary residence because people are more likely to default on an investment property loan than they are on a primary mortgage.
Typically, lenders will charge 1% to 3% more interest than the rate on an owner-occupied property. So if the rate was at 4% for your primary home mortgage, you may have a 5% to 7% interest rate on your investment property mortgage.
Because you’ll likely need to save a little more for an investment property than you would a primary residence, it’s crucial to put your money somewhere that is both safe and has the potential to grow faster with compound interest.
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SoFi can’t guarantee future financial performance.
This information isn’t financial advice. Investment decisions should be based on specific financial needs, goals and risk appetite.
SoFi doesn’t provide tax or legal advice. Individual circumstances are unique. Consult with a qualified tax advisor or attorney.
The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
Advisory services offered through SoFi Wealth, LLC, a registered investment advisor.
This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.
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