How to Calculate the Ideal Investment Property Down Payment

Purchasing an investment property is an exciting opportunity to increase your income stream and create a better financial situation for yourself. However, purchasing property can be a challenging process. Many investors struggle to determine their perfect investment property down payment. Paying too much can lower the principal but leave less capital for necessary repairs and maintenance. Paying too much will increase mortgage payments. Striking a balance with your down payment will help you achieve financial success and can be obtained by following these tips.

Understanding Investment Property Down Payments

For many investors, an investment property is a second or additional property. It is not their residence. Property owners view investment properties as a means to financial gain. This may mean that they’re looking to rent it out to tenants, create a retail space or flip the property to re-sell for a profit. However, investment property mortgages typically have higher rates and may require a minimum down payment of 15%.

The property’s potential for profit is why determining an ideal down payment is so important. If the mortgage payment is too high, it may affect the property’s ability to generate positive monthly returns. However, a higher down payment requires a larger initial investment from the property owner. For some property owners, it may be easier to pay a larger mortgage payment with revenue from the property while others may prefer to pay more of the principal up front.

Determining the Ideal Down Payment Amount

There’s no one-size-fits-all solution or magic number when it comes to determining a down payment. It largely depends on the location of the property, property type and your personal financial situation. 

Location

First, consider the property’s location. Mortgage rates can vary from location to location based on the local economy. Before deciding on a down payment, research average mortgage rates for investment properties in the area of your desired property. Understanding the average rates and property value will help you determine the proper down payment.

Property Type

Are you purchasing an up-to-date single-family home in the suburbs or a run-down retail location? Lenders will take into consideration the property type and value to determine the risk associated with your venture. Riskier investments will likely come with higher mortgage rates, so understand how your property type will affect your rates.

Desired Monthly Cash Flow

Are you looking to make a profit right away? If so, a higher down payment will decrease your mortgage payment, allowing you to pocket more of the property’s revenue as profit. But if you’re prepared to play the long game and slowly increase your profits, a larger mortgage payment and smaller down payment may be right for you. Remember, the amount you pay upfront will affect your monthly payments, which in turn affect your cash flow.

Loan-to-Value Ratio

A loan-to-value ratio (LTV) measures the property value compared to your mortgage loan amount. So a mortgage taken for the full cost of a home would have an LTV of 100%. Lenders may use your potential LTV to determine whether or not they want to finance your property and often want to see a lower LTV ratio. Paying a larger down payment can decrease your LTV and can potentially increase your chances of finding a good mortgage rate.

Personal Finances

If you’ve been in the investment property game for a long time, you may have the capital and income stream to handle a larger down payment. However, if you’re just starting, you may only have the funds for a minimum down payment. Remember, a bigger down payment isn’t always better, especially if it’s going to impede your ability to market the property, make repairs and conduct regular upkeep and maintenance. Take into consideration your savings and expected costs to find a down payment that works for your finances. 

Benefits of a Higher Down Payment

A larger down payment can make your investment property more successful. The more you can pay upfront, the more likely you are to receive ideal loan terms and rates. Paying a large down payment will decrease your LTV, making lenders more likely to offer you competitive rates. A lower interest rate is crucial in lowering your monthly mortgage payments and the amount you will pay over the lifespan of your loan. Plus, lower mortgage payments will help optimize your monthly returns, improving your cash flow and the profitability of your property. It may require a larger initial investment but can improve your finances over the long term.

Strategies to Save for an Investment Property Down Payment

An investment property down payment can seem like a daunting goal to achieve. However, with careful planning and diligent savings, it can be obtainable. One method to boost your savings is to allocate a portion of your monthly income toward saving. Take a look at your budget and determine a percentage that you can spare. Then, create a plan to automatically set aside that amount into a high-yield savings account every month.

Additionally, you can look for places in your budget where you can cut expenses. Perhaps you lower your allocation toward unnecessary costs such as eating out or discretionary spending. Tightening your budget for the short term can lead to more financial success in the future.

You can also look to alternative methods to build your savings. If you have marketable skills, you could start a side hustle and use that additional income to increase your savings. Additionally, you could use the traditional market and other investment vehicles to grow your savings, helping you achieve your down payment goal more quickly. 

Obtaining Financing for Your Rental Property

Once you’ve identified a potential property, you’ll need to start the process of obtaining funding. Financing an investment property can include taking out a traditional mortgage or looking for alternative solutions.

Traditional Financing Options

Traditional financing includes applying for mortgages from banks and other lenders. One option is seeking a conventional loan or a mortgage that’s not from a government-backed agency. These lenders will determine their ability to fund you and their interest rate based on the investor’s credit score. The better your credit score, the more likely you are to get a competitive rate.

You may also be eligible for an FHA loan, which is a mortgage loan insured by the Federal Housing Administration. These loans typically require a lower down payment than conventional loans and will lend to people with lower credit scores. However, they may not be a good option for investors with higher income and credit scores. 

Creative Financing Alternatives

Investors can follow alternative paths to find funding for their properties. For example, they could search for a property where the seller is open to seller financing. In this type of agreement, the buyer pays the seller in installments instead of taking out a mortgage.

Investors could also seek funding from private lenders, who would provide capital for a down payment in return for a percentage of profits or a predetermined return on investment. Additionally, investors could find a lender to provide a hard-money loan, which is a short-term loan that can help individuals cover real-estate transactions.

Investors can also consider finding a partner or additional investors to split the cost with and share in the profits. This option can decrease the initial investment needed from the individual and help split maintenance and upkeep costs and responsibilities.

Start Your Real Estate Journey

Financing an investment property may seem like a long, challenging process, but you can use smart strategies to fund your project. Whether you’re able to make a sizable down payment or the minimum required for your mortgage, a strong plan and understanding of your finances can lead your property to success. If you have questions about how to save for a down payment or which funding option is right for you, speak to your trusted financial adviser.

Frequently Asked Questions