You’ll need to have some cash to start property investing, whether you want to flip houses or become a landlord, but how much is enough?
When you buy real estate for investment purposes, you aren’t looking for your forever home. You’re looking to make money, either as a landlord or by flipping the property. To do so, you need money to get the deal moving. How much depends on the details, including the cost of the property, the financing you choose, and how much risk you’re comfortable with. Here are some tips to decide how much money is sufficient to start property investing.
For future landlords
The general “rule” is that you need to have at least 20% of the purchase price in cash to qualify for a conventional loan. It makes sense when you start property investing to buy something cheaper and start small with your loan. For investors looking at buying a property or two to rent out, a conventional bank loan, home equity loan, or home equity line of credit are common. It’s important not to borrow beyond your ability to repay, especially if things don’t go exactly as planned with your investment. Rental properties are usually long-term investments, so you’ll want to plan for beyond the first year.
Of course it’s possible to get a loan with less than 20% down, sometimes a lot less. In fact, according to the National Association of Realtors the median down payment was 12% for all buyers in 2019—with 6% for first-time buyers and 16% for repeat buyers. Shop around for a lender offering low down payment options and know that your credit score affects a lender’s willingness to offer money with a low down payment. Be ready to negotiate to see what each institution is willing to work with.
See also: What is the 70% Rule in House Flipping?
Why put 20% down?
- Lower monthly payments. The more money you put down, the lower your monthly payments will be because you’re borrowing less money.
- No PMI. You won’t need to pay private mortgage insurance, or PMI, which is generally required on conventional loans with less than 20 percent down.
- Access to lower interest rates. You may qualify for lower interest rates with your bank because the loan is considered less risky.
- Makes your offer stand out. The bigger your down payment, the more your offer may appeal to the sellers—important in a high-interest property.
- Financial uncertainty is high. If you are making a real estate investment in uncertain times, you may decide to play it safe and avoid becoming overleveraged.
Why put less than 20% down?
- You need to have cash for other purposes. The property may need updates or a renovation that you want to pay for in cash. You may want to buy more properties. Or, you may want to have cash on hand for emergencies or if the property doesn’t rent right away.
- You’re buying a piece of property you can easily afford. Just because you can put 20 percent down doesn’t mean you have to. If you’ve got plenty of cash or reliable cash flow, there’s less risk in putting less money down.
- It’s all the money you have. If you want to invest in real estate now but it may take you years (decades?) to reach that magical 20% number, it’s often best to put down what you can to start making money and building equity now.
- The market is rising rapidly. The payoff is that you can quickly gain equity if the market shoots up. The gamble is if the market takes a sharp downturn, you could be left underwater.
Here’s how the different down payment scenarios look on paper:
An investment property costs $250,000 and you put 20% down ($50,000). Assume you take out a 30-year fixed-rate loan at an interest rate of 3.1%. Also assume your taxes and insurance come out to approximately 1.75% of the value of the property. Your payment in this scenario would be $1,219.
If you put 10% down ($25,000) on that same house, assuming nothing else changes, you would pay $1,426 a month. At 5% down ($12,500), the monthly would be $1,519. Keep in mind that in both of these latter two scenarios, you’d be paying mortgage insurance on the loan.
Of course, these numbers aren’t drastically different because interest rates are at a historic low right now. At interest rates closer to historic norms, the differences would be much more significant.
The takeaway: Given today’s low interest rates, if you can rent the property for more than your monthly cost (a cost that may go beyond your mortgage), putting less money down might be the right choice so you can make more investments.
For future house flippers
While the general guidance for future landlords applies to future house flippers too, house flippers usually need access to more money to complete a flip. Landlords need only enough cash to buy a house, do any repairs (usually minor), and have a reserve in case of emergencies. Flippers need enough cash to secure a loan and funds to renovate the house and to pay for costs during the renovation, such as property taxes, insurance, utilities, and the like.
House flippers tend to look for financing outside of a traditional bank loan due to the nature of the deal. In the case of flipping, how much you put down depends on factors such as:
- How you choose to finance your property investment
- Your success as a flipper (most lenders will want a bigger down payment from a newbie than a seasoned pro)
- The state of the market in general.
For instance, if you choose what’s known as a hard money loan or bridge loan, you will likely be required to put money down (generally anywhere from 10-30%). But you’ll be able to borrow against a percentage of the after repaired value (ARV) price of the home, not just the sales price. That means you have to come up with the down payment the private lender requires, but you won’t have to pony up the cash for renovations. It’s important to note that these loans are usually short-term (12 months) and have substantially higher interest rates and fees.
Some flippers also work with private financing. Private financing means borrowing money from people you know, such as friends and family. So it’s possible to not have to use any of your own cash if your investors agree.
The takeaway: Unless you are a seasoned flipper with a strong track record of making money on your investments, most financing options will require a down payment. Starting with a lower-cost flip can help you build a relationship with a lender and insulate you from any unforeseen costs or an undue amount of risk.