Do you live in a real estate market with high-priced homes? Or do the houses or neighborhoods you can afford not excite you? Thankfully, there’s more than one route to real estate ownership. When you buy an investment property before buying your first home, you capitalize on several benefits, including the potential for passive income, which can help you save for a downpayment.
REASON #1: HOME VALUES ARE HIGH
The first reason to consider buying an investment property before your first home is because home values continue rising. According to CoreLogic, home prices across the United States have increased by 4.3% in the last year, with an additional 2.2% increase expected within the following year. Zillow reports that the average home value in the U.S. is currently $359,892 and the median listing price is $399,933. The median rent is $2054.
According to the National Association of REALTORS (NAR), single-family home values increased by 89% (in most metro areas). In addition, homebuilding was not keeping up with demand in two-thirds of the measured metro areas.
There is more competition for real estate purchases, as millennials have become the largest generation of home buyers looking to buy their first home or invest in a rental property. As long as the economy maintains current levels, these trends will likely continue. However, if demand continues to remain high, home sales will decline while prices increase.
Being outpriced with home prices continuing to rise is one of the major reasons homebuyers consider buying an investment property before their first home. If they choose an affordable market experiencing job and population growth, they could leverage the equity on a property in a relatively short time.
Use NAR’s interactive map to learn more about median home prices in the US.
REASON #2: INTEREST RATES ARE COMING DOWN
While the super-low interest rates during the pandemic are over, loan rates are still historically low. With the recent Fed rate cuts, more investors are likely to enter the market. Keep in mind that the interest rate you qualify for depends on multiple factors: 1) down payment amount, 2) credit score, and 3) debt-to-income ratio.
Down Payment Amount
Many first-time homebuyers put down between 3% and 5%. This includes an additional monthly cost of mortgage insurance based on the price of your home. If you are planning on buying your first home as an investment property, mortgage insurance is not offered, and a down payment of 20% is required. Putting more money down on a home will help you qualify for a lower interest rate.
Credit Score
Banks are looking for ‘strong borrowers’ when accepting or declining potential mortgage loans. Borrowers with credit scores above 740 present a lower risk to lenders. In turn, you’ll likely qualify for a low interest rate. Interest rates will increase if your credit score is below 740 because lender risk rises. Like any investor, banks look at risk versus return on investment or ROI. If the risk outweighs the reward, lenders will either reject the loan you are applying for or require a high interest rate to ensure they get their money back.
If you find it difficult to qualify for a loan with a low interest rate due to a small down payment, lower credit score, or other circumstances, consider applying at a smaller bank. Typically, smaller banks have more lending flexibility than big, national banks.
Debt-to-Income Ratio
Lenders also consider borrowers’ debt-to-income ratio. Again, the lower the perceived risk, the greater the chance your loan will get approved and have a low interest rate. Having money reserves in the bank to cover your expenses for six months will increase the likelihood of qualifying for a low-interest loan.
Whether buying your first home or considering first-time investment property loans, it’s important to understand what lenders are looking for. Below, we will break down the types of mortgage loans for first-time buyers.
What is an FHA Loan?
The U.S. Federal Housing Administration (FHA) offers a home loan that makes it easier to qualify for first-time buyers. This loan is unique because it protects private lenders, like banks and credit unions, from losing money on ‘higher risk’ borrowers. In short, if you don’t repay your loan, the FHA will pay the lender instead. The details of an FHA loan are outlined below:
- Requires smaller down payment (3.5%)
- Get approved with a lower credit score
- Buy single-family homes, condos, multi-unit properties, and manufactured homes
- Extra funding for repairs and renovations with FHA 203k program
- Mortgage insurance premium required (1.75%)
- Must live in the property for a minimum of one year (Please note: buying multi-unit properties and living in one while renting out the other units counts!)
What is a Conventional Loan?
Conventional loans differ from other home loans because they are not insured by the government, meaning they are a non-government-sponsored entity. Because these loans are not backed or guaranteed by the government, they are more rigid and difficult to qualify for, as lenders are assuming all of the risks. More details of conventional loans are outlined below:
- Requires larger down payment (20%)
- More difficult to qualify for than other loans (higher credit score)
- Several different types of conventional loans are available
REASON #3: WHERE YOU WANT TO LIVE ISN’T AFFORDABLE
Are you ready to purchase your first home but can’t afford to buy one in the area where you want to live? With home values on the rise, many first-time home buyers may find it nearly impossible to purchase an affordable property in the neighborhood they want to live in. If the area you want to live in is too expensive, adds too much time to your commute to work, or has a less-than-desirable crime rate, it’s worth considering buying an investment property to rent out. While you continue to rent in an area you want to live in, you’ll get your foot in the real estate door, generate monthly cash flow, and build equity until you can afford to buy a home in the area you want.
As mentioned earlier in this article, home values in metro areas are so high that the possibility of buying your first home anywhere close to a major city is nearly non-existent. Instead of settling for a house you don’t want simply because you can’t afford anything better, consider looking at rental properties to invest your money.
Being a first-time home investor does have its perks! You have the opportunity to buy in a growing area, take advantage of time in the market, and maintain your current lifestyle rather than buying and getting overwhelmed with a hefty mortgage payment.
REASON #4: FLEXIBILITY IN YOUR LIFESTYLE
Flexibility may be important to your lifestyle if you’re young, single, or married without kids. Buying a home limits your ability to relocate, which may not appeal to everyone. While the stability of owning and living in your own home may be desirable to some, being tied to a mortgage payment every month may not fit your current lifestyle. However, that doesn’t mean you shouldn’t buy at all. Buying an investment property allows for flexibility to move, but you won’t miss out on getting in on a growing real estate market.
REASON #5: TAX BENEFITS OF BUYING AN INVESTMENT PROPERTY
Rental real estate has more tax benefits than almost any other investment out there. Failure to take advantage of rental property tax deductions can cost landlords thousands of dollars a year. So why are rental property owners paying more in taxes than they have to? Simply because they have no idea, there are multiple tax deductions they could be taking advantage of. Check out the following tax deductions that you shouldn’t miss out on:
Save on Interest
Interest on rental property is typically the biggest tax deductible expense for owners. This includes, interest on your mortgage loan, or other loans used to improve the property, and if you use a credit card for anything relating to the rental property, interest can be deducted.
Don’t Pay for Depreciation of Rental Property
Depreciation is the loss of value in an asset over time. Essentially, wear and tear. Because a rental or investment property is a long-term (lasts more than a year) tangible asset ( i.e., buildings, cars, appliances, etc.), it falls into the tax category of a capital asset. This means depreciation is not tax deductible during the first year of ownership. After the first year, rental property owners can deduct depreciation in smaller amounts over a longer period of time.
Claim All Property Expenses
Many first time real estate investors aren’t aware of the many different types of property expenses that can be deducted each year on taxes.
Cost of Repair
Any reasonable repair cost (not including improvements) to your investment property is tax-deductible within the year it occurred. Common repairs include fixing leaky pipes, broken windows, and repainting.
Use of Personal Property
If you choose to furnish your rental with personal property (e.g., appliances and furniture), you can deduct these expenses after a year (for property costing up to $2,000). Be sure to take advantage of this deduction from now until 2022.
Cost of Insurance
Any premiums you pay on property insurance are tax deductible. This includes fire, flood, theft, and landlord liability insurance.
Don’t Forget to Claim…
- Travel Expenses
- Legal Services
- Home Office Deductions
Take Advantage of Other Types of Tax Deductions
Pass-Through Tax Deduction
This is an income tax, not a rental tax deduction, made by the Tax Cuts and Jobs Act. Depending on your income, landlords can deduct (1) up to 20% of net rental income, or (2) 2.5% of initial cost of rental property, plus 25% of cost for any employees or independent contractors used (if applicable). This deduction is scheduled to end in 2025.
As you learn about tax deductions that may affect the return on your investment, be sure to also speak with your accountant about how to save the most money using tax deductions. Remember, the more you know, the more you save.
REASON #6: INVEST IN MONTHLY CASH FLOW POTENTIAL
Instead of buying a home and paying the mortgage yourself every month, consider an buying an investment property to rent out. Other people pay your mortgage, and you’ll start building equity on your property immediately without paying a dime toward a mortgage. Plus, charging more for rent than your monthly mortgage payment will produce extra cash flow that can go towards debt, bills, rent or savings for the down payment of your next house.
REASON #7: CREATE LEVERAGE OR EQUITY TO BUY A HOME YOU ACTUALLY WANT OR PAY OFF DEBT
As discussed earlier in this article, creating leverage or equity is another great reason to buy an investment property before your first home. First-time home buyers are either buying their first home, usually a starter home in a less-expensive area or buying an investment property to rent out. The latter option allows rental property owners to sell, refinance, or use monthly cash flow from the rental to leverage buying their first home a few years down the road.
When property owners have leveraged enough cash to buy a home, they actually want to live in, selling their rental property or hanging on to it as an investment will open up more opportunities to qualify for loans or put down a large down payment to secure a very low interest rate.
Explore Distressed Properties & Homes
What does distressed property mean? Distressed sales are homes or properties that have usually been foreclosed on that the bank is willing to sell at a loss in order to clear its books. These distressed sales also help drive down the cost of all properties in the area.
Distressed properties are enticing because (1) low price, (2) instant equity potential, and (3) a few repairs can increase value rapidly. By taking advantage of low mortgage rates and inexpensive financing, first-time home buyers are able to buy a bargain property, make a few improvements, and likely sell it sooner rather than later for a profit.
How RealWealth Can Help
As the real estate market becomes increasingly competitive and homes become difficult to afford for first-time buyers, exploring and learning about your options will help you make the best investment decisions for your goals. At RealWealth, we help people learn about real estate investing, and we connect them with turnkey property teams who sell single-family and multi-family turnkey properties in affordable nationwide markets. Membership is 100% free, yes, free, and there is no obligation to purchase. If you want to learn more, join RealWealth today!
