POST WRITTEN BY Richardson Domond
The right real estate investment, whether a single-family home or a multifamily property, is a valuable addition to your portfolio. But the learning curve can be steep as you prepare to purchase your first property. Your future success will depend on your current creditworthiness and capacity to secure financing, so it’s important to take your time as you explore options and get your affairs in order.
Here is an overview of the key steps you need to take in the six months leading up to a real estate purchase.
In the first three months:
Evaluate your credit.
Your credit score carries a lot of weight with lenders. It can determine whether or not they decide to approve your loan application, and what interest rates they offer you. The difference between mediocre credit and stellar credit may add up to significant savings in monthly payments over many years.
Run credit reports with the three major credit bureaus: Equifax, Experian and TransUnion. Federal law entitles you to get a free copy from each reporting company every 12 months. Look at your credit score, credit utilization ratio and debt-to-income ratio, and review reports for common errors, such as incorrect or incomplete identity information, account status or current balance data.
Resolve any credit problems you find.
You have to fix any inaccuracies and address any legitimate negative marks on your credit report before moving forward with financing. If you have late payments, accounts in collection or bankruptcies on your report, consider working with a reputable credit repair company to improve your creditworthiness. You can manage this process on your own, but for timely and effective results, it’s often worth outsourcing to experts who can help you correct legitimate concerns, reduce your credit utilization ratio and raise your overall credit score.
Set aside money in an account.
Before you invest in a property, you need to build up funds for the purchase, as well as reserves to cover three to six months of mortgage payments. Lenders want to see seasoned money, meaning that it has been sitting untouched in a checking or savings account for some time. They will also be concerned about any large deposits or expenditures leading up to the purchase. To avoid setting off red flags, take a slow and steady approach to accumulating the money in your account, and don’t make any major purchases.
In the next three months:
Start shopping for financing options.
Once your credit is in good shape and you’ve started to build your savings, you can begin to research different lenders. Unless you’re able to pay all cash for a property, you need to acquire some type of loan. There are many ways to finance real estate investments, all with different requirements, benefits and drawbacks. Here are a few of the most common types of loans:
• Conventional loans are categorized as either conforming loans or non-conforming loans.
• Conforming loans are available through or guaranteed by private lenders (like banks or mortgage companies) or two government-sponsored enterprises, the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac). Conforming loan limits are adjusted annually to keep pace with the average U.S. home price and they vary by county. For example, the conforming loan ceiling in most areas across the US is $510,400 for 2020. However, in some markets like Los Angeles and New York where home prices are higher, the maximum conforming ceiling is $765,600.
• Non-conforming loans (or jumbo loans) are above the conforming loan limit. Since jumbo loans cover larger amounts, they are riskier and tend to have higher interest rates, stricter qualifying standards and larger required down payments.
• FHA loans are backed by the Federal Housing Administration but issued by private lenders. They require lower minimum credit scores and down payments (as low as 3.5%).
• Fixed-rate loans have interest rates that are fixed for the loan’s entire term, meaning monthly payments will stay the same for the duration of the loan.
• Adjustable-rate loans have interest rates that can change over time, meaning monthly payments can increase or decrease.
• Hard money loans are offered by individuals or investors, not traditional mortgage lenders. Hard money loans short-term (generally one to five years) and are backed by a hard asset, a property that is used as collateral for the financing. They have higher interest rates and are often used to purchasing properties that need major construction.
Investing in real estate is a smart way to build wealth, but you have to do your due diligence before making your first purchase. Follow these steps in the coming months, and you’ll be well-positioned to take the first step into real estate investment.