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Buying An Investment Property: 3 Signs You’re Ready And What You Need To Know

Victoria Araj9-minute read

September 25, 2023


Are you thinking about investing in real estate you can rent out or use as a vacation home for  travelers? If so, it can turn into a reliable source of income. But how do you know if you’re ready to become a landlord?

We’ve created a crash course on everything you need to know before getting a loan for your first investment property. Let’s walk through the signs that suggest you’re ready to buy and the steps you can take to prepare to apply for an investment property loan.

Investment Property Definition

An investment property is real estate purchased to generate passive income (earn a return on the investment) through rental income or appreciation. Investment properties are typically purchased by a single investor or a pair or group of real estate investors.

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3 Signs You’re Ready To Buy An Investment Property

First, know that the buying process is different for an investment property versus a primary home. Before you invest in property, make sure you meet the qualifications discussed in detail here:

1. You’re Financially Stable

Investment properties require a much higher level of financial stability than primary homes, especially if you plan to rent the home to tenants. Let’s go over some of the costs you’ll need to cover when you buy an investment property.

Mortgage Payments

If you’re taking out a mortgage to finance your investment property, you’ll want to make sure you can afford the monthly mortgage payments. This shouldn’t be a problem if you’re renting the house to tenants, as the rental payments should cover the costs of your home loan. Later, we’ll get into the steps for calculating your annual rental income, net operating income (NOI) and return on investment (ROI).   

Down Payment

Most mortgage lenders require borrowers to have at least a 15% down payment for investment properties. The amount of your down payment will depend on the individual lender and the type of home loan you secure. If you take out a conventional mortgage, for instance, you’ll likely need a down payment that’s anywhere from 15% – 25% of the home’s purchase price.

Initial Home Purchase Costs

In addition to a higher down payment, investment property owners who move renters in must  have their homes cleared by inspectors – or at least that’s the case in many states. Make sure you have enough money in your budget to cover the initial home purchase costs, like a home inspection and closing costs.

Home Maintenance Costs

As a landlord or rental property owner, you must complete essential repairs – like expensive emergency plumbing and HVAC repairs – in a timely manner, which can require a lot of money. Some states allow tenants to withhold their rent payments if you don’t fix broken home utilities on time.

Make sure you budget more money than you think you need for regular and emergency home repairs.

Tenant Costs

Investment property expenses don’t just begin when tenants move in or when you assume responsibility for the property’s current residents. You also need to budget money for advertising and credit checks to make sure you take in the best tenants possible. Great tenants are an asset for your property, while bad tenants can increase your expenses dramatically.

2. The Return On Investment (ROI) Is There

Real estate investors often see positive cash flow with their investment properties in today’s market, but the savviest investors calculate their approximate return on investment (ROI) rates before purchasing a property. To calculate your ROI on potential property investments, follow the steps outlined below:

Estimate Your Annual Rental Income

Search for similar properties currently up for rent in your area. Find an average monthly rent for the type of property you’re interested in and multiply that rent price by 12 for a year’s worth of income.

Calculate Your Net Operating Income

After you estimate your potential annual rental income, calculate your net operating income (NOI). Your net operating income is equal to your annual rental estimate minus your annual operating expenses. Your operating expenses are the total amount of money it takes to maintain your property every year.

These expenses include homeowners insurance, property taxes, maintenance and homeowners association (HOA) fees. Don’t include your mortgage loan or interest in your net operating expense calculation. Subtract your operating expenses from your annual rent estimation to find your NOI.

Find Your ROI

Finally, divide your NOI by the total value of your mortgage to find your total ROI. Your ROI helps you understand whether you should invest in one property over another. It can also give you an idea of your real estate investment’s profitability.

ROI Example Calculation 

Let’s say you buy a $200,000 property you can rent out for $1,000 a month. Your total potential income is $1,000 × 12 months for a total of $12,000. Let’s also assume the property costs about $500 a month in maintenance fees and taxes.

  1. $500 × 12 = estimated operating expenses of $6,000.
  2. Subtract your operating expenses from your total rent potential: $12,000 − $6,000 = $6,000 of net operating income.
  3. Divide your NOI by the total value of your mortgage: $6,000 ÷ $200,000 = 0.03, which makes this property’s ROI 3%.

If you buy a property in a solid area and know you can rent to reliable tenants, a 3% ROI is great. However, if the property is in an area known for short-term tenants, a 3% ROI may not be worth your time and effort.

3. You Have The Time To Manage It

Investment property management still takes a lot of time. Here are a few tasks you’ll be responsible for when you purchase a rental property:

  • Putting up advertisements for your property to attract potential tenants
  • Interviewing potential tenants
  • Running background checks on tenants
  • Ensuring tenants pay their rent on time
  • Performing maintenance on your property
  • Making timely repairs if something in the home breaks down

You also must do all of this while working around your tenant’s “right to privacy” – a legal standard that prevents you from dropping by unannounced without at least 24 hours of warning in most states.

Before deciding to buy an investment property, make sure you have plenty of time to maintain and monitor the house.

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What To Consider Before Buying An Investment Property

Time, down payments and returns are just a few pieces of the investment property puzzle. Next up are some other considerations to think about before you invest.

What Are The Housing Market Trends?

You’ll want to choose a property that rises in value over time. But how can you tell which areas will become the next best places to invest in real estate? The only way is to watch an area’s housing market indicators and rental trends over time and compare the direction of previous property prices and taxes to where they are now.

A home purchase is a major investment, so don’t be afraid to take plenty of time to do your research and analyze market trends to find the perfect area before taking out a mortgage.

Should You Buy With A Partner?

Buying a property with a partner might seem like a great idea. You can pool your money, split maintenance costs and combine your home repair skills to save money on professional contracting costs. However, entering a real estate partnership also splits your potential profits in half and puts you in the position of sharing legal liability with another person.

For example, if your tenants tell your partner about a pest problem and your partner doesn’t fix the issue in a timely manner, your tenants may sue both of you because you’re both landlords. You’re both equally responsible for providing a habitable environment for your tenants.

You should also remember that if something goes wrong with your partner and you split the cost of the home equally, you’re both legal owners of a single property. Make sure the person you choose is trustworthy, responsible and proactive with maintenance if you decide to go in on a rental property with someone else.

How Much Will Property Taxes Be?

Property taxes are taxes that homeowners pay to support their community and local government. Property taxes fund fire departments, public schools, libraries and other local projects. The amount you pay in property taxes is directly related to the value of your home. If your home is worth more money, you pay more, and vice versa.

Local governments set their own property tax rates, so the specific amount you pay in property taxes depends on your house’s location. Speak with a local real estate agent or mortgage lender to calculate how much a certain house will require in property taxes.

No estimate is going to be perfect, though, because every homeowner also qualifies for a different level of property tax exemptions.

Should You Hire A Property Management Company?

You’ll need to decide whether you want to personally handle property repairs, tenant management and maintenance or hire a property management company to manage the daily maintenance on your behalf.

Property management companies take both scheduled and emergency repair calls and check up on your property with both drive-bys and scheduled visits to make sure tenants respect your space. They can also collect rent on your behalf. Some property management companies likewise offer tenant placement services and eviction processing for an additional fee.

In exchange, the property management company takes a percentage of your monthly rent. If you live far away from your property or lack the home repair skills to fix the property, hiring a property management company may be a good idea.

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Applying For Investment Property Loans: How To Prepare

Mortgages and loans for investment properties – such as a non-owner-occupied mortgage – work a little differently than those for residential properties. Let’s walk through some of the ways you can prepare to apply for a mortgage loan on an investment property. 

1. Check The Investment Property Loan Requirements

Mortgage lenders can be stingier with loans for investment properties than loans for primary residences. This is because the risks of foreclosure and default are typically higher for rental properties.

Most fixed-rate mortgages require at least a 15% down payment with a 620 qualifying credit score for an investment property. Your credit score should be at or above 620 if you’re applying through Rocket Mortgage®.

2. Secure Mortgage Preapproval

It’s a good idea to get preapproved for a mortgage before you start searching for homes so you know how much home you can afford. You can apply online with Rocket Mortgage to get an approval.

A preapproval, also called initial mortgage approval, is different from a prequalification. A prequalification only tells you how much money you might be eligible for. A preapproval, on the other hand, requires your financial information so the mortgage company can provide an offer that’s customized for you.

While mortgage prequalification only looks at your credit and your inputted estimate for income and assets, preapproval involves a hard credit pull and proof of income and assets.

3. Gather Necessary Paperwork

When you apply for a mortgage, you also must provide some basic personal information. In most instances, your mortgage lender will require you to share 2 years of tax returns, 2 years of W-2s and 2 months of bank statements. These documents prove you have income stability and enough money to cover your monthly payments.

Investment Property FAQs

Do you still have questions about buying an investment property? We address some frequently asked questions below:

How many investment properties can I own at one time?

If you’re looking to expand your investment portfolio, you can buy as many rental properties as you can comfortably afford. If you’re financing each home purchase with a loan, however, there’s a limit on the number of mortgages you can have at once.

Fannie Mae only allows borrowers to have up to 10 properties financed with conventional mortgage loans. If you’re not sure what you can afford, consider speaking with a financial advisor or loan officer about your mortgage options.  

How do I get the best mortgage rate for an investment property?

You’ll want to improve your qualifying factors if you want to secure the best mortgage rate for a rental property. Ways to get a better interest rate include raising your credit score, lowering your debt-to-income ratio (DTI) and making a larger down payment on the property. 

Can I buy an investment property without a down payment?

No, you’ll need to put money down to take out a mortgage on an investment property. Most lenders require at least a 15% down payment.

Can I refinance a mortgage on an investment property?

It’s possible to refinance an investment property. You may want to refinance in order to take advantage of low mortgage interest rates, change your loan terms or borrow against the equity you’ve built in the house.

To refinance, you’ll want to decide on the type of refinancing (like a cash-out refinance) that works best for your situation. Then, you’ll compare lenders and rates, apply for the refinance and close on your new mortgage loan. 

The Bottom Line: Owning An Investment Property Requires Planning And Preparation

If you’re thinking about buying an investment property, start by assessing your financial stability and return on investment for that particular property. Then, decide whether you have time to manage a property or if you should hire a property manager. Finally, you’ll want to consider the housing market, property taxes and other costs involved with managing a rental property.

Once you’re ready to move forward with buying an investment property, the next step is to get your financing in order. Start your mortgage application and you’ll be on your way to purchasing your first investment property.

Get approved to buy a home.

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Victoria Araj

Victoria Araj is a Section Editor for Rocket Mortgage and held roles in mortgage banking, public relations and more in her 15+ years with the company. She holds a bachelor’s degree in journalism with an emphasis in political science from Michigan State University, and a master’s degree in public administration from the University of Michigan.