Are you interested in becoming a landlord? A rental property can generate regular income and build long-term wealth. However, saving up for a down payment and other associated costs can be challenging.
Here are seven smart strategies to help you meet your financing and savings goals as you prepare to buy a rental property.
1. Calculate Rental Property Purchase Costs
Succeeding as a landlord requires careful planning before buying your first rental property. First, you'll need to calculate how much money you need to make the purchase. Typical costs associated with investing in a rental property could include:
- • Loan application fees
- • Real estate transfer tax
- • Home inspection fees
- • Appraisal fees
- • Legal fees
- • Down payment (more on that later)
Talk to your lender or realtor about potential rental property costs and fees before purchasing a property.
2. Save for A Down Payment
Lenders have different rules for rental property down payments than for owner-occupied homes. While you might buy a home with just a 3% down payment, most landlords must put down at least 15% to buy a rental property.1 Before making an offer on a rental property, consider how you'll save for a down payment and how long it will take to do so.
If you buy a multiunit property like a duplex and live in one unit and rent the other, however, you might qualify for a Federal Housing Administration (FHA) loan. In this case, qualified borrowers can put down as little as 3.5%.2
Consider an FHA 203k loan as another down payment option for rental homes. With this loan for fixer-upper properties, you put just 3.5% down, live in the home as you repair it and receive financing for the rehabilitation.3 When the home is complete, it's ready for you to rent out.
3. Save Strategically
Once you've figured out how much money you'll need to purchase a rental property, calculate how much you can contribute toward monthly savings.
If you haven't already done so, organize your finances and create a monthly household budget. Record your after-tax household income and all the money you spend each month. Allocate what's left toward your rental property savings.
Forecasting when you'll reach your rental property savings goal is easy, especially when you use the RVC Savings Calculator.
For example: Say you need $20,000 to cover your first rental costs and down payment. You've already saved $10,000 and need another $10,000. So you can save $500 a month for 20 months. It's an easy calculation: $10,000 divided by $500 = 20 months until you meet your goal.
Saving strategically also means thinking about where you park your cash so it grows. For example, stashing your cash in a high yield savings account or a money market account with a competitive interest rate can help your savings grow faster. A high interest CD can also help you grow your savings faster and achieve your down payment goal.
4. Increase Your Income
Another way to meet your savings goals faster involves making more money. Look for creative ways to boost your income. For example:
- • Browse your garage, basement, kitchen cupboards or attic for items to sell via online classifieds, eBay or your local Facebook groups. Small kitchen appliances and seasonal sports equipment could be quick sellers.
- • Consider starting a side hustle in real life or online.
- • Take a part-time job, start a dog-walking business or become an Uber driver.
- • Try becoming a virtual assistant, social media manager or freelance writer to get the income boost you need to grow your savings faster.
5. Research Financing Options
Unless you're paying cash for the whole purchase, the money you'll need to save to buy an income-producing property depends on how much financing you can get.1
For example, perhaps you plan to buy a property that costs $250,000, you have a $50,000 down payment and expect to finance $200,000. However, your lender approves financing of just $180,000. You will need to save an additional $20,000 to buy the property.
That's why it's a good idea to carefully research rental property finance options early on in your quest to buy a rental home.
Conventional financing for rental properties
If you have a mortgage on your home, you're likely familiar with conventional financing to buy real estate. However, with this type of financing, lenders often ask for higher down payments if the property is (or will become) a rental unit.1
Borrowers qualify for conventional financing based on their credit scores, assets, liabilities and ability to carry the additional loan payments.1 Your lender may also ask for proof of emergency savings.
Note that potential rental income may sometimes be included in the qualification process for this type of financing.1
Home equity loans
If you own a home, consider tapping into your home equity with a home equity line of credit. This could allow you to finance your rental purchase at a lower interest rate than a conventional loan.4 However, remember that you would borrow against your home and not the rental property in this scenario.
Private money loans
Private lenders offer financing at a typically higher interest rate than traditional lenders, but may also have less strict requirements for borrowing to buy a rental property.5 As such, a private loan may offer a temporary solution to getting your first rental property. Then, as your income and equity grow, consider applying for a loan with a lower-rate lender.
6. Don't Forget Phantom Costs
Keep in mind that the #LandlordLife is not a free ride: You must pay the “phantom costs" of rental properties. These expenses may include taxes, homeowner association fees, landlord insurance, repairs and property management fees.6
Some experts suggest using the 50% rule to set aside an amount equivalent to 50% of the rental income when budgeting for phantom costs.7 Others suggest using the 1% rule, which involves saving 1% of your rental home's property value for ongoing repair costs.7 Whatever you choose to do, make sure to consider these costs when creating your emergency savings fund.
7. Avoid These Rental Property Savings Mistakes
Learn the common pitfalls to avoid while saving for a rental property so you can make wiser financial decisions and sidestep money problems down the road.8 Some common mistakes include:
- • Not budgeting for renovations required at purchase, such as fresh paint, updated appliances, professional cleaning and carpet cleaning
- • Not budgeting for emergency savings for unexpected repairs or lost rent due to vacancy
- • Not being familiar with local landlord and tenant laws
- • Not budgeting enough for legal fees
- • Not understanding how your lender calculates rental income as part of your overall income for financing qualifications
- • Not budgeting for private mortgage insurance (PMI), which is required if your down payment is less than 20% of the purchase price8
- • Not budgeting for homeowner's insurance or landlord insurance9
Talk to your lender or realtor about what to watch and plan for when it comes to common rental property purchase mistakes.
Plan and Prepare to Boost Savings for Your First Rental Property
You can become a landlord and earn rental income when you buy your first rental property. Maximize your odds of success by planning, preparing and researching special programs for residential landlords before you buy.
First, calculate your rental property purchase costs and create a timeline for savings. Next, look for income-boosting opportunities to save more money faster. And if you don't qualify for conventional financing, consider creative financing and research loan opportunities with local private lenders.
Ready to start saving for your rental property down payment? Make your savings work harder in a high yield savings account, money market account or certificate of deposit.
Sarita Harbour is a freelance financial writer with more than 12 years of experience writing about personal finance for families, 12 years of experience as a banker and financial advisor and 30+ years of experience as a mom! Learn more at Harbour Content Development Inc.
READ MORE: What Should I Know Before I Take Out My First Mortgage?
Sources/references
1. Jackson, N.M. How to Get a Mortgage for a Rental Property. Forbes. Updated February 23, 2021.
2. Let FHA Loans Help You. U.S. Department of Housing and Urban Development.
3. 203(k) Rehab Mortgage Insurance. U.S. Department of Housing and Urban Development.
4. Luthi, B. How to Buy an Investment Property With Home Equity. Experian. Published September 8, 2022.
5. Naftulin, S. Going Private: A First-Timer's Guide to Private Lending for Real Estate. Forbes. Published November 9, 2021.
6. Honeyager, M. Solved! What Does Landlord Insurance Cover? Bob Vila. Updated January 19, 2023.
7. Rental Property Maintenance Myths. Real Property Management.
8. Suknanan, J. How to Figure Out If You Actually Have Enough Money to Buy Your First Home. CNBC. Updated June 9, 2023.
9. Seboldt, T. Solved! I'm a Landlord — Do I Really Need Landlord Insurance? Bob Vila. Updated March 17, 2023.