Most of us would love to have five or ten rental properties generating passive income for us every month. Far fewer of us actually own any rentals, having bumped up against one tall barrier to entry: cash.
It takes investment capital to build a portfolio of rental properties. Cash for the down payment, cash for closing costs, cash for repairs, cash for operating reserves.
Which raises a simple question: if cash is what’s holding you back from building passive income from rental properties, how can you get started in the investment property game with less cash?
Try these ten ideas to minimize the cash you need to start building your own rental portfolio. With each property you add, the income makes it easier to save and buy the next!
All lenders price their loans based on perceived risk. The higher the risk of the borrower defaulting, the more the lender must charge to justify the risk, and the less money they’ll lend against the same collateral.
Which means if you want a lower down payment and interest rate, you need to make yourself a low-risk borrower.
That starts with improving your credit. If you don’t pay every bill on time, automatically, every single month, set up automated recurring payments so none slip through the cracks. Your payment history marks the single greatest factor in determining your credit score. You may even be able to remove some late payment from your credit history, giving your score an instant boost.
Next, pay down your credit card balances below 30% of the maximum credit lines. That demonstrates to the credit bureaus that your credit usage is under control.
If you don’t have much credit history, you may need to establish it. Consider a secured credit card (which holds a little cash as collateral), or a “credit builder loan” (essentially a loan to yourself, held in escrow by the “lender,” who reports your monthly payments as if they’re for a regular loan).
Lenders earn a tidy profit by charging you an origination fee or “points” at the settlement table. One point is equal to 1% of your total loan amount. They add up quickly – two points on a $300,000 mortgage come to $6,000 in origination fees alone!
The worse your credit, generally the higher the origination fee that the lender charges you. So by cleaning up your credit history, you can not only reduce your down payment, but also reduce the points you pay at the closing table.
Some lenders also let you pay more in points to reduce your interest rate, or vice versa. That can offer another route to coming up with less cash at closing, albeit one that you pay for later.
An acronym for buy, renovate, rent, refinance, repeat, the BRRRR method basically involves buying a fixer-upper, renovating it, then refinancing it to keep as a long-term rental.
What does that have to do with your cash investment? Well, the beauty of the BRRRR method is that you can pull your original cash back out when you refinance.
The idea is that you create enough equity when you renovate the property to then take a cash-out refinance once renovations are finished. Lenders base the refinance amount on the after-repair value, not the price you paid to buy the fixer-upper originally.
Thus, you can end up with $0 of your own cash tied up in the property after renovating it. That lets you recycle the same cash into another property, perhaps even another BRRRR deal to keep using the same cash repeatedly to grow your portfolio.
When you buy a fixer-upper, you pay less up front for the property, which means a lower down payment and lower closing costs than comparable turnkey properties in the same neighborhood. All of which saves you money at settlement.
But you then need to renovate the property, which costs money. Fortunately, you can pay for all materials using your credit cards, to finance them. And many contractors nowadays accept credit cards as well, allowing you to finance labor costs with plastic too.
If you’re new to renovating properties however, be careful not to get in over your head. Cosmetic updates make a great first place to start, but once you get into structural or trade repairs like rewiring an old house, you start needing to pull permits from the local housing authority, suffer through inspections, and coordinate repairs with multiple specialist contractors rather than one single crew.
As my grandfather taught me growing up, you don’t get what you deserve in life; you get what you negotiate.
When you make offers and negotiate pricing, consider negotiating for a seller concession, not just a lower price. Your lender will cover the majority of the purchase price, but you have to cough up all the closing costs in cash yourself – unless the seller pays for them for you, in the form of a seller concession.
While you’re negotiating, talk to the seller about holding a second mortgage to cover some or even all of your down payment.
Not all sellers will consider it, of course. But if the seller will lend you the down payment, it certainly puts a dent in how much you need to bring to the table!
Have equity in your home? Tap into it with a home equity line of credit or HELOC.
As a rotating line of credit, you can draw on it whenever you like, much like a credit card. You then pay it back at your own speed, also like a credit card. At least until the draw phase ends and the HELOC enters the fixed repayment phase.
You can even take out HELOCs on rental properties, if you have equity in them.
Draw on your HELOC to cover your down payment, your closing costs, your renovation costs, or any other expenses as see fit. Just note that conventional mortgage lenders don’t allow you to borrow the down payment, so this tactic works best when you borrow from a hard money lender or a portfolio lender (a lender who keeps the loan in-house rather than selling it off on the secondary mortgage market).
Just like a HELOC, you can tap into business credit lines and cards to cover the down payment or closing costs as well.
In fact, it works even better. First, business credit lines aren’t secured against your primary residence, so if the worst happens and you default, you don’t lose your home. Second, these credit lines remain rotating indefinitely, never rolling over to a fixed repayment phase like HELOCs do.
Remember though, the more debt you take on to buy a rental property, the greater your expenses and the worse your cash flow. At a certain point, the property ends up costing you more money in a given year than you earn in rental revenue.
Real estate investors can use several tricks and loopholes to borrow homeowner financing to pay for investment properties. Which puts a huge dent in your down payment, because homeowner loans require far smaller down payments than investor loans. For example, FHA loans require only 3.5% down for homebuyers with credit over 580, and conforming (Fannie Mae & Freddie Mac) loans require as little as 3% down. Read up on the differences between FHA and conventional loans for more details.
First, they can move in for a year, then move out and keep the property as a rental. Conventional mortgage lenders require a minimum of one year’s residency to qualify as a homeowner, so technically you could buy a new property every year with homeowner mortgages.
Second, investors can house hack. While there are many ways to house hack and live for free, the classic model involves buying a multifamily property, moving into one unit, and renting out the neighboring unit(s). Conventional mortgage loans allow properties with up to four units, so you can build your portfolio of rental doors by moving into the property for at least a year.
And hey, it doesn’t hurt that your tenants cover your mortgage and other housing expenses!
With a 3% down payment instead of a 20%+ down payment, it’s far easier to come up with the money, and possibly even buy a house with none of your own money down.
For even more money toward your closing costs or down payment, consider wrangling a buyer rebate from your buyer’s agent.
A buyer rebate involves the real estate agent giving you a portion of their commission (typically paid by the seller). While this would ordinarily need to be negotiated with your real estate agent, there are pre-existing networks of buyer’s agents who agree in advance to give you part of their commission. This way, you can score a buyer rebate without having to negotiate for it!
With every property you add to your portfolio, it gets easier to buy the next.
First, you build more income with each rental property you buy. That income helps you save up a down payment faster, and helps you qualify for better mortgages.
Many lenders also look at your experience when they price their loans – the more properties you own, the more confident they feel lending you money. Remember, lenders price based on risk.
Finally, with every property you buy, you add another asset that appreciates in value. As your properties appreciate and build equity, you can then tap that equity in the form HELOCs on those rental properties.
Which in turn reduces the amount of your own saved cash you need to come up with to invest.
What’s holding you back from building your own portfolio of rental properties? What strategies are you exploring to reduce the cash you need to invest?