How can rental properties perform better than stocks, but have lower volatility and risk? Doesn’t high-return mean high risk?
The answer is simple: there’s a higher barrier to entry to invest in rental properties.
Anyone can throw $100 into an index fund. No minimum cash requirements, no education required. It’s one of the great advantages of investing in equities, despite their volatility.
But rental properties, despite their strong returns and low risk, pose two large challenges to new investors: they require more money to purchase, and they require more skill than index fund investing.
We’re all about providing education and guidance with the “skill” part of that equation. But what about cash? Doesn’t it take tens of thousands of dollars to buy a rental property?
Here are some ideas to help you buy your first rental property with no money down. Or rather, less money down – there’s no free lunch in life, but you have several options to slim or even eliminate your down payment requirements.
Consider House Hacking First
House hacking is the easiest way to buy your first rental property. And in the bargain, you get to live for free!
The concept is simple: you buy a small multifamily (2-4 units), move into one of the units, and rent out the other(s). Your neighboring tenants’ rent covers your mortgage and other housing costs, for effectively free housing.
And when you move out, you keep it as a pure rental property, and the cash flow only improves from there.
How does this help your down payment? Mortgage lenders require far lower down payments on owner-occupied properties than investment properties. It’s a simple risk calculation for them: borrowers are far less likely to default on their home mortgage than a rental property loan.
One popular low-down-payment loan program is FHA, which allows a 3.5% down payment as long as your credit score is over 580. (And let’s be honest, if your credit score is under 580, you should probably work on paying down debts before buying a rental property.)
But FHA isn’t the only option – there are loan programs out there that require even less money down, and sometimes no money down at all. Talk to at least three local mortgage lenders or brokers about different program options, before settling on a lender and loan program.
Seller Financing
Wait a second though; who says you have to go through a loan program at all?
Sometimes sellers will finance the property for you, allowing you to negotiate any terms you want! Including the possibility of no down payment.
This works especially well with sellers who have no mortgage, or perhaps inherited the property and don’t know what to do with it. Maybe the property needs repairs, and the seller doesn’t have the cash to make them?
Often, they’re happy to accept regular monthly payments for the property, and take the income along with a quick settlement and not having to hassle with Realtors and commissions.
Not every seller is open to this, but many are. It’s worth exploring with them, and can prove an effective way to buy your first rental with no money down.
Free Mini-Course: Passive Income from Small Multifamily Properties
Assume the Seller’s Mortgage
Even if the seller isn’t willing to directly finance the property, you still may be able to work out a way to buy with little or no money down.
You can offer to assume the seller’s mortgage and make payments on their behalf. You step into their (presumably low-interest) loan, leaving you with only the remaining difference to come up with.
Here’s the thing: when you buy a property with conventional financing, lenders often won’t let you borrow the down payment. They want your skin in the game.
But in this case, you’re not borrowing a purchase mortgage, you’re just assuming the existing one, and paying the seller separately for any difference.
That means you can pay them however you want!
You could borrow money from friends and family. Borrow from your credit card, or a personal loan. Or work out a loan with the seller themselves!
Negotiate a Seller-Held Second Mortgage
Say you find a lender willing to lend you 90% of the purchase price, but don’t have enough money to cover the other 10%.
One place to get the money? The seller, once again.
Not every lender will allow this, so before you negotiate tooth and nail with the seller to offer you second mortgage, talk to your primary lender first.
It’s worth noting that FHA loans do not allow seller-held second mortgages.
Collateral-Based Lenders Are More Flexible on Fund Sources
Conventional and FHA lenders are sticklers for rules and regulations. They may not let you borrow money from the seller, or from anyone else, to let you buy a rental property with no money down.
But not every lender is so fussy about where your down payment comes from.
Landlord lenders and hard money lenders typically lend based on the property itself, the collateral, rather than on you as the borrower. The good news is they usually don’t care where your down payment comes from, as long as it’s not from them.
The bad news? They’ll lend at a lower LTV (loan-to-value ratio), which means they require a larger down payment.
Plan on coming up with a down payment of at least 20% for a landlord lender, and at least 25% for a hard money lender. (Tip: Hard money lenders are best for short-term purchase-renovation loans, not long-term landlord loans. If you’re buying a property that’s ready to rent and you want affordable long-term financing, we’ve broken down the lending terms of several landlord loan programs.)
By using a landlord lender or other collateral-based lender, you can borrow the down payment from elsewhere. Friends, family, credit cards, personal loans, the seller, your retirement account; wherever you want.
One other advantage to using a landlord loan or other collateral-based lender? They don’t charge mortgage insurance (called PMI for conventional loans and MIP for FHA loans). That means that even if the interest rate is higher, your monthly payment could still be lower, since you don’t have to flush money into mortgage insurance.
What short-term loan options are available for buy and rehab?
What about long-term landlord loans?
We break down several real estate investor and landlord lenders on LTV, interest rates, closing costs, income requirements and more.
Partners
We’ve mentioned friends and family several times now as possible sources of money for your down payment. But who says lending you money is the only option?
They may want to partner with you on a deal!
Imagine the following scenario: you don’t have any money for a down payment, but you’re willing to learn how to invest in rental properties. Your friend has money for a down payment, but no time to spend learning the ropes of buying rental properties.
Match made in heaven. They provide the down payment, you provide the sweat.
Chances are, you know someone who’s looking to diversify and invest some money in real estate. Who doesn’t love passive income? And rental properties produce passive income better than just about any other investment.
Credit Cards
Like friends and family, we’ve mentioned credit cards a few times above. While we spent an entire article walking through the pros and cons, risks and “rewards” (see what we did there?) of using credit cards to buy rental properties, they’re worth exploring briefly here too.
The bad news: credit cards charge cash advance fees (usually 3-4%), and they charge high interest rates (10-25%).
The good news is that they’re flexible, and often the cash advance fees are mitigated by the reward points.
Imagine you buy an $100,000 rental property, and get a landlord loan for $80,000 of it, leaving a down payment of $20,000. You pull $20,000 (or whatever you can) as a cash advance from your credit card, pay a 3% cash advance fee, and get 1.5% of that back in the form of rewards.
Paying 1.5% as a finance charge is nothing to scoff at.
As for the interest, the trick is to pay that balance down, and fast. You’re on a race against the clock at that point: how quickly can you pay off the credit card balance? If the answer is “within a few months,” it’s a promising strategy. If the answer is “within a few years,” think again.
But at least you’ll have rental income from your property to help you pay it down faster!
HELOCs & Second Mortgages on Your Residence
Another idea to buy a rental property with no money down is to borrow money from your current residence.
Home equity lines of credit (HELOCs) are especially useful for this. You secure a line of credit against your home, and you draw on it as you need it, and pay it back with rental income.
In the example we used above, you borrowed a landlord loan for $80,000, leaving you to come up with the other $20,000 to buy your $100,000 rental. It’s a lot cheaper to borrow money from a HELOC than it is from your credit cards!
At least for the interest rate. The up-front costs to pull out a HELOC will be higher, since the lender will need to run a title history on your home and will almost certainly charge you junk fees.
Still, HELOCs are the gift that keep on giving. You can keep rotating it through as you buy a rental property, pull money out, pay it back, and repeat.
Second mortgages (AKA home equity loans) are less flexible but can still be used to cover your down payment on a rental property.
Get quotes for HELOCs and second mortgages from multiple lenders at LendingTree.com.
More Ideas to Buy a Rental Property with No Money Down
Have you thought about using your retirement accounts to buy rental properties? What about crowdfunding websites?
One traditional model – which still requires cash up front, but you get it back – is the BRRRR strategy. It stands for buy, renovate, rent, refinance, repeat. You’ll need either a hard money loan or a fix-and-flip online lender, and they’ll require a down payment, but they’ll lend you money for the repairs.
When the renovations are finished, you refinance the property and pull your original cash back out. The good news is that these are collateral-based lenders, so you can use the same strategies discussed above to borrow money elsewhere to cover the down payment.
Take our free mini-course on buying rental properties for more ideas for where to come up with money for your down payment.
If you’re willing to get a little creative, you’ll be amazed at how little cash you actually need to buy your first rental property!
What tactics have you used to buy rental properties with no money down? What’s worked for you? What hasn’t? Share your experiences below!
Good summary of the techniques to buy real estate without much cash. Still takes something normally, but as you pointed out, there are plenty of ways to slim down the cash needed.
Love your guys’ articles, so glad I found Spark Rental!
GReat article on buying your first rental property with no money down. Obviously there’s no one panacea, but by combining different techniques you can cut away at the amount of money you need to buy a rental property.
Great article & content. WE have aquired properties by working with property owners who want to retire & maintain their income. By offering a property management agreement along with a Master lease Purchase Option Agreement we have been able to aquire multiple properties. #TNREIA
Great idea Doug, and one that not enough investors consider!
Leveraging is a great tool if you have no money sitting in your hand. It is really good way to build up your rental portfolio but you should also stay cautious while using some kind of leverage. Leverage works best when the property rates in your area are appreciating. But if the rates depreciate, leveraging can work against you and you can even lose your money you have put in down payment. 2008 market crash was the real example.
Some good points here, but it’s terrible advice to suggest someone could put a down payment on a credit card.
I bought a house financed nearly entirely on a credit card once. The more experience you have as a real estate investor, the more creative you can get with approaching it. But you need to master the fundamentals first, and to your point, novice investors need to be careful about over-leveraging themselves.