Smart Steps for Investing in a Second Property

Smart StepsDo you want to earn passive income? If so, investing in real estate might be the answer. As home prices stabilize, there’s been an increase in the number of people investing in rental properties.

Owning a rental property can create extra income for you each month. However, before you jump into buying a second property, you need to understand the good and the ugly. A rental unit is a big responsibility, so you need to get your finances in order and do your research before investing.

Improve Your Credit Score

The fact that you already own a home doesn’t mean you’ll automatically qualify for another mortgage loan. Truth be told, having an existing mortgage in your name makes you a risky applicant. Mortgage rules for buying a second/investment property are more stringent than buying a primary residence. Your lender may require a higher credit score and a lower debt-to-income ratio. Aim for a credit score in the mid 700s or higher. Pay off as much debt as possible, such as credit cards and auto loans, and always pay your bills on time.

Know the Local Real Estate Market

If you jump into buying an investment property too soon, you could end up in financial hot water. Research the local area. For example, what type of properties make good rental units in the area? What’s the average rental rate for these properties?

Knowing this information provides a pretty accurate picture of how much you should spend on a property, and how much you can expect in rental income. If you spend too much buying a rental property, you might not earn as much in rental income, especially if your mortgage payment is comparable or more than the average rental price for the area. Ideally, you’ll want to purchase an investment property below market value, such as a foreclosure or a short sale.

Can You Afford an Investment Property?

Consider whether you can realistically afford to purchase and own a rental property. Based on the condition of the house, you might need to make improvements or repairs on your own dime. Also, once a tenant’s lease ends and he moves out, it might take a couple months to find a new tenant (depending on the local competition), at which time you’ll have to cover the payment. A rental property can provide a steady income stream, but there are no guarantees. So, make sure you can handle the monthly payment on the second property, in addition to your personal expenses — just in case the house sits empty for a period.

Consult with Other Landlords

There’s a good and a bad side to owning rental properties.  If your friends, relatives or coworkers also have rental properties, get their advice and listen to their stories. You might envisions yourself earning big bucks from an investment property, but owning a rental is work. You’ll have to pay taxes on your rental income, tenants might skip out on the lease early, and you never know when you’ll have to spend money on repairs. Speak with experienced landlords and then decide if you’re up for the challenge.

Buying a rental property can generate passive income and improve your personal finances. However, consider whether you have the financial resources and the time to manage a rental property.

This article originally appeared on Total Mortgage.

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