Investing is a vital way to grow your wealth; while riskier than a savings account, Treasury Bond, or Certificate of Deposit (CD), these options provide a greater return on investment, which can be reinvested to create exponential growth. Of all investments, real estate is one of the most promising, as it capitalizes upon fundamental needs: the need for housing and office space.
When managed correctly, an investment property can provide you with a steady income and build equity for when you’d like to sell your real estate and either utilize the money for retirement or place it in other options.
Most people pay for their investment properties through mortgages, just as for residential real estate; as such, it’s important to understand investment home loan rates, including how other market conditions will impact your potential interest rate. Today, we’ll discuss some of the most significant factors you must be aware of when choosing to jump into investment real estate.
What to Expect With Investment Interest Rates
First of all, investment property real estate rates are higher than they are for owner-occupied home loans; this is because they are considered riskier for lenders. Investors may choose to pay off their loan ahead of time, meaning that the lender loses out on interest over the long term, or they may choose to get rid of the property entirely before the mortgage is completed.
In general, you can expect the interest rate for an investment property mortgage to be about 1.5% higher than that for a residential home loan; this means that if, for example, the current interest rate for consumer loans is 3.5%, your interest rate would be about 5%. As such, you’d pay approximately $95,000 in interest more than the consumer over the life of your loan.
Market Conditions and Interest Rate Volatility
Like consumer loans, investment property interest rates are heavily influenced by the current real estate market and the economy as a whole. For example, in 2022, the Federal Reserve worked to curb inflation by raising interest rates, which increased the borrowing cost across the board and slowed the housing market, which had been red-hot due to the pandemic.
Fixed-interest mortgages are often the most susceptible to this volatility; in fact, they track almost exactly to changes in Federal Reserve policy, dipping and rising when the Fed drops or raises interest rates to provide market stability. Adjustable-rate mortgages are a bit more fluid, which makes them more attractive when interest rates are high, and they can then be refinanced into a fixed-rate mortgage when rates drop.
When considering the perfect time to purchase an investment property, it’s critical that you keep a close eye on market conditions and review economic projections that will help you know when it’s time to get the process started. Do your research and prepare your information so that you won't be left in the dust when the perfect time and property comes along.
Reading the Terms and Conditions of Your Loan
As with any loan, investment property mortgages have a variety of stipulations, so you must read the terms and conditions with a keen eye, perhaps soliciting the help of a real estate lawyer who can help you determine whether you’re getting a good deal.
Many investors prefer debt service coverage ratio (DSCR) loans, as they allow you to purchase a property under a corporation name and leave your personal finances out of it, but these loans have a unique feature that isn’t as common in consumer loans: a prepayment penalty.
This penalty, which is usually for the first five years, requires you to pay a percentage of the overall principal in addition to your payment should you choose to get ahead on your mortgage. Prepayment penalties are often on a “step down” schedule, meaning that you will pay more of a penalty in the first year of the mortgage, but the percentage drops as the loan seasons.
While it’s common for this penalty to be in place for the first five years, as mentioned previously, some states only allow a prepayment penalty for the first three years. You need to be aware of the mortgage laws in your particular state, in addition to the stipulations of the loan, to ensure that you’re not unduly punished should you choose to pay ahead after three years.
Real estate is a powerful way to grow your wealth, but it also has a downside: higher interest rates. These rates, like those for consumers, are tied to overall market conditions, but volatility is of especial concern for investors, given that they will already be paying more than the average homeowner. This, alongside the terms and conditions of a loan, should guide your real estate purchase strategy.
Buy when rates are low and sell when rates are high by keeping abreast of economic conditions, and be sure that you’re familiar with exactly what you’re signing to plan ahead.