Dave Friedman is Co-Founder and CEO of Knox Financial, the smart and frictionless way to turn a home into an investment property.
When people think about personal finance, topics related to spending, saving and investing often come to mind. A less-considered topic is how personal finances come into play when you’re considering buying an investment property.
Whether you’re moving and plan to turn your old house into an investment property or you’re about to purchase your first investment property, here are five personal finance questions you should ask yourself:
1. What personal financial goals are tied to this property?
If you’re about to commit to an investment property, it’s critical to ask yourself what personal finance goal you hope the property will help you achieve. Your answer to this question will determine what type of property you should buy.
For instance, let’s say you have a short-term personal finance goal, like saving for a big expense that’s coming up in a year or two. In this case, you should do a back-of-hand calculation to make sure any property you purchase will help you generate the revenue you’re seeking. You’ll likely want to carry a lower mortgage and choose a property in an area where the rental market is strong enough to get a tenant within a few months of purchasing.
In contrast, if you’re looking at your property as a long-term investment that you don’t plan to touch for 15 or more years, you could consider buying a more expensive property with a bigger mortgage, confident that the value of the property will appreciate significantly in the decades to come.
2. How will I pay for the down payment?
Once you decide on the personal finance goals related to your investment property and find a property that matches these goals, the next step is coming up with the funds for a down payment. Here, you’ll have a few options:
• You can use money you already have that’s liquid, like cash or stocks.
• If you’re a homeowner, you can consider doing a cash-out refinance of your home or taking out a home equity loan.
• If you’re turning the home you’re moving out of into an investment property, you can consider a refinance that helps you afford the down payment on your new home while holding on to your old home as an investment.
3. How much should I pay for the down payment?
If you want to start generating cash flow from your property as quickly as possible, you’ll want to lower your mortgage as much as possible. In this scenario, consider making a bigger down payment.
However, it’s important to keep in mind that mortgage interest rates remain near record lows. So if your personal finance goal is to build as much wealth as possible through your investment property in the long term, you could consider a minimum down payment. If you have a fixed amount of money saved for the down payment, you could use part of that money for the down payment and put the remainder into assets that have the potential to generate more interest.
4. Will I have a big enough emergency fund after buying the investment property?
Whatever you do, don’t completely deplete your savings to buy an investment property. I strongly recommend having three to six months’ worth of expenses on hand in case of an emergency. However, if you have more than six months’ worth of emergency funds already saved, you could responsibly use a portion of those emergency funds for the down payment of your new home.
5. How will I pay for everything that comes with owning an investment property?
When you become an investment property owner, do you plan to do all the work associated with the property or will you get help with some of it?
Here are a few considerations when making this decision:
First, make a list of everything that has to be done for an investment property — marketing the property, communicating with tenants, maintenance, insurance and accounting, to name a few. Then estimate how much each of these items will cost you per year.
Second, determine the opportunity cost of you spending time on your investment property. For instance, if you have to spend a day dealing with maintenance or showing the unit to a new tenant, does that mean you won’t get paid for that day?
Third, compare how much it will cost you to hire help with how much it could potentially make you. For instance, if you work with an experienced realtor to price and lease your property, they will charge you for their services, but they might lease the property for more money than you would have been able to get.
If you consider these five questions as you debate becoming an investment property owner, you’ll be well on your way to ensuring that your investment aligns with your personal finance goals.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.