For most real estate investors, cash for down payments proves the greatest choke point. Your ability to build your rental portfolio and passive income is constrained by your bank balance.
Because unlike homeowner mortgages, which can require as little as 3% down, rental property loans typically only cover 70-80% of the purchase price. That leaves investors on the hook for the other 20-30% as a down payment.
So how can investors get creative in coming up with a down payment for their next rental property loan?
Before getting creative, start simple: invest in more affordable markets. It literally costs ten times more money to buy an apartment in New York City than it does in many Midwestern towns. Get comfortable with out-of-state real estate investing to access far more affordable markets, which can chop your down payment to a fraction of what you’d need in your home market. If foreigners can invest in US properties, you can invest as an out-of-state American!
Beyond looking outside your home market, try these outside-the-box tips to come up with your next down payment for a rental property.
1. Roth IRA
You can withdraw money you contributed to your Roth IRA at any time, penalty-free and tax-free.
Why? Because you already paid taxes on it. If you want to pull money out of your Roth IRA to invest in rental properties, the IRS won’t stop you.
You can also pull out up to $10,000 in earnings tax-free and penalty-free if you plan to buy a multifamily rental property to live in yourself for a year (better known as house hacking). It’s one of the most overlooked benefits of a Roth IRA.
That said, you also lose the tax benefits that you originally invested for. Roth IRA balances grow tax-free, but if you pull your money out, it no longer compounds for tax-free growth.
One option to keep those tax benefits is to open a self-directed Roth IRA, and use it to buy rental properties! Just bear in mind that it comes with some extra complications and expenses, such as having to pay a self-directed IRA administrator.
2. Draw on a HELOC
If you have equity in your home, you can tap into it to cover the down payment on your next rental property. Open a home equity line of credit (HELOC), which you can draw on at any time and pay back on your own schedule, similar to a credit card.
You can even open HELOCs against your other rental properties, if you have enough equity in them. Lenders offer a lower maximum LTV however, when they extend HELOCs against rental properties.
While using a HELOC for your next down payment makes for a flexible option, it comes with its own downsides. Most notably, the hefty closing costs when you first open it, comparable to taking out a full rental property loan.
3. Tap Unsecured Business Credit Lines & Cards
Those closing costs typically add up to thousands of dollars – a stiff price to pay for the flexibility of a HELOC. But what if you didn’t need to do a closing at all?
Real estate investors qualify as business owners, and therefore qualify for business credit cards and lines of credit. Rotating credit lines not secured against real property, and therefore not requiring a settlement or title work.
You can research and apply for these on your own, or you can go through a business credit concierge. These services find the best business credit offers on your behalf, and then negotiate higher credit lines for you. In between rounds of fundraising they scrub your credit report to remove the inquiries, and show you how to draw on business credit cards without paying a cash advance fee.
4. Cross-Collateralize Other Properties
Some lenders accept a lien on a second property in lieu of a down payment.
Say you apply for a rental property loan, and they approve you with a $50,000 down payment. You have another rental property with $100,000 in equity in it, so you offer up a lien against that second property as additional collateral to the lender instead of coming up with a down payment.
The lender gets additional collateral to secure their loan, ensuring that they don’t lose money if you default and they have to foreclose. You get to avoid coming up with a down payment, as one more way to get creative with your financing.
5. Recycle the Same Down Payment with the BRRRR Strategy
The acronym BRRRR stands for buy, renovate, rent, refinance, repeat. It’s more work than simply buying turnkey properties, but it comes with an enormous advantage: you get to pull your down payment back out when you refinance.
It works because the refinance is based on the after-repair value, not the original purchase price. That means you can recycle the same down payment over and over, all the while growing your rental portfolio and cash flow.
If all that renovation spooks you, consider a hybrid “BRRRRkey strategy” instead. Just remember that lesser home improvements yield less forced equity, limiting the amount of money you can pull out when you refinance.
Some landlords look to save on costs and save up down payments faster by self-managing their rentals. But don’t assume your rentals will necessarily cash flow better – property managers can reduce your vacancy rate, keep your rent collection current, and reliably raise rents each year to keep pace with market pricing.
Consider finding a property manager to streamline your day-to-day labor and management headaches. It can actually improve your cash flow rather than reducing it, which says nothing of the time it frees up for you.
Time that you can spend finding deals on new rental properties, rather than fielding tenant phone calls and hassling with contractors.
G. Brian Davis is a landlord, real estate and personal finance writer, and the co-founder of SparkRental.com. Swing by SparkRental for free rental investing tools such as a free rental property calculator, free video courses on building passive income from rentals, a free online rent collection service, and a lengthy library of other free landlord tools.