Buying your first investment property is a big decision! Business Banking Officer Carrie Borgstrom offers valuable insights and reminders for first-time property investors.
These tips are meant for buyers of residential real estate who plan to rent out the property. Royal specializes in investment property loans for one to four family housing, such as a single-family home, twin home, or triplex.
Business Property Loans Are Different From Your Mortgage
If you’re thinking about purchasing a residential property for the purpose of renting it out, one of the key things to know is that business property loans are different from most home mortgage loans. “One of the first discussions I have with people looking to use a business loan to purchase a residential property is that there isn’t a 30-year fixed rate loan option,” explains Carrie. “Instead, there’s a lot more flexibility with how to structure things!”
Understanding Business Property Loan Fixed & Float Terms
Instead of the standard fixed-rate loan you might be familiar with from purchasing your own home, business property loans usually have a period of time where the interest rate is fixed followed by a period where the rate can change.
For example, your investment property loan could have a fixed interest rate for five years and then a rate that can change or “float” for ten years. During the float period, your loan interest rate can go up or down based on an index rate that changes with market conditions. Royal offers several combinations of lock and float term options. Borrowers also have the option to re-lock the rate during the float period if they prefer.
One popular choice includes a ten-year lock term followed by a ten-year float term. “The big benefit to these loans is getting a fixed rate for up to ten years,” says Carrie. “Especially for first-time property buyers, having a consistent rate and payment locked in means they can focus on managing their property and business finances before worrying about changing rates.”
Of course, the best business property loan terms for a buyer will depend on their individual financial situation. “There are a lot of things to consider when choosing the best business property loan for you,” says Carrie. “A big part of my role is having a conversation with borrowers to understand where they’re at and helping them decide on their best option.”
Royal Offers Fully Amortizing Business Loans
One big differentiator compared to most business loans is that Royal offers fully amortizing business loans. Fully amortizing means that the principal and interest repayment happens throughout the loan term and loan maturity occurs when the loan is paid in full.
Royal’s fully amortizing business loans are different from many financial institutions that only offer business loans as a balloon loan. In a balloon loan, when the loan term ends (typically three to five years after origination), the remaining loan amount is due in full. Borrowers often choose to refinance this large balloon payment into a new loan, which can mean additional loan origination costs, appraisal fees, and uncertain rates.
In contrast, most Royal business borrowers can re-lock their loan rate during their loan’s float term with just a credit check and small fee instead of a full appraisal and closing costs. Carrie notes that having a fully amortizing loan provides additional peace of mind for borrowers. “Balloon payments can add a lot of uncertainty to a first-time business borrower’s plate. Royal’s amortizing loans help provide consistency and eliminate some of what keeps new investment property owners from sleeping at night.”
Qualifying For A Business Investment Property Loan
Royal considers many of the same creditworthiness factors for both traditional home loans and business property loans. Royal checks personal credit scores for business owners, and the score plays a big role in getting a business loan approved. A healthy personal credit score shows a lender that you repay your debts on time, and most borrowers who use personal credit responsibly have similar habits when it comes to repaying their business loans.
Royal also considers a borrower’s debt service coverage ratio when approving a business loan. For an investment property, the income in this ratio should include a percentage of the property’s fair market rental income plus a buffer for potential future vacancies. Business loans are not included on your personal credit report, so you’ll also need to provide details about any other business debts before being approved.
Unlike a home loan for a primary residence, down payment assistance options are not typically available for business property purchases. Almost all borrowers will need to bring at least a 20% down payment to be approved.
Beyond the down payment funds, business loan borrowers may be required to keep a certain amount of cash reserves available to qualify for a loan. Plan to keep three to six months of loan payments available as cash in a deposit account, depending on your financial situation.
“Remember that a business property has a different set of risk factors compared to a personal mortgage loan,” says Carrie. “If you encounter a financial challenge, you’re going to keep your personal residence paid first and worry about your rental property second.” By making loan approval decisions based on our requirements, Royal is able to lower the risk for both borrowers and Royal.
Don’t Forget About Ongoing Property Needs
It’s very important to plan for the ongoing financial needs of a potential business investment property. “We like to create what-if scenarios with borrowers,” Carrie says. “We want to get a realistic picture of their monthly cash flow and make sure that they are positioned to succeed before moving ahead with a loan.” Carrie also likes to have borrowers plan to save 15% of their gross rents each month. She explains, “This allows 5% for cash reserves, 5% for maintenance costs, and 5% for repairs.”
Another item to plan for is the property’s real estate taxes and insurance costs. For maximum flexibility, Royal doesn’t escrow funds for business loans, so you’ll need to save for these expenses on your own.
Finally, if you plan to be a landlord for the property, remember that you’ll have a new set of skills to learn. Think about how you’ll advertise the property and attract tenants. You’ll also need to set the property rent structure, choose which lease terms to offer (such as month-to-month or yearly options), accept and screen tenant applications, and make decisions about pets, parking, and other property policies. You can also choose to handle some aspects of property maintenance like lawn care, snow removal, appliance repairs, and ongoing property upkeep yourself, or hire a property management firm to assist.
“Being a landlord is more than just collecting rent each month,” says Carrie with a smile. “That’s why it’s so important to talk through the financial side of it and make sure that it’s going to be worth it!”
Royal Credit Union Is Your Trusted Advisor
Royal welcomes business loans of all sizes. “Royal is willing to take the time to explain things to first-time borrowers and make sure that they understand how everything works throughout the loan process,” notes Carrie. “We love helping folks get their investment property up and running!”
There’s also plenty of room to grow with Royal. Besides business property investment loans, Royal offers business operating accounts, a business credit card and other business credit options, as well as cash management and treasury services to meet the needs of almost any business. Carrie sums it up by saying, “Members can feel confident that Royal wants to see their business succeed. We build long-term relationships with the people we help, so their goals become our goals.”
Have questions or want to discuss buying an investment property? Reach out to Carrie directly or find a Royal Business Banking expert near you.
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