What you need to know before you buy property as an investment

GeorgeSchofield, Credit.com

With interest rates still hovering near all-time lows, and property values in many places improving but still far below 2007 highs, investing in real estate may seem like a smart move — especially for anyone squeamish about investing in the stock market. (A whopping 76% of consumers are saying no to equities, according to Bankrate’s latest Financial Security Index.)

Bloomberg

But new mortgage lending rules. which went into effect Jan. 1, will have a direct impact on many of these investors’ plans. Credit requirements have tightened, in some cases dramatically, and lenders are now also looking at the number of leveraged properties an investor owns — not just the equity of those homes — before lending any more cash for any purpose.

Here’s what you need to know if you’re going to borrow to invest in real estate:

•The new mortgage rules were drawn up by the Consumer Financial Protection Bureau, created following the enactment of the Dodd-Frank Act in 2010. Some new regulations are designed to protect homeowners from lender and mortgage-service abuses. But others are designed to ensure that borrowers won’t have trouble making their mortgage payments by taking on more debt than they can handle.

•The new rules don’t affect the vast majority of people seeking a new mortgage or who want to refinance an existing one. According to the CFPB, only 12.8% of mortgages originated in 2012 don’t meet the new standard.

•The new rules strictly define a “qualified” mortgage up to 30 years. A borrower’s maximum debt-to-income ratio must be 43% or lower. No negative amortization or interest-only payments.

•If you want to invest in real estate, either to improve and quickly resell (flip) or to generate rental income, know that Federal Housing Administration loans, which require modest down payments, now have lower maximums than before. The top loan amounts vary from state to state, and even within states; in some places, like Florida, the top FHA loan amount plummeted from $417,000 to $285,000 for a jumbo mortgage. So if you have your sights set on a high-end flip or a multi-unit rental property, be prepared to pony up a lot more cash up front.

•Even for more modestly priced structures, for the best rates, down payments on investment properties are typically higher than for a primary residence. Be prepared to pay 25% down vs. 20% for a standard mortgage.

•If you own several properties and want to use the equity in them to buy another property or refinance an existing one, you may be turned down — even if you have stellar credit scores, substantial net worth and a low debt-to-income ratio. Lenders are setting arbitrary thresholds for the number of mortgages a person can hold. In some cases, that number is four.

•You may find your home equity line of credit canceled at the lender’s discretion. Read the fine print.

How to Be a Credit-Smart Real-Estate Investor

Make investment decisions with the expectation of a long-term hold. You may have had an easy time getting a mortgage on an investment property, but your potential buyers may not. Even well-off corporate executives may have trouble buying a new house after a job transfer if they don’t sell their old home before trying to buy a new one.

Build your financial model around liquidity. An unsold flip can end up costing you dearly, since you’ll be on the hook for the mortgage, taxes, insurance and utilities until you can sell it. In other words, don’t tie up all of your free capital in investment property.