Here’s a very easy answer to a very difficult question: How much will a bank lend me to buy a rental?
I know, I know, that’s not very helpful. But let’s break it down and I’ll share what I’ve learned so far.
In general, banks will loan you 80%. But 80% of what? That too depends. 🙂
Something to note, the main “it depends” depends on your credit. If you have really bad credit, they probably won’t loan you nearly as much. If you don’t have a steady income, again, they probably won’t lend you as much. So keep that in mind.
First, let’s start with the HELOC.
The absolute maximum the banks can loan you is the total equity in your house.
Remember: Equity = Value of Your House – Mortgage Remaining
For example, if you have a $200k house and owe $100k on your mortgage, the absolute maximum a bank could loan would be $100k. Now they’ll typically come back from that a little bit, say 80% of that. So the maximum HELOC you could get would be $80k. Sometimes banks will go a bit higher with the HELOC (I think my bank allowed up to 90% of the equity in the house), so theoretically you could get higher numbers. But this at least gives you an idea of how much cash you can get started with when looking for a rental property.
Second, how much will a bank loan you if you go into closing with financing?
This is if you close and get a mortgage for that. In other words, the bank is doing the financing up front.
So this number is also typically 80%. Of the purchase price.
Very important to note that last caveat! It doesn’t matter the value of the house. If you buy a $100k house for $100k, the most they’ll loan you is $80k. Meaning you have to come to the closing with $20k of your own cash. Even if you bought a house with $100k value for $80k, the bank would then only loan you $64k. Or if you bought the house for a mere $5k, they still would only loan you $4k. Despite the value of the house being $100k!!
This brings us to the last, and most important one (to me).
Third, if you buy a house cash then put a mortgage on it, how much would a bank loan me then?
This is the fun one, and another reason you want to track down good, solid deals.
Let me set the stage first. You find a house worth $100k that’s being sold for $80k. From the example above, you already got an $80k HELOC. You close on the house with cash (cash from your HELOC!) and momentarily own the house free and clear. Sure you have a huge HELOC but the house you just bought doesn’t have a mortgage on it. Yet. So you approach your banker, tell him you want a mortgage on the house you just bought, how much will he loan you?
80% of the appraised value of the house!
The important difference is that it’s not 80% of the purchase price, it’s 80% of the appraised value! Remember, the house is worth $100k (appraised for $100k), so that means you can get a mortgage for 80% of the appraised value, or $80k! Which happens to be exactly what you paid for it!
So essentially, you can have zero equity in the house doing it this way. Well technically you have $20k of equity since you bought it at a $20k discount, but what I mean is that you didn’t put any of your own money into it.
To go one step further, let’s say you were able to negotiate a lower price (the power of cash!), and only buy it for $70k. The bank would still be willing to loan you $80k since the value of the house is still at $100k. You can either opt for a lower mortgage, or take the extra $10k and put it towards the next house, fix up the current one, or whatever else you would like!
In cases where you’ve already bought the house (using cash from your HELOC or other cash source), banks look at the appraised value, not the purchase price.
All the more incentive to buy houses at a significant discount – you can essentially buy them with nothing down!
Ok, so here’s your Action Step:
You’ve [hopefully] already talked to your banker to open up a HELOC. Ask him about this method and if he’d be willing to loan you 80% of the appraised value of a house if you already bought it using the cash from the HELOC.
Disclaimer: Yeah, I’m going to do one of these. This information is based on what I’ve discovered and found from my bank. Your mileage may vary. But at least start asking the questions!