If you’re ready to invest in residential investment property, you are about to set off on a juicy, long-term investment that will bring you big bucks in the years to come – if you manage your money wisely. The first step on your way is to get an investment property loan.Sure, you’ve borrowed money before, so you know the drill, right? Actually, there are some key differences with investment property loans that make them a little bit trickier than you would expect.When you took out your loan for your house, it was quite a whopper. It takes a quite a lot of money to buy a house, but with an investment property, you’re looking at a much larger sum of money. This means that you are asking the bank to finance an incredible amount of money, and this can make success difficult.Most of the borrowers that take out these loans are commercial businesses, not private individuals. If you want to get a large sum financed, you have to be familiar with the way commercial businesses do it. This will make you much more informed when it comes time to actually sit down with the folks at the bank. Let’s look at how commercial enterprises do it.There are three ratios commercial lenders use to calculate their expenses. These are the Debt Coverage Ratio (DCR), the Loan-To-Value Ratio (LTV) and the Debt Ratio.You might also see the “Debt Coverage Ratio” as the “Debt Service Coverage Ratio,” or DSCR, to add a little more to our alphabet soup! The idea with the DCR is to determine whether the property’s income will cover its mortgage. The basic equation looks like this:Net Operating Income (NOI) / annual debt service = the Debt Coverage Ratio.The “annual debt service” means everything paid on the loan, including interest and principle.The Debt Coverage Ratio should be at least 1. If it ends up lower than 1, it means that the property will not generate enough income to take care of itself. Anything under 1 is considered a percentage (with 1 being 100%). The property needs to be able to at least pay for 100% of its mortgage.On the other hand, if you have a DCR of 1.15, this is good. This means that your venture is not only paying for itself, but also making 15% profit.The LTV (loan-to-value ratio) is basically a ratio of the amount borrowed against either the price of the property, or its value. In most cases, this simply means the remaining balance of what you have to pay back. If you put 30% money down on a property, you will be paying the other 70% over time. This means that the LTV is 70%.Of course, it’s a little more complicated then that. Here is the equation to determine your LTV:Loan Amount / Purchase Price = Loan-To-Value Ratio(Purchase Price – Down Payment = Loan Amount)This is expressed either as a percentage or a decimal figure. For our example of 30% down, we would call the LTV either 70% or 0.7.The Debt Ratio is the simplest of all. It is the amount of debt you have compared to the amount of your assets.Total Debt / Total Assets = Debt RatioWith the Debt Ratio, the lower the better. If your Debt Ratio is over 1, that means that you have more debt than assets, and you are not in a very good position to receiving any type of financing. It will be tough to find a lender. If you are under 1, that means that your debts are under control, and the lower the number, the more under control your debts are.Before heading to the bank to finance your venture, do these calculations and it will give you a better idea of where you stand. This is an important part of the decision-making process of investing in residential real estate.
If you have a trustee for your IRA retirement account, be aware that many of them will not act as the trustee if there are unconventional investments involved. This includes self directed IRA for real estate. In this case, the IRA account owner will have to find their own trustee that will provide the services needed. It is possible to find a trustee online, but you should start by asking your CPA to see if there is someone they recommend. If you do look online, begin by searching for “self-directed IRAs.” This search will return a list of qualified trustees that can handle you account and any unconventional investments. Nonbank organizations are approved by the IRS and can act as a trustee for your account. Trustees that do handle real estate investments will also oversee all other investments, including stocks, mutual funds and bond. The fact that they also deal with real estate gives them an edge when competing for business. Most often, trustees will not handle an account that involves any unorthodox investments.When you locate a trustee, consult with your CPA before taking any further steps. In addition to advising you on what is the best IRA, your CPA can perform a credibility check which will determine if your selected trustee is professional and financially stable. It is very important to have the right trustee handling your investments. The wrong trustee can place all of your assets at risk.Self-dealing IRAThere are strict rules enforced regarding any acts of self-dealing. Self-dealing occurs when the IRA account holder uses the funds in the account to satisfy personal financial objectives. If your transactions do not meet the IRS guidelines, the transaction will be scrutinized. The IRS and Department of Labor (DOL) will work together to determine if the transaction is allowed and legal.There are many instances in which the IRS will consider a transaction self-dealing. If you purchase any stock in a corporation that is closely held, especially if the owner of the IRA account is an officer, the IRS will deem the transaction as self-dealing. Another example is using the funds in IRA accounts to purchase a vacation home that will be used by the account owner. There are other situations that can be deemed self-dealing, so it is always best to consult with your CPA if you intent to invest in something other than the typical stocks, bonds and mutual funds. If you are found to have violated any rules pertaining to prohibited transactions, your IRA tax-free status could be jeopardized. You may also face penalties. Also keep in mind if your trustee engaged in prohibited transactions, that individual will face a 15% excise tax on the amount that is involved in the transaction.It is best to steer clear of any investments that seem untraditional. If you would like to expand your IRA investments, talk with a financial advisor or your CPA to determine what types of transactions are allowed. You do not want to take the chance of losing your tax status or incurring any penalties.IRA account owners can face many risks with certain IRA investments. It is possible for those investments to lose their tax-free status, which could result in a large penalty. It is important to follow Traditional and Roth IRA rules to avoid any issues pertaining to other investments. Real estate investment is permissible as long as the rules are followed. It is possible to but rental property with the funds in your IRA. Remember that any rent collected will be considered another source of income, and this amount will be subject to taxes.Learning all the rules and regulations of the IRA will help a great deal. While all things are not explained, many questions can be answered simply by reviewing the rules of the IRA account. If you have further questions, do not hesitate to ask your CPA. You do not want to place your assets at risk.