Tuesday, December 4, 2007

A Potential Investor's Questions

I spoke to a potential investor recently, and he had a few general questions about purchasing an investment property. In case anyone else may have similar questions, I have posted his questions and my responses below.

If you have any of your own questions, feel free to contribute them, and I will do my best to post the answers promptly.

1) Is there a rule of thumb that tells what percentage of your gross income you should not exceed in order to qualify for a loan as an investor?

Answer - The sum total of all your expenses (mortgage, food, clothing, insurance, etc.) should not exceed 50% of your gross income.

2) Given that I have a certain amount of equity in my primary residence, is there a rule of thumb about how much I may be able to use as leverage for the purchase of an income property?

Answer - No, there is no rule of thumb - the current situation in the mortgage industry is complex and driven by the large number of foreclosures in real estate market. Although it is unlikely for an investor to qualify for a 100% loan, if you can prove your income (this is called a "full doc" loan in mortgage industry lingo), and you have a very good FICO credit score, you may be able to finance 90% of the purchase price.

3) If I choose to purchase a new property and keep my existing home, what is the best way to proceed?

Answer - You must evaluate your position carefully and proceed based on your own financial requirements and objectives; there is no single solution that fits each investor's unique requirements. However, one option would be for you to lease your existing home, thereby converting it into an investment property. Once you have a signed lease, (and you have equity, a good credit score, etc.,) then you should be able to obtain a loan to purchase the new primary residence.

NOTE - When you convert a property from a primary residence to an income property, in addition to reporting gain or loss from the rental each year, you should also consider CAPITAL GAINS tax implications for the future. When you eventually sell an income property, you must pay the capital gains tax if it is sold at a profit - unless you do a 1031 exchange and "trade" up to a more expensive income property.