Real estate loan: financing your rental investment

A rental investment is a major project that requires a large budget. However, investors rarely have sufficient liquidity dedicated to this purpose. In this case, a home loan is the best solution to finance the purchase of a property.

Why a loan to invest in rental real estate?

Borrowing from the bank to make a rental investment allows the investor to take advantage of many benefits, including an advantageous interest rate and, above all, the possibility of acquiring a property without a major savings effort .

Thus, if one has financial availabilities, some may wonder whether they should be placed in real estate and, more particularly, rental? Of course, the rental profitability of this investment is interesting, but is it enough to put all one's savings into it when it will be possible to take advantage of a credit that will make it possible to carry out this project? In France, rates are low enough at the moment to not hesitate to take advantage of this leverage. All the more so because, if the real estate investment project is of quality, it will be easily defensible before a banker and the provisional budget in his financing file that will be presented to him will provide sufficient guarantees.

The only constraint will be not to reach a debt ratio of 33%, which will inevitably put off the banker (note that depending on the financial situation and the assets available to the investor, the bank may lend more than 33%). Having met owners with very large assets, it should be borne in mind that credit leverage is the best way to get rich with real estate.

The interest of real estate credit

Real estate investment is the only type of investment that can be financed on credit. Thus, it is possible to take advantage of the leverage effect for the acquisition of a rental property. It is a practical financing solution as it allows you to become the owner of a property that would be more difficult to pay in cash. Thus, the investor can still finance his home while preparing the financing of new real estate.

A profitable investment

The interest rate is often the reason for financing a real estate investment on credit. The interest rate of the loan is always lower than the gross rate of return of the real estate investment. Therefore, if the return on capital is added to the gross return, the overall net return will be higher than the cost of borrowing. At present, with particularly low interest rates, both individuals and professional investors can take advantage of this situation to build up assets on credit. In addition, the investor can use the rents received from the lease to cover part of his monthly payments. On the other hand, in order to reduce the amount of the monthly payments, it is always possible to invest in the real estate project or to extend the duration of the loan.

The real estate loan is an advantageous solution for the financing of a rental investment. However, whether or not the investor has savings available, he must be solvent and have a capacity for debt in order for the bank to be inclined to grant him a real estate loan. In the majority of cases this means that the investor has a regular income, which will give the banks the confidence to grant loans for rental property.

Deduction of interest in rental property investment

The other advantage of taking out a loan is that you can deduct the interest: if you rent empty, the interest will be deductible from your property income; if you rent furnished non-professionally, it will be deductible from your rental income; if you rent furnished professionally, it will be deductible from your overall income.

Deduction of interest on empty leases

When renting empty, the owner-lessor can deduct the loan interest from his land income. In addition, where there is a land deficit in the case of this rental investment, it will be deducted from the overall income. Therefore, with the reduced overall income, taxes will also be reduced automatically. There is no ceiling on the amount of deductible interest, nor is there a time limit. This deduction also includes ancillary costs such as loan application fees and notary fees.

Deduction of loan interest in furnished rentals

Within the framework of furnished rentals, the investor can opt for the status of professional furnished landlord (LMP) or the status of non-professional furnished landlord (LMNP). The latter allows the investor to benefit from a flexible and particularly advantageous tax regime with less taxed rental income. By choosing the real estate tax system with this status, the owner-lessor can benefit from a deduction of loan interest on his rental income. On the other hand, by opting for the flat-rate system, it will not be possible to deduct his loan interest. On the other hand, the investor can benefit from a 50 % flat-rate deduction on his income. For a professional lessor of furnished accommodation, he can deduct his expenses from his overall income. That is to say that the loan interest is considered as an expense. Thus, they are also deductible.

Death and Disability Insurance

Often, the real estate loan dedicated to the financing of a rental real estate program is associated with a life and disability insurance. Thus, in the event of death, total loss of autonomy or permanent disability of the owner, this insurance covers the repayment of the loan. Subscribing to this insurance is then a way to protect your family as it can still keep the rented property while continuing to receive rent. The investor is not obliged to subscribe to this contract with the lending bank. For this, he has the possibility to turn to another insurance company to reduce the total cost. The loan insurance premiums paid are also deductible from the land income. This provides the borrower with a tax-optimized tax benefit.  

What kind of loan to invest in real estate?

To find the type of loan best suited to his or her project, the borrower can negotiate with banks for the most interesting loan. The rate, application fees and early repayment penalties can be discussed. He can choose to have a life and disability insurance and to choose the type of rate : fixed rate or variable rate (then select a capped rate which will limit the possible revaluation). Finally, between repayable credit (capital and interest spread) or in fine (the capital is repaid in one go, at a scheduled date) with a maximum deduction of interest, here too, the options must be well thought out.

The amortizable loan

For a first rental property investment, the banker will rather direct the borrower towards the classic amortizable loan. Also, the formula concerns particularly medium-taxed investors. The objective for this type of real estate loan is to use the rents received to repay the capital and interest at the same time. With a depreciable loan, the repayment of the capital can be spread over time. In this case, each monthly payment will take into account the repayment of the capital, the interests as well as the death and disability insurance. At the beginning of the loan, the borrower will pay more interest and then the repayment of the total capital will be done in a progressive way. Consequently, the deduction of the interests from his property income will be more important during the first years. Over time, the proportion of deductible interest will decrease. As a result, the tax optimization associated with this deduction will also gradually lose its effectiveness.

Credit at the end of the day

With the bullet loan, the borrower will pay back the loan interest every month and then pay off the capital in one lump sum at the end of the operation. Compared to an amortizable loan, this formula offers a lower monthly payment as it only includes interest and insurance premiums. That is to say that the capital will be paid in one lump sum, according to a date set in advance in the contract. It should be specified that for the credit in fine, the interests of loan are more important. Thus, throughout the repayment, the deduction of the latter will be maximum. In addition, for an investor who already has a rental property portfolio, his tax base may be reduced. The bullet loan dedicated to the financing of rental investment will make it possible to optimise the tax treatment of the investment and increase the yield.

Often the credit in fine is associated with an investment such as life insurance for example. Thus, in order to be able to repay the capital in full on the scheduled date, the bank may require an initial payment of at least 30% of the amount of the real estate investment on this life insurance. However, in order to be sure that you have the necessary sums for the payment of the capital, it is important to be well informed about the type of life insurance that the bank offers.

How to optimize your loan for the financing of a rental investment?

Granting a real estate loan is an important transaction that commits the borrower over the long term. Thus, investors in rental real estate should not take the project lightly. Indeed, certain points must be studied to guarantee the success of the project.

Assess its debt and acquisition capacity

Before taking out a loan, it is first important to evaluate the amount that can be spent to repay the loan. To do this, you must take into account your expenses, the current loan terms and all your expenses. Once the accounts have been completed, it is possible to know one's capacity for indebtedness. Note that the bank will base itself on this debt capacity to grant the loan or not. In addition, only 70% of the rental income is taken into account in the repayment of the monthly loan payments. This is a precautionary measure in the event of unforeseen events such as unpaid bills or repairs. Thus, if his income is fair in relation to the desired monthly payments, the borrower can always defend his file with various financial organizations. Indeed, the criteria may vary from one banking institution to another. As regards the capacity of acquisition, it will be evaluated according to the personal contribution of the investor and the monthly payments which he will be able to grant to his real estate loan.

Interest deduction for your rental investment

The other advantage of taking out a loan is that you can deduct the interest: if you rent empty, the interest will be deductible from your property income; if you rent furnished non-professionally, it will be deductible from your rental income; if you rent furnished professionally, it will be deductible from your overall income.

In the case of rental property, the duration of the loan taken out will be a determining factor in the profitability of the project. It is important to know that the shorter the repayment period, the higher the monthly payments will be. Although this risks weakening the balance of its accounts in the event of difficulties, a shorter repayment period is subject to a particularly attractive interest rate. On the other hand, opting for a long-term home loan means lower monthly payments. With a longer repayment period, there will be less risk of over-indebtedness of the borrower and he has the possibility to invest in other projects in parallel. Despite the fact that the property loan may be more expensive for a longer repayment period, this solution reduces the borrower's ability to take on debt. It is important to note that a mortgage can be repaid over a period of 20 to 30 years. Thus, the long-term loan is rather advised.

The interest rate

Compared to the credit dedicated to the purchase of a principal residence, the interest rate of the loan for a rental investment is generally higher. It is 0.1 to 0.2 points higher than a conventional loan. However, the borrower always has the possibility to negotiate with his banker in order to obtain the best rate. There is no rate difference between buying a new or old property. For investor loans, interest rates can be fixed or revisable. The monthly payments can also be adjustable or deferrable. It should be noted that by opting for this credit, it is possible to negotiate the interest rate, the penalty charges as well as the early repayment charges. Thus, to choose the most efficient offer, one should not hesitate to make the competition play. You can also call on the services of a professional such as a loan broker. As for the repayment period and the rate applied, the investor can obtain a rate of 0.60% over seven years. In order to take advantage of this rate, his income as well as his contributions must be justified. On the other hand, for a loan spread over 15 years, the interest rate may increase by 1,10 %.

Financing on credit or through savings?

Unless you have a large sum of money on hand, the best way to finance the purchase of a property is to borrow it. This solution makes it possible to acquire a property for a rental investment project and to repay the monthly payments from the rental income. However, to take advantage of this financing, it is essential to calculate the profitability of your investment. Indeed, it is necessary that the latter can cover all the expenses such as the borrower's insurance and the monthly payments. Therefore, it is advisable to make these calculations before embarking on a loan project. To do this, it is possible to make a loan simulation online or at the bank. The main advantage of financing the purchase of a rental property on credit is that it allows you to take advantage of an advantageous loan rate with less interest as the sum borrowed will be large.

 

editor's photo
  • Mickael ZONTA
  • President, Investissement-Locatif.com

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