5 Essential Financial Steps To Take Before Investing In Real Estate

Paul Singh March 10, 2020

If you've been thinking about investing in real estate, getting your finances in order before you start searching for properties and scheduling appointments will save you from money headaches in the long run.

Real estate investments could be one of your largest investments, and unless you have cash ready to invest, you'll need a plan for financing and a plan for cash flow in the future. Here's what you need to do before heading out to property shop:

1) Create A Financing Plan

If you have strong credit, consistent W-2 income, and a sizeable down payment, traditional financing could be your best option for your first real estate investment since interest rates are typically low and the terms are attractive. Figure out how much you can afford based on your current expenses, and how much cash you'll need to have on hand for renovations and upgrades. Make sure you know where your liquid funds will come from to improve your chances of landing a good deal. With cash, you can move faster, which will motivate most sellers.

2) Review Your Credit Report And Keep It Healthy

Request a copy of your credit report through one of the credit bureaus and make sure you dispute any errors or provide an explanation for any derogatory issues or late payments. Keep your credit score from slipping by avoiding any new credit inquiries, canceling any credit accounts, or lowering your limits with any creditors.

3) Get Mortgage Pre-Approval

With an approved mortgage in hand, most lenders will lock in an interest rate, so if rates fluctuate upwards while you're searching for the perfect investment property, you can relax knowing that your rate isn't going to change. To get pre-approved for a mortgage, you'll need to have the following in order:

Personal documents: Two forms of government-issued ID, your social security number, as well as proof of ownership of other property, including your primary residence or other investment properties.
Tax returns: For the previous year, and potentially for the last two years.
Proof of income: W2s, paycheck stubs, 1099s, or if you're self-employed, a year-to-date profit and loss statement.
Proof of assets: Bank statements, 401Ks, IRAs, and money held in stocks or mutual funds.
Summary of all debt: Primary property loan(s), credit card balances, student loans, and all monthly payment amounts.

4) Stay Competitive By Doing Your Homework

Just because your financing is approved, doesn't mean you're ready to start shopping. Do some comparison shopping and contact other lenders to see what kind of interest rate they can offer. A few percentage points might not seem significant, but can save tens of thousands or more over the lifetime of a loan and affect your monthly cash flow. Consider checking with a bank other than the one you bank with; they might be very likely to be more competitive to win new business.

5) Liquid Funds

Based on your financing plan, you'll have figured out how much cash you need to have in hand for a down payment and closing costs. Also factor in how much cash you'll need for renovations or repairs if the properties you'll be considering aren't turn-key. Consider your cash flow from month to month to make sure you're not projecting negative cash flow. Or if you are, that you have a backup source of cash such as drawing from your personal accounts.

The goal of real estate investing is usually to make money. As your investment style evolves and matures as a real estate investor, the amount of risk you can withstand is bound to change. Keep your original goals in mind, and do your homework to help position yourself to enjoy the financial returns.