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Before buying an investment property, you need financing. Using leverage is simply using other people’s money to make more money for you.

Acquiring leverage also works best when property values are on the rise. There are several ways real estate investors get funding for an investment property. Let me tell you what I did and what someone getting started might do.

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What Is Leverage?

Leverage is using borrowed capital to increase potential profits. Simply put, it’s using other people’s money to make money for you.

For our second investment property, I asked my bank for financing, but it would not lend for investment properties in Florida. I wasn’t sure where to go next so I turned to the internet and found Quicken Loans. They were more than happy to give me a 30 year fixed loan at 25% down.

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Quicken Loans offers affordable mortgages paired with award-winning client service and is ranked the highest in customer satisfaction in the U.S. by J.D. Power.

Getting Financing for Your Rental Property

With good credit, it’s notdifficult to get financing for a rental property. But the financing company will charge a higher APR than if it was your primary residence. Generally 0.75 – 1.25% points higher. They also expect you to place a larger down payment, between 20-30% in total. Why?

Because the bank considers an investment loan to be riskier than a loan for a primary residence.

A large broker might want 30%, while a small lender will accept 20%. I used a local mortgage broker who was recommended by our real estate agent on our third rental.

While working with the local broker I told her my plan of purchasing a house every 2-3 years until I had enough cash flow to retire early. Perhaps this helped me get a better deal on a 30 year 5/1 ARM mortgage than I was getting at other companies.

In the end, I had such a great experience with the local broker that I told her that for my next house, I would be checking with her first. Now I consider her part of my real estate team. Shop around to find the best interest rates.

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How to Make an Offer

Now that you’ve found the home and you have pre-approval for a loan, you are ready to make an offer on the house. The final sales price and the mortgage terms will be the last pieces of the puzzle.

And the most important influence on your investment returns.The best way to improve your cash on cash returnisto negotiate better financing.

Don’t let the excitement of this final step ruin what you have spent time working towards. Saving a couple thousand off the purchase price or getting a 0.5% lower interest rate will save you significantly more over the length of the mortgage. Don’t be intimidated by negotiations.

Work with your real estate agent to make a solid offer. You can offer lower than you might on your personal home because now you are thinking in terms of monthly cash flow and how to maximize potential returns, not just how much you love the house.

If the real estate market is slow or the house has been on the market for a long time you can really start off low and see how willing the seller is to negotiate.

Don’t forget that your real estate agent is working for you. If they understand that you will be buying more properties in the future, they will be working hard to keep your business.

Get Your Rental Property Inspected

After you reach an agreement with the seller you can have your home inspector walk through the property with you and write up their report.

Your purchase contract should have addendums for any major issues that come up during the inspection. Then you will have to discuss with the seller who will pay for repairs.

I like to ask questions when walking around with the inspector. I watch shows on HGTV to get an idea of what common issues contractors find in homes.

The more homes you look at, the easier it gets to spot things like cracks in the foundation, pipe leaks, and mold.

All of this helps you spot issues early when looking at the property. This also helps you decide if you should look for another or offer a lower purchase price.

Prepare Your Financials

Once under contract, the paperwork begins. If you have never purchased a home this can be a daunting process. Banks require credit reports, bank statements, pay stubs, tax returns, proof of down payment, proof of reserves (in case you need to pay the mortgage and can’t find a tenant), and more.

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Before the closing date, they will pull your credit score again. They want to make sure you have not opened any new lines of credit that would affect your loan approval (and determine if you’re worth the risk).

Note: Several years ago, if you had a pulse you could get a mortgage with zero down. Now the banks are actually doing their job of assessing loans and managing risk. I don’t mind jumping through a few hoops if it helps to avoid the next major global market meltdown.

Leveraging Other People’s Money

Now that we are discussing mortgages, we can talk about the concept that sets real estate apart from other investments: leverage. Leverage is using other people’s money to make money for you.

In the stock market, you pay 100% of your money to control 100% of your investments. In real estate, you pay 20% of your money to control 100% of a property.

When you sell that property or generate monthly income on that property, you’re making money on the full value of the investment and multiply your returns.

How Does Leverage Work?

To understand how leverage in real estate works, let’s look at the example of three people who have $100,000 to invest in real estate.

Person A bought a $100,000 investment property outright. After taxes, insurance, and property management fees, the property generated a cash flow of $500 a month. At the end of the year, Person A will have made $6,000, a 6% return on investment.

Person B invested $20,000 into five different investment properties. After mortgage payments, taxes, insurance, and property management fees, the properties generated a cash flow of $200 a month per house. At the end of the year, Person B will have made $12,000 – a 12% return on investment.

Not only is Person B making more money, she also controls $500,000 worth of real estate, compared to only $100,000. This means more opportunities for home value appreciation and lower risk. Why?

Because Person B has superior diversification.

The more homes you own, the more diversified you become, which increases your potential returns. Owning one unoccupied