When you invest in a rental property, ROI is everything. You either generate a positive return on your investment or you don’t.
And while the agreed-upon sale price is obviously the most essential factor when you run the numbers, you mustn’t ignore closing costs. For all intents and purposes, they’re a part of the investment.
Anything you can do to lower those costs will leave a higher return for you.
Closing Costs: What to Expect
Closing costs on a rental property are the fees and expenses paid in order to facilitate the closing. They include funds to close out the escrow, inspection fees, professional fees paid to an attorney, mortgage fees, property taxes (prepaid and impound amounts), title company fees, and other items.
The closing costs on an investment property are not going to be substantially different from the closing costs you’d expect to pay on an owner-occupied property. Though every transaction is different, the seller typically covers the real estate agent’s commissions, while the buyer is responsible for the vast majority of the closing costs.
On average, you should expect to pay between 2 percent and 5 percent of the loan amount for closing costs. That might not sound like a lot, but it adds up: On a $300,000 property, buyer-side closing costs could range from $6,000 to as much as $15,000.
If this is your first investment property purchase, these numbers might sound alarming. You probably haven’t factored an extra $6,000 to $15,000 into your calculations.
Such numbers could easily throw your calculations off and shift a property from a decent investment to one that will take much longer to recoup its value.
Strategies for Lowering Your Closing Costs
What should give you heart is that almost everything is up for negotiation when a real estate deal is put together – and that includes closing costs. The more you know about these costs, how they’re calculated, and the various other options, the lower you can move the final amount.
Here are several suggestions:
1. Ask the Seller to Chip In
The first thing you can do is ask the seller to chip in. You need to do this during the initial negotiations, however; you can’t accept an offer and then suddenly come to the seller a week before closing and ask him or her to cover some of the costs. (Well, technically you could, but the seller will probably say no.)
If the seller does agree to chip in, you’ll have to work with the person to figure out the best way to do it. Some sellers might agree to lower the purchase price by a certain amount, while others will simply pay for some of the costs out of pocket.
2. Shop Lenders
You should definitely shop around for multiple mortgage loan offers from various lenders. Although interest rates may be pretty similar from one lender to the next, you’ll find that fees can vary rather substantially. In some situations, it could be a difference of several thousand dollars.
For the best results, apply with multiple lenders within the same day or two (in order to ensure similar market conditions) and include a variety of institutions, which means banks, online lenders, and credit unions.
3. Consider Using Your Own Bank
If you have an established relationship with a bank or credit union, you’ll want to include them in the mix. Get a loan offer and ask about such details as discounts, rebates, and loyalty rewards for existing clients. Some banks and credit unions will even waive fees or reduce the interest rate.
4. Avoid Buying Points
As you likely know, many mortgage lenders give buyers the option to purchase discount points in order to obtain a lower mortgage rate. This is a fee that’s paid directly to the lender in exchange for a lower rate.
This can be a smart move if you’re fairly certain you intend to hold onto the property for the long term, but it’s not the best option for rentals. You definitely don’t want to do it if you plan to flip the property.
5. Negotiate Everything
Remember that everything is up for negotiation – literally everything. Though many lenders have little reason to lower fees during a hot market, they’re much more apt to compete on fees if the market softens.
If nothing else, you can shop around and use lower fees as leverage to get a specific lender to bring its higher fees down to a more reasonable market rate.
6. Push Closing to the End of the Month
One popular way to lower your closing costs is to wait until the end of the month to close. This may reduce the amount of interest you’re required to fork over at the closing table.
“You don’t make your first house payment at closing, but the lender wants you to pay interest for each day you own the home,” real estate professional Shala Munroe writes. “If you close on the 28th of the month, you only have to pay interest for two or three days. If you close on the 1st, you have to pay interest for every day in that month.”
Other real estate professionals say it’s actually more cost-effective to close at the beginning of the month, because it gives you two months in the property without a mortgage payment (instead of just one). You might have to weigh the pros and cons of each to figure out which makes more financial sense for you.
7. Deduct or Depreciate
Meet with your CPA to get clarity on which closing costs can be expensed right away in the form of a deduction and which will have to be depreciated over time. Mortgage interest, for example, can be deducted.
The same goes for real estate taxes. Closing costs like legal fees, real estate commissions, recording fees, surveys, and title insurance must be depreciated over a period of 27.5 years.
Work With Green Residential
At Green Residential, we work with Houston real estate investors and landlords to reduce stress, optimize cash flow, and create steady streams of predictable income month after month. We handle the day-to-day tasks of managing your rental properties so you can focus on the big picture.
Want to learn more about how we can help fatten your portfolio with hands-off property management? Please contact us today!