SoFi

For many homeowners who need cash in short order, a second mortgage in the form of a home equity loan or home equity line of credit is a go-to answer. A second mortgage can help you fund everything from home improvements to credit card debt payoff, and for some, a HELOC serves as a security blanket.

You can probably think of many things you could use a home equity loan or HELOC for, especially when the rate and terms may be more attractive than those of a cash-out refinance or personal loan.

Just know that you’ll need to have sufficient equity in your home to pull off a second mortgage.

What Is a Second Mortgage?

A second mortgage is one typically taken out after your first mortgage. Less commonly, a first and second mortgage may be taken out at the same time in the form of a “piggyback loan.”

Your house serves as collateral.

An “open-end” second mortgage is a revolving line of credit that allows you to withdraw money and pay it back as needed, up to an approved limit, over time.

A “closed-end” second mortgage is a loan disbursed in a lump sum.

It’s not called a second mortgage just because you probably took it out in that order. The term also refers to the fact that if you can’t make your mortgage payments and your home is sold as a result, the proceeds will go toward paying off your first home mortgage loan and then toward any second mortgage and other liens (if anything is left).

How Does a Second Mortgage Work?

A home equity line of credit (HELOC) and a home equity loan, the two main types of second mortgages, work differently but have a shared purpose: to allow homeowners to borrow against their home equity without having to refinance their first mortgage.

Rates

HELOCs may have lower starting interest rates than home equity loans, although HELOC rates are usually variable — fluctuating over time.

Home equity loans have fixed interest rates.

In general, the choice between a fixed- vs variable-rate loan has no one universal winner.

Costs

Home equity loans and HELOCs come with closing costs and fees of about 2% to 5% of the loan amount, but if you do your research, you may be able to find a lender that will waive some or all of the closing costs.

Some lenders offer a “no-closing-cost HELOC,” but it will usually come with a higher interest rate.

Example of a Second Mortgage

Let’s say you buy a house for $400,000. You make a 20% down payment of $80,000 and borrow $320,000. Over time you whittle the balance to $250,000.

You apply for a second mortgage. A new appraisal puts the value of the home at $525,000.

The current market value of your home, minus anything owed, is your home equity. In this case, it’s $275,000.

So how much home equity can you tap? Often 85%, although some lenders allow more.

Assuming borrowing 85% of your equity, that could give you a home equity loan or credit line of nearly $234,000.

After closing on your loan, the lender will file a lien against your property. This second mortgage will have separate monthly payments.

Types of Second Mortgages

To qualify for a second mortgage, in addition to seeing if you meet a certain home equity threshold, lenders may review your credit score, credit history, employment history, and debt-to-income ratio when determining your rate and loan amount.

Here are details about the two main forms of a second mortgage.

Home Equity Loan

A home equity loan is issued in a lump sum with a fixed interest rate.

Terms may range from five to 30 years.

Recommended: Exploring the Different Types of Home Equity Loans

Home Equity Line of Credit

A HELOC is a revolving line of credit with a maximum borrowing limit.

You can borrow against the credit limit as many times as you want during the draw period, which is often 10 years. The repayment period is usually 20.

Most HELOCs have a variable interest rate. They typically come with yearly and lifetime rate caps.

Second Mortgage vs Refinance: What’s the Difference?

A mortgage refinance involves taking out a home loan that replaces your existing mortgage. Equity-rich homeowners may choose a cash-out refinance, taking out a mortgage for a larger amount than the existing mortgage and receiving the difference in cash.

Taking on a second mortgage leaves your first mortgage intact. It is a separate loan.

To determine your eligibility for refinancing, lenders look at the loan-to-value ratio, in part. Most lenders favor an LTV of 80% or less. (Current loan balance / current appraised value x 100 = LTV)

Even though the rate for a refinance might be lower than that of a home equity loan or HELOC, refinancing means you’re taking out a new loan, so you face mortgage refinancing costs of 2% to 5% of the new loan amount on average.

Homeowners who have a low mortgage rate will not benefit from a mortgage refinance when the going interest rate exceeds theirs.

Pros and Cons of a Second Mortgage

Taking out a second mortgage is a big decision, and it can be helpful to know the advantages and potential downsides before diving in.

Pros of a Second Mortgage

Relatively low interest rate. A second mortgage may come with a lower interest rate than debt not secured by collateral, such as credit cards and personal loans. And if rates are on the rise, a cash-out refinance becomes less appetizing.

Access to money for a big expense. People may take out a second mortgage to get the cash needed to pay for a major expense, from home renovations to medical bills.

Mortgage insurance avoidance via piggyback. A homebuyer may take out a first and second mortgage simultaneously to avoid having to pay private mortgage insurance (PMI).

People generally have to pay PMI when they buy a home and make a down payment on a conventional loan of less than 20% of the home’s value.

A piggyback loan, or second mortgage, can be issued at the same time as the initial home loan and allow a buyer to meet the 20% threshold and avoid paying PMI.

Cons of a Second Mortgage

Potential closing costs and fees. Closing costs come with a home equity loan or HELOC, but some lenders will reduce or waive them if you meet certain conditions. With a HELOC, for example, some lenders will skip closing costs if you keep the credit line open for three years. It’s a good idea to scrutinize lender offers for fees and penalties and compare the APR vs. interest rate.

Rates. Second mortgages may have higher interest rates than first mortgage loans. And the adjustable interest rate of a HELOC means the rate you start out with can increase — or decrease — over time, making payments unpredictable and possibly difficult to afford.

Risk. If your monthly payments become unaffordable, there’s a lot on the line with a second mortgage: You could lose your home.

Must qualify. Taking out a second mortgage isn’t a breeze just because you already have a mortgage. You’ll probably have to jump through similar qualifying hoops in terms of home appraisal and documentation.

Common Reasons to Get a Second Mortgage

Typical uses of second mortgages include the following:

•   Paying off high-interest credit card debt

•   Financing home improvements

•   Making a down payment on a vacation home or investment property

•   As a security measure in uncertain times

•   Funding a blow-out wedding or other big event

•   Covering college costs

Can you use the proceeds for anything? In general, yes, but each lender gets to set its own guidelines. Some lenders, for example, don’t allow second mortgage funds to be used to start a business.

The Takeaway

What’s the point of a second mortgage? A HELOC or home equity loan can provide qualifying homeowners with cash fairly quickly and at a relatively decent rate. If you prefer not to have a second mortgage, you may want to explore a cash-out refinance, which is another way to put some of your home equity to use.

Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.

SoFi Mortgages: simple, smart, and so affordable.

FAQ

Does a second mortgage hurt your credit?

Shopping for a second mortgage can cause a small dip in an applicant’s credit score, but the score will probably rebound within a year if you make on-time mortgage payments.

How much can you borrow on a second mortgage?

Most lenders will allow you to take about 85% of your home’s equity in a second mortgage. Some allow more.

How long does it take to get a second mortgage?

Applying for and obtaining a HELOC or home equity loan takes an average of two to six weeks.

What are alternatives to getting a second mortgage?

A personal loan is one alternative to a second mortgage. A cash-out refinance is another.

---

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility for more information.

*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

^²SoFi Bank, N.A. NMLS #696891 (Member FDIC), offers loans directly or we may assist you in obtaining a loan from SpringEQ, a state licensed lender, NMLS #1464945.
All loan terms, fees, and rates may vary based upon your individual financial and personal circumstances and state.
You should consider and discuss with your loan officer whether a Cash Out Refinance, Home Equity Loan or a Home Equity Line of Credit is appropriate. Please note that the SoFi member discount does not apply to Home Equity Loans or Lines of Credit not originated by SoFi Bank. Terms and conditions will apply. Before you apply, please note that not all products are offered in all states, and all loans are subject to eligibility restrictions and limitations, including requirements related to loan applicant’s credit, income, property, and a minimum loan amount. Lowest rates are reserved for the most creditworthy borrowers. Products, rates, benefits, terms, and conditions are subject to change without notice. Learn more at SoFi.com/eligibility-criteria. Information current as of 06/27/24.
In the event SoFi serves as broker to Spring EQ for your loan, SoFi will be paid a fee.

SOHL-Q424-117

Read more

One of the top tax benefits available to real estate investors is depreciation, the income tax deduction that comes from spreading out the cost of a property over the time that you use it and deducting a portion of its cost each year. Cost segregation, in turn, is a tax strategy that can be used to accelerate depreciation deductions — so it’s definitely worth knowing about.

Keep reading for a look at how cost segregation in real estate works and if this often-overlooked planning tool might make sense for you.

Definition of Cost Segregation

Cost segregation is a tax planning tool used by businesses and those who invest in real estate to accelerate depreciation deductions on certain parts of their properties.

Basic Concept

Instead of using just one or two categories (or asset classes) to calculate the depreciation on a property for income tax purposes, cost segregation separates the property into multiple categories, some of which have shorter depreciation periods. This allows property owners to claim a larger portion of their depreciation deduction sooner, which can lower their tax liability and increase their cash flow. (Remember to consider the full list of possible tax strategies as an investment property owner, including offsetting rental income with deductions such as the mortgage interest deduction.)

Purpose in Real Estate Investing

For real estate investors, depreciation is typically divided into two categories: building and land. Land doesn’t depreciate for tax purposes, but buildings do. Generally, residential buildings are depreciated over a 27 1⁄2-year period, according to IRS requirements, and nonresidential buildings are depreciated over a 39-year period.

Because the depreciation period on a building is so long, the yearly deduction owners get doesn’t necessarily amount to significant savings. Though the depreciation deduction adds up over time, it can take a while for an owner to realize the tax benefit. Some owners paying for a property with a home mortgage loan may think about exploring cost segregation to capture tax benefits to counteract those monthly payments. (They may also want to read up on how to avoid capital gains taxes on real estate.)

Cost segregation analysis puts additional categories beyond land and building into the mix, which means some parts of the property (certain fixtures, site improvements, or equipment, for example) may be depreciated over a shorter period of time (typically five, seven, or 15 years). This can give owners the ability to take larger deductions sooner, which can result in substantial tax savings, potentially accelerating the return on investment and boosting the overall financial performance of the investment.

Recommended: Amortization vs. Depreciation

How Cost Segregation Works

Cost segregation analysis requires identifying and reclassifying building components into categories that have shorter depreciation periods for tax purposes. This can allow real estate investors to accelerate the depreciation deductions for these specific items and lower their tax liability earlier in their ownership of the property.

For example, plumbing fixtures, furniture, equipment, and other components that aren’t permanently attached to the building could potentially be classified as personal property and depreciated over five years instead of 27½ or 39 years. Site improvements (such as landscaping, paving, and fencing) could be classified as land improvements and depreciated over 15 years. These tighter timelines can allow an owner to take advantage of available tax breaks sooner rather than later.

Recommended: Buying a Foreclosed Home

Cost Segregation Study Process

Usually, the first step in deciding if and how to use cost segregation is to hire a financial firm (preferably one with expertise in engineering and tax law) to perform a cost segregation study on your building and its systems. What is a cost segregation study? Your team will:

•   Analyze your property to determine which components can be separated into categories with shorter depreciation periods.

•   Use documentation — such as home inspection reports, a recent property appraisal that shows how much the house is worth, closing documents from the property sale, and other relevant records — to inform and support their decision-making.

•   Prepare a report that shows you how much you might save on taxes by implementing a cost segregation strategy.

You can then use this information for tax planning and preparation purposes.

Benefits of a Cost Segregation Study

The goal of cost segregation is to reduce your tax liability so you can put that money back into your business, perhaps with improvements or by taking out another investment property mortgage. But a cost segregation study may offer other advantages, as well. Here’s a breakdown of the benefits a professional cost segregation analysis may provide:

•  Increasing tax savings by reducing the depreciation period for certain assets.

•  Increasing cash flow and improving the overall return on investment by accelerating depreciation deductions.

•  Improving asset management and offering a more accurate accounting of the property’s assets and their value.

•  Finding other potential tax credits and incentives.

•  Ensuring compliance with tax laws and IRS regulations.

Types of Properties Suitable for Cost Segregation

Cost segregation could be a useful strategy for a wide range of real estate investments. But it can be especially well-suited to properties that have specialized equipment, systems, or a significant number of other assets that could be reclassified to a shorter depreciation period, such as:

•  Commercial real estate like retail spaces, office buildings, and warehouses

•  Rental properties, including multifamily residential buildings

•  Resorts and restaurants

•  Medical facilities

When Should You Consider Cost Segregation?

Timing can be an important factor when considering a cost segregation strategy. You can order a study at any time, but it may be particularly useful if you’re the owner of a newly constructed building, a recently remodeled or renovated property, or a newly acquired property. This way you can use the information when you file your tax return and maximize the tax savings at a time when you need it most.

Cost Segregation Methods

There aren’t any established requirements for the preparation of cost segregation studies, but according to the IRS, six of the most common approaches include:

•  Detailed Engineering Approach from Actual Cost Records: Uses actual records — blueprints, specifications, contracts, job reports, and other construction documents — to determine costs.

•  Detailed Engineering Cost Estimate Approach: This is similar to the approach above, but it uses estimated instead of actual costs.

•  Survey or Letter Approach: Contractors and subcontractors are contacted to provide information on the cost of specific assets that they installed on a particular project.

•  Residual Estimation Approach: This is a shortened method for which only short-lived asset costs are determined. The total amount of these asset costs are subtracted from the total project cost.

•  Sampling or Modeling Approach: This method uses a model (or template) to analyze multiple facilities that are nearly identical in construction, appearance, and use.

•  Rule of Thumb Approach: This approach generally uses little or no documentation and is based instead on the preparer’s “experience” in a particular industry.

Working with Cost Segregation Professionals

You may find it helpful to use an online calculator to help you estimate how much you’ll save on taxes and to decide if it’s worth proceeding with a cost segregation strategy. But when it’s time to do the actual study, it’s generally not a DIY job. (According to the IRS’s Cost Segregation Audit Technique Guide, the No. 1 element of a quality study is “Preparation by An Individual with Expertise and Experience.”)

Engineering firms, tax advisory firms, construction cost consultants, and some large accounting firms often have a team of specialists that perform this type of work. Or you may be able to find a cost segregation firm that focuses exclusively on providing cost segregation studies.

Costs Associated with Cost Segregation

The price of a cost segregation study may vary significantly depending on several factors. But you can expect to pay anywhere from $5,000 to $30,000 or more based on the size of the property, the assets being analyzed, location of the property, the level of detail in the study, whether the work is done in person or remotely, and the experience and reputation of the firm doing the work. It can be helpful to do some comparison shopping and to get quotes from the firms you think could be the best fit for your goals.

Once you’ve estimated the costs involved, you can decide if the tax and other potential savings are worth the time, effort, and money that will go into a cost segregation study.

IRS Guidelines and Regulations

According to the Cost Segregation Audit Technique Guide, to meet IRS expectations, a taxpayer should submit a “quality cost segregation report” supported by a “quality cost segregation study.” The guide provides an in-depth look at what it takes to meet those expectations and the legal and legislative precedents that got us where we are today. And it stresses that taxpayers must be able to substantiate their asset classifications and depreciation deductions.

The Takeaway

Cost segregation is a complex tax deferral strategy that allows real estate investors to lower their tax bills earlier in their ownership by reclassifying certain parts of their property to shorter depreciation periods. This can help them free up money sooner for reinvestment or other purposes.

You may want to talk to a financial professional about whether cost segregation would benefit you, and how to find the right team to get the process started.

Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.

SoFi Mortgages: simple, smart, and so affordable.

FAQ

How much can I save with cost segregation?

Several factors can go into determining how much you could save with cost segregation, including the cost of your property, whether you have assets that can be reclassified to a shorter depreciation period, and how much your cost depreciation study costs.

Is cost segregation only for new properties?

A cost segregation may be more efficiently executed for a new property or one that’s been recently renovated. But by using a “look-back” study, the strategy could also be used on a property that you’ve owned for several years.

How long does a cost segregation study take?

It could take the firm you hire one to two months to complete your cost segregation study, depending on the size of your property and how helpful you can be with providing the information and documentation they require.

---

Photo credits: iStock/

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility for more information.

*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

This article is not intended to be legal advice. Please consult an attorney for advice.

SOHL-Q424-008

Read more

You’ve probably used an Automated Valuation Model (AVM) without even realizing it. When you open up your favorite real estate site, type in a street address, and instantly see an estimate of what the property is worth, you can thank an AVM. This data tool, which has proliferated in recent decades, uses software, algorithms, and existing information to calculate an estimated value for a given piece of property.

AVMs may have made it easier to estimate the sale price of a house you have your eye on, but they have their limitations, too. Below, we’ll dive into how AVMs work, how they’re used — and when you might still need to rely on a human appraiser.

What Is an AVM?

Pinning down how much a home is worth is a process known as property valuation — and has historically been a job for human property appraisers. But as computers proliferated and software evolved, eventually, AVMs were created. They’ve been around for a while now: Zillow launched its Zestimate product, which functions on an AVM, in 2006. It’s now possible to get a basic understanding of what your home is worth in mere seconds.

How AVMs Work

AVMs allow big companies like Zillow — as well as lenders, real estate agents, and shoppers — to get a quick estimate of a home’s value at a glance. These software products use a matrix of existing data (more on that below) to spit out a good guess as to what a home might be worth.

AVMs are also helpful because they’re updated in real time based on ever-changing market factors. For instance, if one property on a block sells for a higher price than expected, that sale price will begin factoring into the AVMs for the other homes on the block as soon as the information is public. In other words, the information is far more dynamic and constantly up-to-date than a human appraiser could offer with a single study.

Recommended: The Home Mortgage Interest Deduction Explained

Key Components of AVMs

AVMs utilize a collection of different data sources and statistical algorithms to build their estimates. There are several different AVM companies that offer these programs to clients who use them, and they each have their own proprietary way of computing home values.

Some of the most common information that automated valuation models rely on includes:

•  Public records that can include information like property sales and tax history

•  Multiple Listing Service (MLS) data, which offers pricing information on other, similar properties (known in the industry as “comps”)

•  Information about the property, such as its age, size, and tax assessment, which may be pulled from public record

Using machine learning combined with algorithms created by the professionals coding the software, AVMs can use these pieces of information to generate an up-to-date estimate for just about any property in America — though its level of accuracy may vary.

For example, with newly constructed properties, there may not be many perfect comps available in the area, which could lead to a less accurate AVM estimate. There are other situations where AVM accuracy might be lacking, too — we’ll dig into that below.

Applications of AVMs

Automated valuation models are useful in a whole host of situations — from mortgage lending, where lenders can use the information to make better informed underwriting decisions, to portfolio management, which can help investors understand the current value of their real estate assets.

And as anyone who’s ever quickly looked up the price of an eye-catching house can attest, AVMs are very useful for property shoppers, too. As long as the estimate is treated as just that — an estimate rather than an exact price — having access to AVM information can help browsers understand which homes they can afford to make an offer on or how much financial preparation they’ll need to do to be able to afford the house of their dreams. (They won’t, however, give you a complete picture of how much it will cost to own the home. For that you need a mortgage calculator with taxes.)

Advantages and Limitations of AVMs

Like everything else in life, AVMs have both advantages and limitations to keep in mind.

Advantages of AVMs include:

•  Speed. Even the very fastest human property appraiser can’t update every property’s valuation every few hours like an AVM can.

•  Cost-effectiveness. While appraisals must be paid for on a per-appraisal basis, factoring in the appraiser’s time working and expertise, companies may pay for AVM software once or as an affordable subscription service.

•  Scalability. Since AVMs rely on algorithms, they can offer thousands of valuations based on less overall work than the bespoke human appraisal process.

On the other hand, their drawbacks include:

•  Potential for inaccuracy. Any algorithm is only as good as the data fed into it, and mistakes in public records do happen. Records can also be outdated — not reflecting an HVAC upgrade, for example.

•  Inability to assess intangibles. There are some factors (such as property condition) that can affect a home’s value that don’t easily translate to a database. In these instances, a human appraiser still has the edge.

AVM Accuracy and Reliability

As we’ve seen, although AVMs can offer a lot in terms of speed and cost-efficiency, they can sometimes lag behind human appraisers when it comes to accuracy. You might hear the phrase “AVM appraisal” but a valuation isn’t truly the same as an appraisal that you would get from a professional. Newly constructed or non-traditional properties can be more difficult to assess for value based on comps (since there aren’t many or any good ones), and intangibles like property condition don’t always show up in the data these algorithms draw from.

Fortunately, some AVMs also offer confidence scores, which can help those using the estimates to understand how likely it is that the value offered is accurate (or close to it). You could also check with a knowledgeable real estate professional to get their take on whether a given estimate hews closer or further from the truth.

Impact on the Real Estate Industry

AVMs have already changed the real estate industry by making home value estimates widely and readily available to the general public. Along with helping buyers shop in what can sometimes feel like a confounding market, AVMs also make it easier for those who do own their home to understand how much equity they’ve built — or how much they might stand to gain by selling.

While a human appraisal and home inspection continue to be common parts of most real estate transactions, over time, as they increase in accuracy, AVMs may reduce the need for such services, potentially saving money for those on the market. They could also help speed up the underwriting process for home mortgage loan lenders, as well as making it easier for real estate agents to offer their clients home showings in their price range.

The Future of AVMs

Although AI has been all the rage the last few years, we’re still just at the very beginning of this new line of technology — which has the potential to evolve at an exponential rate. While many AVMs are already incorporating machine learning and other high-tech methods, technological developments along with the continued progress of AI and big data could see these valuations becoming far more accurate and accessible over time.

Recommended: Are Property Taxes Included in Mortgage Payments?

The Takeaway

Automated valuation models, or AVMs, have already changed the real estate industry — and have the power to continue to do so as technology improves and advances. However, human appraisals still have an irreplaceable role in today’s market, ensuring the best accuracy for tax assessments and sales.

Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.

SoFi Mortgages: simple, smart, and so affordable.

FAQ

How do AVMs compare to traditional appraisals in terms of accuracy?

Generally speaking, AVMs are not as accurate as a traditional appraisal. While AVMs are both speedy and cost-effective, their estimates are only as good as the data fed into the program — and, of course, sometimes that data can be inaccurate. AVMs also often can’t evaluate property conditions and other intangible elements that a human appraiser could easily spot.

Can AVMs completely replace human appraisers?

As is true in all parts of technology, as advancements continue, the jobs those technologies make easier may change. For now, human appraisers are still an important part of the real estate market, offering their expertise and individualized focus on a property rather than relying blindly on computer algorithms and data.

How do AVMs handle unique or recently renovated properties?

Nontraditional, newly renovated, or newly constructed properties can be challenging for AVMs, since they utilize publicly available information about comparable properties, or “comps,” to make their estimates (and these types of properties may not have very good comps available). AVMs also assume the same level of condition for all homes, which means they might overvalue a home in disrepair — or undervalue a newly renovated one.

Are AVM results accepted by all financial institutions?

Because AVMs can not (yet) match the accuracy and reliability of a human appraisal, many mortgage lenders still require human appraisals to be part of the purchase process. AVMs are new enough that legislation is still actively being made to regulate their use and ensure they comply with nondiscrimination laws and avoid conflicts of interest. Over time, more lenders may allow AVMs to replace human appraisals, but that’s not the market we have today.

---

Photo credits: iStock/miniseries

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility for more information.

*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

SOHL-Q424-003

Read more

Investing in real estate has the potential to build your assets and make you money for years. Turnkey properties are real estate investments that are designed to be “turnkey” — in other words, ready to rent immediately, with little effort needed from an investment owner. If you’re interested in direct ownership, but don’t want the hassle of renovating a property or finding a tenant, you may want to look into turnkey investing. We’ll break down what it is, what to look for, how to finance it, and what alternatives you have for investing in real estate.

Definition of a Turnkey Property

Turnkey properties are rent-ready homes that are typically new construction or fully renovated. They’re often associated with a turnkey company that has completed the renovation and may already have a paying tenant in the rental unit. It might even have property management services in place.

Turnkey rental properties are most common in areas where homes sell at a lower price point but have high rental rates. Outside investors are often targeted for these investments, which can be both a good thing and a bad thing. There are some key considerations you’ll need to make if you decide to invest in one.

Key Characteristics

Some key features of turnkey rental properties include:

•   Newly built or renovated

•   New systems, such as electrical, HVAC, roofing, and plumbing

•   New flooring, paint, countertops, and cabinets

•   Ready to rent or tenant in place

•   Rent is coming in as per the lease agreement

A turnkey property is meant to have no gaps in monthly rent for the investor, which is a major positive when you’re getting started.

The Difference Between Turnkey and Traditional Properties

The major difference between a turnkey property and a traditional property is there’s usually a middleman involved to make sure turnkey homes are truly “turnkey.” The turnkey company’s role is to buy a property, rehabilitate it, get a tenant in place, and then sell the property for a large profit. Some turnkey companies also provide property-management services.

With a traditional property, you would go through the purchase process with a real estate agent and then do a lot of the leg work yourself. You would have to find a property management company, contractor, cleaner, attorney, accountant, and more.

Recommended: The Ultimate Moving Checklist

Types of Turnkey Properties

Turnkey properties come in all shapes and sizes. What’s available depends on what has been renovated by a turnkey investment company. You’ll see a lot of single-family homes, but you’ll also come across some multi-family units and commercial properties that are ready to go.

Turnkey Investment Process

Investing in a turnkey property is a straightforward process, much like buying any other property. The hardest part of the process is in the research. Here’s what you’ll want to investigate:

•  Markets: You’ll want to find an area with high affordability, high rental rates, and a high rental population. You’ll also want to research neighborhoods to ensure you’re buying in an area where people feel safe renting.

•  Turnkey and property management companies: Read reviews or talk to people who have worked with the property management company before.

•  Individual properties: Look for quality renovations, desirable neighborhoods, and numbers that work. No matter what, you’ll want to see it in person.

Once you find a property you like, you’ll make an offer on a home, get a loan, go through escrow, and sign on the dotted line.

What may be different about a turnkey property is it may not be listed by a real estate agent. You might be buying directly from the company that renovated it.

Advantages of Investing in Turnkey Properties

Turnkey real estate has a number of benefits:

•  Immediate rental income: With a turnkey property, they’re either ready to rent or already rented, which provides immediate rental income. It’s also possible rental procedures and management have already been set in place.

•  Minimal effort: You don’t have to find contractors or put in elbow grease to get the property ready to rent. It has already been done for you.

•  New or renovated: Since turnkey rental properties have been recently updated, they probably look pretty great and can easily rent out.

•  Geographical diversification: If you’re priced out of your own market, you might like investing in another area that’s more affordable. A turnkey property can help you invest without needing to live in that area.

It’s also important to look beyond the fully renovated home to possible drawbacks.

Potential Drawbacks of Turnkey Investments

There are considerable drawbacks to turnkey investment properties, not the least of which may be that all the opportunity for profit may have already been squeezed out of the deal. Consider these possible problems:

•  May be overpriced: Turnkey investment companies aim to get top dollar from investors. There’s little headroom for a property to appreciate when it is priced at the top of the market. And if you are paying top dollar for the property, a significant amount of the rental income can go toward covering a mortgage, not to mention keeping up with repairs.

•  Turnkey companies make the majority of the money: In addition to charging top dollar for the property itself, many turnkey companies also serve as property managers and may charge fees for maintaining and renting out the property.

•  May not be in the best neighborhood: When you’re not a local investor, it can be hard to tell if a property is in a desirable area or not.

•  Rental income numbers may be too optimistic: When you buy a turnkey property from a company, its estimate of rental income may not account for vacancies or missed payments. Run your own numbers.

•  Renovation may not be high quality: Companies that complete renovations may not be putting in the highest quality materials, and pictures won’t capture how good (or bad) the renovation might be.

•  May be difficult to sell at a profit: If the property is turnkey and priced at the top price point, it may be difficult to get top dollar again from another buyer.

Recommended: How Much Is My House Worth?

Who Should Consider Turnkey Properties?

Turnkey properties are often lower-priced properties marketed to out-of-state investors who may be priced out of their local market. This can become a problem if the investor doesn’t know the neighborhood or values of homes in the area. Others who might consider a turnkey property:

•   Investors who don’t have time to assemble a team or rehab a property

•   Investors willing to sacrifice some profit margin for the convenience of a turnkey property

•   Investors who don’t want to manage a property

•   Investors who can find a good deal

•   Investors who want to enter a new market

How to Evaluate a Turnkey Property

Not every turnkey property is going to work for you, and quite frankly, not all of them are “turnkey” as the name suggests. You’ll want to look at the following factors in evaluating a turnkey rental property.

•  Location: Is the home in a desirable neighborhood? Ideally, you want your investment to appreciate or generate cash flow (sometimes both). If the neighborhood isn’t one you’d want to live in, or isn’t kept up very well, that will affect your property’s value. If you’re serious, you’ll want to get on a plane and walk the streets where you want to invest.

•  Property condition: Even with renovated properties, you’ll want to ensure the major systems are in good working condition. It’s easier to get things fixed before you buy the property, so a home inspection is important.

•  Financials: Learn to run your own numbers and analysis to make sure you’re getting a good deal. You don’t want to rely on the number provided to you by the turnkey company. Start with a mortgage calculator with taxes and from there, look at cap rate, ROI, and cash flow.

•  Valuation: Don’t overpay for a property because you are unfamiliar with the market. You can find the fair market value from an appraisal or a BPO (broker’s price opinion).

•  Turnkey company: Thoroughly vet the turnkey company. Talk to people who have used the service. Post questions in online real estate forums and look at reviews online.

•  Management company: Talk to the management company and people who have worked with the management company. You don’t want a company that only does the bare minimum for your property while charging a premium.

Financing Turnkey Properties

Financing turnkey real estate is typically done with traditional home mortgage loans. Financing may be easier to qualify for since properties are in good condition. Typical eligibility requirements for financing include:

•  Credit score: 620 or greater

•  Debt-to-income ratio: No greater than 45%

•  Cash reserves: Three months of cash reserves

•  Mortgage insurance: Required for loans with less than 20% down payment

•  Down payment: At least 15% for one unit, 25% for two or more

•  Maximum loan amount: $766,550 for a single-family home in most areas

Depending on your property, you may need a different loan type, such as a multifamily, portfolio, or apartment loan.

Tax Implications of Turnkey Investments

You get all the tax benefits of ownership with turnkey investments. You’ll be able to deduct certain expenses since you’re paying for them directly. The IRS lists these as:

•   Mortgage interest deduction

•   Property tax (often, property taxes are included in the mortgage)

•   Operating expenses

•   Repairs

•   Depreciation

Comparing Turnkey Properties to Other Real Estate Investments

If you’re interested in real estate investing, but don’t think turnkey homes are right for you, there are other options.

Fix-and-flip

A fix-and-flip property is a property purchased at a discount, renovated, and then sold for a profit. Buying a foreclosed home that needs repairs is a great example of this, but you’ll need to assemble a team to renovate and rent it.

REITs

A REIT is short for “real estate investment trust,” which is a trust that owns income-producing property (often commercial real estate) for the purpose of making a profit for investors. Investors own a share of the trust. It’s considered a passive investment where investors don’t need to make day-to-day decisions. You can buy a REIT on a stock exchange if they’re publicly traded or find the right broker if they’re not publicly traded.

Traditional rentals

You can work with a real estate agent to buy a property to rent out, either residential or commercial. Traditional rentals may need a little work to be ready and you’ll need to find your own team to be able to make it work.

The Takeaway

Turnkey properties sound convenient, but you need to do your homework to make sure the investment is a good one. You’ll also be buying at full retail price, which means there won’t be much room for the property to appreciate. On the flip side, it’s pretty appealing to walk into an investment property without having to fix it up. If you’re looking for direct ownership of real estate without the headaches, turnkey homes might be the way to go.

Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.

SoFi Mortgages: simple, smart, and so affordable.

FAQ

Are turnkey properties good for first-time real estate investors?

Each investor will need to evaluate the pros and cons for themselves. If you want to be as hands-off as possible, even at the cost of possible profits and upside, turnkey real estate investing might be the right fit. If you want to understand and work in your real estate business, you may want to look at the full range of investment options.

How much do turnkey properties typically cost?

Turnkey properties are typically sold at full market value, if not more. Most real estate investors look for properties below market value to get the benefits of appreciation and cash flow, and turnkey properties have a much smaller upside.

Can I visit a turnkey property before purchasing?

Yes, you can and should visit a turnkey property before purchasing, even if the company selling it is giving you assurances that everything looks good and is in working order.

---

Photo credit: iStock/Vesnaandjic

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility for more information.

*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

SOHL-Q424-007

Read more

A blue tape walkthrough is a surface-level inspection of a new home where issues are flagged with blue painter’s tape by the buyer. It’s a normal part of the process for homeowners buying a new-construction home. You’ll complete the final blue tape walkthrough 5 to 7 days before you close on the home, and any issues you draw attention to should be fixed by the builder.

It’s incredibly helpful when you know what to look for. This guide can help you complete the blue tape walkthrough with confidence.

Understanding the Blue Tape Walkthrough

You might hear a blue tape walkthrough called “blue tape inspection,” but it is not, technically speaking, a full home inspection. You’re the one walking through, and you’re not expected to have specialized knowledge. But a blue tape walkthrough is the perfect time to flag cosmetic or functional issues such as paint touch-ups, a door that’s sticking, or tile grout that needs to be cleaned up. Flagged items will be added to the “punch list,” which is a list your builder has of all the items that need to be completed before a homeowner moves into the new construction home.

Taking care of all the punch list items you find is the builder’s job and will make moving into your new home smoother.

Definition and Purpose

The blue tape walkthrough is an opportunity for you to go through the house with your construction manager before you close on your home mortgage loan. You’re ready to get through the closing and focus on your moving checklist — you don’t want to also have to worry about fixing a bunch of things around your new home, so the more you find, the better. After all, you aren’t buying a foreclosed home or a historic home built in the last century. You’re paying for new construction and should make sure you get your money’s worth.

Origin of the Term “Blue Tape”

Blue tape refers to the blue painter’s tape used to visually mark where an issue needs to be addressed. Blue painter’s tape has only been around since 1988, so the origins are fairly recent.

Recommended: Mortgage Calculator with Taxes

Blue Tape Walkthrough Process

The blue tape walkthrough process is pretty straightforward. Here’s when it happens, who does it, what tools are used, and what to expect:

Timing of the Walkthrough

You’re well past the point of making an offer on a home when you take this step. The blue tape walkthrough occurs 5 to 7 days before you’re set to close. It’s not intended as a home inspection. Ideally, that has already been completed. It’s a final walk-through designed to flag minor issues and point out what’s missing or not working.

Participants Involved

The blue tape walkthrough is completed with the new homeowner and a representative from the builder, such as a construction supervisor or community superintendent. The buyer’s real estate agent can also accompany the buyer, as can any other professional the buyer invites.

Tools Used

You don’t need specialized tools to complete a blue tape walkthrough, but you’ll likely want the following:

•  Blue painter’s tape. You’ll likely be given this by the builder, but you can bring your own. You’ll tear off a piece when you find something that needs to be addressed.

•  Measuring tape. If something doesn’t feel quite right or looks off-center, you can use a measuring tape to check.

•  Level. A level can help you check alignment if your eye tells you something seems off.

•  Flashlight. For those hard-to-see areas.

•  Camera. Take pictures of the defects you find. Make sure anything you asked to be fixed previously has been fixed.

•  Notepad. You’ll want to take notes, either on paper or on your device.

Recommended: How Much Is My House Worth?

Common Issues Identified During a Blue Tape Walkthrough

Don’t know what to look for? Unless you have experience, you won’t really know what to look for. It’s helpful to walk through with someone who has construction experience (builder, architect, or designer). Even after an inspection and blue tape walkthrough, it’s normal to miss things.

Hopefully, a home inspection has taken care of the major issues for you, and you’ll be looking for more minor, common issues on your own. Here’s a blue tape walkthrough checklist of what to look for in the interior and exterior spaces of the home.

Cosmetic Defects

You’ll likely see some cosmetic defects, including:

☐  Cleaning. Note areas that need cleaning, especially in the front yard and entrance after construction has been completed. Look for stains in the carpet or scratches on appliances or countertops.

☐  Chipped paint. Mark spots that may have a different sheen or need some paint touch-up.

☐  Drywall. Check for uneven surfaces, gaps, nail holes, or inconsistent texture.

☐  Missing or bad caulk job. Caulk smooths over a lot of edges. There are likely a few places where the builder missed, including sealing in new doors, windows, trim, tubs, toilets, sinks, and more.

☐  Paint overspray. You might see tiny splatters on tile, cabinets, or flooring.

☐  Gaps or visible seams. Mark any gaps you don’t like, such as transitions from one floor to another, a window to a wall, or visible seams along trim work.

☐  Dead grass. If landscape is included in your package, have the dead spots of grass addressed.

☐  Fence damage. Check for broken slats, areas where pests can enter, and uneven installation.

☐  Poor workmanship. Bad tile jobs, sloppy window installation, messy caulk, etc.

Functional Problems

Functional problems are those where something isn’t working the way it should. You may want to check the following:

☐  Working hardware. Check knobs and locks for functionality.

☐  Electrical fixtures. Outdoor lighting and interior lights should be installed and working. Ceiling fans should be installed securely and working.

☐  Drawers and cabinets. Make sure drawers run smoothly and cabinet doors lay even. They may need an adjustment or need hardware installed. Make sure the shelves are there.

☐  Windows. Test all the windows and make sure they open and close properly and smoothly. Make sure they lock securely.

☐  Doors. Both interior and exterior doors need to function properly. If they stick, they may need a slight adjustment. If you can see light through the sides of an exterior door, it may be missing weather stripping or need an adjustment.

☐  Plumbing. Run every faucet in the home and look for leaks. Make sure you have hot water. Flush all the toilets. Make sure you have water pressure. Make sure everything drains properly. Make sure you can find the water shut off.

☐  HVAC. Turn on heating and cooling mechanicals. Does your thermostat work? Take a look at the filter on the cold air return as it likely needs to be changed after construction has ended.

☐  Appliances. Make sure appliances that were included in your home purchases are installed properly. The dishwasher is often installed incorrectly. Use the oven or cooktop and make sure each burner works. Run the microwave for a bit.

☐  Garage door. Check to see if the garage door is operational.

☐  Grading. Make sure there’s a proper grade away from the house so water doesn’t settle around the foundation.

☐  Sprinkler system. Check the sprinkler system for leaks and errant spray.

Missing Features

The blue tape walkthrough checklist is longer still. Next step: Make a note of any feature that was promised, but has not yet been installed. Common issues might include:

•   Dishwasher, washer and dryer, or stove vent hood.

•   Dryer vent not installed.

•   Wiring for a TV or other electronics.

•   Upgrades you paid for.

•   Safety features, such as a fire alarm, carbon monoxide detector, or safety rails.

Importance of the Blue Tape Walkthrough

A blue tape walkthrough can help with quality assurance, help protect your investment, and ensure accountability on the part of the builder.

But perhaps what’s most important about a blue tape walkthrough is it helps take care of issues before you move in. When something comes up after you move, it’s much more of a hassle to fix than if it had been caught during an inspection or blue tape walkthrough.

Preparing for Your Blue Tape Walkthrough

If you’re working closely with your home builder, it’s likely you’ll have more than one blue tape walkthrough. You might be visiting the site all along and have noted issues that needed to be addressed when you saw them.

If this is your first blue tape walkthrough, here are a few tips to prepare:

•  Visit the home frequently (where possible). You may notice and flag issues that can be fixed before your last blue tape walkthrough with the builder.

•  Communicate with your construction manager. A good construction manager will likely flag issues better than you can. Good communication can help ensure issues are fixed in a timely manner.

•  Print out a checklist and take it with you. When you’re going through the house, you may forget what to look for. Take a checklist with you.

•  Ask for advice from experts. It’s hard to know what to look for, but you may have people in your network that are willing to help prepare you for a blue tape walkthrough.

•  Create your own punch list. You’ll want to be sure you have your own punch list to help the builder follow through.

After the Blue Tape Walkthrough

After you’ve completed your blue tape walkthrough, there are a few follow-up items to take care of:

•  Share your punch list with the construction manager. While they have their own punch list, just make sure you’re on the same page with what issues need to be addressed.

•  Set a timeline for repairs. On that same note, communicate with your construction manager about when you want repairs to happen. It’s not uncommon for a builder to say they’ll come fix something after your loan is closed, but they might be more inclined to fix something quickly if they haven’t been paid.

•  Follow-up with inspections. You’ll want to visit the property again to ensure the issues have been cleared up.

Blue Tape Walkthrough vs. Final Walkthrough

When you’re comparing a blue tape walkthrough vs. a final walkthrough, the major difference is the purpose. The purpose of a blue tape walkthrough is to flag minor issues the builder needs to address before closing. The purpose of a final walkthrough is intended to ensure the home remains in the same condition as when you wrote the contract and contractual obligations have been met.

The Takeaway

You play an important role in the blue tape walkthrough — don’t be afraid to take the time you need to flip every light switch and run every appliance to ensure that the details of your new home are taken care of before you move in. With a little blue painters tape, you can visually communicate to the builder what needs attention and where it is located.

You don’t need special knowledge, but it can be beneficial to bring along someone who can flag potential issues with you. The more that’s addressed before you move in, the less you have to stress about after you’ve moved into your new, beautiful — and fully functioning — home.

Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.

SoFi Mortgages: simple, smart, and so affordable.

FAQ

Why do real estate agents use blue tape?

Real estate agents or a home builder’s representative use blue tape, also known as painter’s tape, to mark walls and other areas because this tape is specially made so that it does not damage painted surfaces.

What is a blue tape inspection?

A blue tape inspection is not a true home inspection but rather a buyer’s walkthrough of a newly built home to identify anything that needs to be fixed before the closing. The buyer and a builder’s representative will walk through the home to look for cosmetic issues (such as dents or chipped paint) or functional issues (non-working appliances, for example) that need to be addressed.

---

Photo credit: iStock/Seth Cortright

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility for more information.

*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

SOHL-Q424-004

Read more