Getting started with your first real estate investment can be intimidating.
For starters, it requires a lot of money. Second, the profitability of your investment is highly dependent on prevailing market conditions. Third, with the myriad of financing options to choose from, it can be challenging to find the best loan program for you.
In real estate investing, knowledge is an advantage. Knowing which loan product that suits your needs nets you the maximum returns allowing you to come out on top with every investment.
In this article, we'll walk you through different investment property loan options available to you to help you reach your investing goals.
Investment properties are real estate that you purchase with the intent of generating cash flow in the form of sales profits or monthly rental income.
Generally, investment properties fall in any of the following types:
In addition to providing cash flow every month, you can also take advantage of the eventual appreciation in market value if you own it long enough.
Purchasing a property requires a large amount of capital, and unless you were able to save up enough, more often than not you will be reliant on loans.
There are several loan options open to you in order to help you fund your real estate purchase.
Check them out below:
Conventional investment property loan programs can be obtained from private lenders such as banks, credit unions, and mortgage lenders. Conventional lenders follow Fannie Mae guidelines such as: a minimum of 3 percent down, a credit score of at least 620, and a DTI ratio of 45-50 percent when vetting a borrower for approval.
These mortgages aren't offered or guaranteed by the government, so interest rates and credit score requirements tend to be higher. However, compared to government-backed FHA or VA loans, you don't have to live in the investment property you're looking to acquire in order to qualify.
Fix and flip loans allow you to purchase a property in as is condition, do some repairs and upgrades, and sell it for a profit down the line.
With loan terms of up to 24 months, fix and flip loans are known for lightning-fast approval times, where you can get the money within a week from your application.
This type of investment property loan provides a much-needed cash infusion which can be used to meet an existing financial obligation as you wait to secure permanent financing on your rental properties.
They close much quicker than a traditional loan, so you can avail of them when you're in a pickle. Additionally, bridge loan lenders are open to working with borrowers based on their future plans for the property, such as renovations or repositioning. The only drawback is a higher interest.
These are usually short term loans to fund new construction or the rehabilitation of an old property.
Instead of a one-time release of funds, the money is usually escrowed to be drawn upon depending on building progress. Payments usually start 6 to 24 months after you close on construction loans with the tradeoff of higher interest rates compared to other loan programs.
Nevertheless, you have the choice of paying the balance in full or converting it into a long-term investment loan.
If you go for this type of investment property loan, you'll only be making interest payments for the first 12 to 24 months of the loan, with the lender only requiring the full payment after.
If you're flipping a home, this can be really helpful, as you'd have access to funding immediately without the obligation to pay everything back at once.
As long as you're consistently making your mortgage payments, you're continually building your equity. Simply put, equity is the difference between your home's value and how much you currently owe. And as long as it's a net positive, it's a stash of wealth you can access through a home equity loan.
A home equity loan is another loan you can take out against the equity you currently have. This doesn't replace your initial mortgage, but rather adds a second one with a separate monthly payment. Do note that lenders would usually only let you borrow between 75-90% of your equity, depending on your credit score and your DTI ratio.
Similar to a home equity loan, a cash-out refi allows you to borrow against the equity that you have on your home, but instead of a second mortgage, it pays off your existing investment property loan with a new higher loan amount and lets you pocket the difference.
Cash-out refinancing for conventional and FHA loans requires that you leave 20% equity. Only VA loans allow a 100% cash out.
For example, your investment property has appreciated and is now currently worth $400,000, but you owe $250,000 on the mortgage. Leaving a 20% equity of $80,000, you can refinance the new loan amount of $320,000 and get the $70,000 in cash after paying off the original investment property mortgage of $250,000.
Since this is a new loan, your interest rate might change, and you will have to pay a higher amount each month.
Insured by the United States government, an FHA loan protects lenders from default, making it possible for them to offer lower investment property mortgage rate to borrowers. With this loan, you can buy a multifamily rental property (up to 4 units), with the condition that you'll be using one of the units as your primary residence for at least a year.
If you or your spouse belong to the military, police, national guard, or the reserves, you can apply for VA loans to fund your real estate purchase.
With relaxed credit guidelines, zero money down, and minimal closing fees, you can take advantage of a VA loan to get your start in real estate investing. This loan allows you to purchase a rental property of up to 7 units, as long as you live in one.
Similar to home equity loan, a HELOC is also secured by the equity you've built up in your investment property. But instead of getting a lump sum and paying it in fixed amounts every month as in the case of the former, a HELOC works like a credit card which you pay off monthly. As such, interest rates and the amount you pay each month can vary.
However, unlike credit cards which slap you with interest when you are unable to make payments, with a HELOC you can lose your home if you do. Therefore, it is important to stick to a budget and avoid impulse spending.
While you could technically get a business credit card with a limit high enough that would allow you to purchase real estate, the high interest rates doesn't make it worth the added expense.
To get the most value out of your card, choose one that gives you rewards such as cash backs and points for purchases associated with your business (e.g. construction expenses). Low to no annual fees is also a boon. Additionally, using business cards doesn't reflect on your personal record so carrying a large balance won't wreck your credit.
For example, if you're a house flipper, a card that rewards you for renovation purchases can really help you save money and increase your profit margin.
To help you save time, we looked at some of the best business cards suited for you.
High cash backs: Wells Fargo Active Cash Card gives 2% cash rewards on your purchases
Everyday business expenses: Ink Business Preferred Credit Card earns you 3x points on your first $150,000 purchases. You also get 100,000 bonus points upon sign up
Furniture and electronics purchase: US Bank Cash+ VISA Signature Card rewards you with a 5% cash back on two categories of your choice for up to $2,000 in combined eligible purchase
Using your personal card in lieu of real estate loans should only be used if it's the last resort. However you might be in situations where you might need the convenience of instant liquidity.
Just remember to clear your balance in time and in full, to avoid being slapped with absurdly high interests.
Hard money loans are popular among house flippers due to the fast closing times. On the other hand, hard money lenders are very much willing to extend financing since they get their money back--plus interest!--quickly.
It's pretty much a win-win for everyone involved.
Do note that the required money down is pretty steep, around 25 percent, with high interest rates and upfront fees. There are prepayment penalties too, so take the time to read the loan terms!
The best investment property lenders are more interested in the real estate deal than on the borrower's personal financial situation.
As a matter of fact, some lenders don't even ask for income documentation. But still, they have to protect themselves somehow. So, in order to secure their stake, they provide collateral-based rental loans after a thorough appraisal.
Rental property mortgage loans can be had for 15- to 30-year terms, with a manageable monthly mortgage payment. Minimum loan amount usually starts at $500,000 with no prepayment penalties in case you decide to pay off your mortgage earlier.
Yes, you can access your retirement account to fund your investments. However, we advise you to consider all aspects of your financial situation before drawing from your retirement fund since if the investment doesn't work out, it can spell disaster for your retirement.
You can get conventional investment property loans either from private institutions such as banks and mortgage companies, or from government sponsored enterprises (GSEs) Freddie Mac and Fannie Mae.
While you have to complete an official mortgage application and submit to more stringent requirements, what's good about traditional financing is that they are generally cheaper than hard money lenders or portfolio lenders.
They also have a couple of drawbacks:
So, how do you scale your investment property business? Well you can consider...
Scaling up your business doesn't mean you have to scale up the complexity of your finances. In fact, you can even simplify it by consolidating all your business loans for multiple properties in a single mortgage.
Portfolio lenders don't have to follow federal guidelines in underwriting investment property loans so they have the ability to be more flexible to your needs. They also can close really fast, usually below 20 business days, instantly giving you access to capital when you need it.
However, this convenience doesn't come free, as they usually charge upfront fees and higher rates.
Hard money lenders provide quick, short-term financing for fix-and-flip and fix-and-lease investors. They provide loans for a variety of property types, and it doesn't matter whether you require financing for a rental property or a commercial property.
Some of these lenders require you to have some experience with investing, but if you're a first-timer looking to get your feet wet in real estate investing, fret not. You'll find hard money loan providers who can work with new investors.
In lieu of investment property mortgage loans, you can talk with the seller if they are willing to provide owner financing.
The main draw of this is that the sale can close quickly, without going through the hassles of approvals from financing institutions. It would typically require some cash upfront, with the remaining balance will be paid off depending on the agreed-upon schedule.
Owner-financed investment property loans don't show up on your credit history, which can be an advantage for you. However, making timely payments have no effect in bolstering your credit score.
This is literally the friendliest of all loan options available to you if your cash reserves aren't enough to fund your investment property.
You're free to work out the loan terms, interest, payment schedule, and funding amount depending on your needs. In the end, this may be the cheapest loan program you can tap into.
Keep in mind though, that getting investor loans from friends and family requires massive amounts of trust and goodwill. It can be a personal catastrophe if your real estate deals don't work out.
Choosing from a myriad of providers can be daunting. So in order to figure out the best investment property loans suited for you, we compiled them in a handy list:
Best hard money lender: Kiavi
Best rehab loan provider: Lending One
Best for portfolio building: CoreVest
Best for simultaneous multiple flips: AMZA Capital
Best for large loans: Flip Funding
Best for commercial property loans: Lendio
Best for construction loans: Nationwide Home Loans Group
Real estate lenders view investment property lending to be riskier than financing a primary residence.
It is understandable, since you're far less likely to default on the home you live in compared to an investment property that you lease out to your tenants. Because of this, the onus is on you, the borrower, to prove that you are financially stable to be approved for financing.
Investment property lenders look at the following criteria to determine your viability:
The minimum credit score required depends on the type of investment property loan you want to get. In summary:
In addition to your credit score, the debt to income ratio (DTI ratio) is another measure of creditworthiness. This shows how much debt you currently have relative to your monthly income, so a low DTI ratio is a green flag to lenders.
Although most lenders would prefer borrowers with a DTI ratio of under 45 percent, as long as you have a high credit score and substantial asset and cash reserves, your DTI ratio can be higher.
Also known as mortgage reserves, you must have around two to six months' worth of monthly payments available in your bank account so you have a higher chance of approval.
With regards to rental property loans, the lender also looks at the profitability of the rental property. They may ask for copies of lease contracts, tax returns showing rental income, and rent rolls.
For FHA and VA loans, some lenders allow you to add the estimated rental income from the property you're looking to purchase so you can qualify for the loan.
The Debt Service Coverage Ratio is almost similar to the DTI ratio, in that it is a measure of the debt relative to income. However, while the DTI is based on your personal income, the DSCR depends on a property's income.
Ideally, your DSCR should be greater than 1 to be able to get approved for a rental property loan. If your DSCR falls below 1, it means the property is not making enough to cover the debt payments and you will have to use your personal funds to address the shortfall.
In addition to the above, you must also be able to present your bank statements, a list of rental properties you currently own, the sales contract (when purchasing property you intend to fix and flip), an LLC operating agreement (for non-conventional lenders), and your driver's license.
Of course, investment loans are evaluated on a case-to-case basis, so your lender may still request additional documentation.
These types of loans are ideal for investment properties that you intend to sell for a profit down the line or collect monthly rental income on. You can have lower monthly mortgage payments since they only go towards the interest, with the principal to be paid off at an agreed-upon later date.
A thing to keep in mind is that interest rates in these loans are usually variable: it usually starts with very low rates during the introductory period, only to double or even triple it after a while, so it is in your best interest to check the fine print thoroughly before committing.
Looking to secure a traditional mortgage on your residential rental properties?
Be prepared to put up at least 20 percent down payment.
This is due to the fact that mortgage insurance doesn't cover investment properties, so conventional mortgage lenders are wont to take a pragmatic approach regarding investment property loans.
However, if you can put up a larger down payment, say 30 percent, these lenders can give you a better interest rate. With a higher down payment, you're carrying more of the risk, so you have more to lose if the investment goes south, in turn providing the lender a greater security against losing money in the property.
The borrower's credit score can have a significant impact on interest rates.
If your credit score falls below 740, you will have to pay a fee in order to avail of the same interest rates for a higher credit score. The additional fee imposed ranges from a quarter of a point to as high as two points--with a point equivalent to 1 percent of the investment loan. This means if you're taking out a loan of $500,000, an additional $5,000 will be added to the principal if you're below the credit score threshold.
The alternative to paying this fee is to accept a higher interest rate.
A national mortgage lender can have more stringent requirements than your neighborhood bank. If your down payment isn't substantial or your credit score isn't that high, consider approaching your local community bank or mortgage loan officer. Also, since they know the local real estate landscape better, they may be able to suggest investment property loan options that best suits you.
Want to skip the whole process of qualifying for investment loans? You can go ahead and negotiate with the seller themselves for owner financing.
Also known as seller financing, the owner-seller acts as a lender, but instead of giving cash for the purchase to the buyer, they extend a line of credit net of the down payment. You can then start making payments akin to conventional mortgage loans until the balance is paid in full.
Generally, you will be asked to sign a promissory note which contains the loan terms such as the interest rate, the payment schedule, and what would happen in case of default. Depending on your arrangement, the owner may hold on to the title until you completely pay off the loan.
Choosing the best investment property lender ultimately depends on your needs.
Whether you're seeking a loan to fund the construction of a multi family rental, or the rehab of a property you just purchased, there is a loan provider for you, providing you with competitive rates and investor-friendly terms allowing you to grow your business.
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