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What Type Of Loan Is Best For Investment Property

Investment Property Financing 101
Written by
January 19, 2023
/
6
min read

Are you looking to generate income through investing? Oftentimes, real estate proves to be a lucrative investment. Rental properties and house flipping were once sources of a side income. In today’s climate, they can be profitable enough as a primary source of income. The sole catch is that investment property loans aren’t easy to attain.

Borrowers must adhere to stricter requirements for investment and rental property loans. However, with many options, investors can often find something to suit their needs. This guide will examine ten investment property loan options. 

 

What is an Investment Property Loan?

This type of mortgage is necessary to purchase property intended to produce income. Whether it's a short-term investment of renovating and flipping the property or a long-term rental plan, a loan is often necessary. While similar to a traditional home loan for a primary residence, investment properties pose a greater risk of default and, therefore, more difficult to acquire. 

 

Requirements for Investment Property Lending

Investment property loans differ from typical home loans. Compared to a primary residence, lenders view investment properties as being riskier. As a result, the eligibility requirements demand more financial stability. A loan for an investment property will have specifics, such as:

 

  • Higher Minimum Credit Score: A minimum credit score of 620 is common for a conventional home loan. Since investment properties pose more risk, lenders often raise the minimum requirement to 640 or even higher for more extensive, multifamily homes.
  • Higher Debt-to-Income (DTI) Ratio: Lenders also increase their standards for a borrower's DTI ratio to be below 36 percent. Alas, some lenders allow for rental income from the purchased property to be added to help qualify.
  • Proof of Rental Income: Lenders request evidence when using rental income to qualify for a loan. That includes copies of leases, rent roll history, and tax returns accounting for revenue. 
  • Proof of Mortgage Reserves: Also known as cash reserves, these are monthly payments in the borrower’s bank. Depending on the loan and property, lenders might want to see between two and six months' worth of mortgage payments in reserves.
  • Larger Down Payment: While a 20 percent down payment is recommended, sometimes a down payment of as little as 3.5 percent will suffice. With investment properties, most lenders enforce that 20 percent down payment.

 

Ten Investment Property Loan Options and How They Work

When investing in real estate, several excellent loan choices are available. Traditional banks and credits are the most common lending source with many options, but other financiers are also focused on providing specific loans to investors. When purchasing an investment property, the following are the loan options to consider:

1. Conventional Bank Loan

Current primary residence owners might be familiar with conventional loans, considering they absorb over half of the housing market. The federal government does not back conventional mortgage financing; therefore, one does not have to live on the property. Instead, this type of loan adheres to Fannie Mae and Freddie Mac regulations. 

For a conventional home loan, a 20 percent down payment is often the standard to avoid added expenses such as mortgage insurance. Alas, lenders tend to increase that figure with investment properties, sometimes up to a 30 percent down payment. Each state's conventional loan program differs from the next, so confirm the requirements with your local real estate market beforehand.

2. FHA Multi-Family Loan

Traditional mortgage lenders and brokers also offer Federal Housing Administration (FHA) loans. An FHA loan is government-backed and often has lower credit scores and down payment requirements. Plus, income from an existing rental property can be used to help meet eligibility.

Since this loan is federally insured, the investor must live on the property for at least 12 months. An FHA loan is ideal for multifamily housing, whether new construction or renovated, where the buyer can use other units as rentals to qualify.

3. VA Multi-Family Loan

Another government-backed loan program offered by traditional lenders, banks, and credit unions is provided by the U.S. Department of Veterans Affairs (VA). VA joint loans are exclusive to active duty military personnel, veterans, and eligible spouses.

If you meet the requirements, you have some advantages to using a VA loan for an investment property. One is that they are guaranteed without the minimum credit scores or down payments. These loans allow military borrowers to buy a multifamily property up to seven units, as long as they live within one of them as their primary residence.

4. Hard Money Loan

A common loan for flipping investment properties is a hard money loan. These loans are for short-term investments. A hard money loan is sometimes easier and faster to qualify for. A property's estimated after-repair-value is a more prominent factor than credit and income with this option.

Sometimes, lenders expect borrowers to pay off hard money loans within less than a year. Therefore, they don't come cheap. A 25 percent down payment, additional upfront points, high-interest rates, and increased closing costs are often standard.

5. Private Money Loan

A private money loan is from another individual rather than an institutional lender. Most private money loans are from the initial investor's relatives or close associates. However, when no relative is in a position to lend money on investments, local real estate networking events are great places to connect with investors. 

Interest rates and terms for private money loans vary. Those new to real estate investing should consider who they accept money from to avoid damaging relationships. These loans are often protected by a legal agreement giving the lender the right to foreclosure due to default payments.

6. Blanket Mortgage Loan

Real estate investors wishing to buy numerous rental properties and subsidize them into one loan may consider a blanket mortgage loan. Both private lenders and mortgage companies offer these loans. Terms such as the length, interest rates, and requirements on credit scores and down payments deviate with every creditor.

With a blanket mortgage loan, rental properties are often cross-collateralized, meaning each property serves as collateral. Requesting a release clause is an easy way to prevent that and market one or more of the properties covered by the blanket loan without refinancing the others.

7. Portfolio Loan

Although not exclusive to investment properties, portfolio loans are common for real estate investing. These include mortgages on small multifamily and single-family properties held by the same lender. While each unit will have a separate loan, lenders often provide a discount for multiple loans.

It is possible to tailor a portfolio loan's terms to the borrower's individual needs. Alas, since these loans are easier to qualify for those possessing multiple properties, they often include higher fees and potential prepayment penalties.

8. Home Equity Loan / HELOC

Another approach in acquiring an investment property is to use the equity on your primary residence. By taking out a home equity loan, home equity line of credit (HELOC), or cash-out refinance, borrowers can fund up to 80 percent of their home’s equity value. That can go toward purchasing, refinancing, or renovating. 

Depending on the financing, utilizing home equity to fund a real estate transaction has advantages and disadvantages. For instance, with a HELOC, one may borrow against the equity as they would with a credit card, paying interest each month. On the other hand, a cash-out refinance has a fixed rate but could make your primary mortgage last longer and entail more interest.

9. Seller Financing

There are situations when sellers can act as a lender. That can be the case for sellers who own the property or with minimal mortgage debt. With a seller carryback or owner financing, the lender can generate interest income and a mortgage payment instead of collecting their profits all at once.

Seller financing makes sense for landlords who wish to disperse their capital gains tax payments over the course of their loan. That contrasts with completing a 1031 tax-deferred exchange, although it requires similar underwriting criteria. 

10. Commercial Loans

Commercial real estate is a lucrative investment. The aforementioned loans are suitable for residential properties but not as accommodating for commercial locations. On top of the typical requirements such as good credit, a commercial investment property loan mandates a business plan.

These loans have assorted requirements. Commercial real estate offers conventional, hard money, and small business loans. These loans can go toward office space, retail, and industrial use.

Bottom Line

Financing an investment property is an excellent way to diversify one's portfolio and create a new source of profit. Income-producing real estate pays off with monthly rent and later with property appreciation and tax benefits. It’s difficult to find these advantages with other assets. With so many loans, investors will find something suitable.

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