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Are you interested in generating income through investments? Real estate often emerges as a lucrative choice. Rental properties and property flipping, which were once secondary income sources, have now become substantial primary income options. However, obtaining investment property loans can be challenging due to the variety of loan types and fluctuating interest rates across different states.
Investors need to meet stringent requirements when seeking investment and rental property loans. Nevertheless, there are numerous options available, allowing investors to find suitable solutions. In this guide, we will explore ten investment property loan options, providing information on mortgage rates and associated costs for each option.
What Is an Investment Property Loan?
An investment property loan is essential for acquiring property intended for income generation. Whether it involves short-term investments like renovating and flipping properties or long-term rental strategies, securing a loan is often necessary. Although similar to traditional home loans for primary residences, investment property loans entail a higher risk of default, making them more challenging to obtain.
Requirements for Investment Property Lending
Investment property loans differ from typical home loans, as lenders view investment properties as riskier endeavors. Consequently, eligibility requirements are more demanding. A loan for an investment property typically entails:
1. Higher Minimum Credit Score: Conventional home loans commonly require a minimum credit score of 620. However, investment properties, with their elevated risk, often necessitate a minimum requirement of 640 or even higher, especially for larger multi-family properties.
2. Higher Debt-to-Income (DTI) Ratio: Lenders set stricter standards for the borrower's DTI ratio, often requiring it to be below 36%. Some lenders allow rental income from the purchased property to be factored in to help meet these criteria.
3. Proof of Rental Income: Lenders may request evidence when using rental income to qualify for a loan. This includes providing copies of leases, rent roll history, and tax returns accounting for rental revenue.
4. Proof of Mortgage Reserves: Mortgage reserves, which are monthly payments in the borrower's bank account, are often required. The specific amount varies based on the loan and property, with lenders typically requesting between two and six months' worth of mortgage payments in reserves.
5. Larger Down Payment: While a 20% down payment is generally recommended, some lenders may accept as little as a 3.5% down payment. However, most lenders typically require a 20% down payment for investment properties.
10 Loan Options for Investment Properties and How They Work
Real estate investors have access to various loan options when investing in properties. While traditional banks and credit institutions are the most common sources of lending, other financiers specialize in providing specific loans for investors. Here are the loan options to consider when purchasing an investment property:
1. Conventional Bank Loan
Conventional loans, which account for a significant portion of the housing market, are often used by current primary residence owners. Unlike government-backed loans, conventional loans do not require the borrower to live on the property. Investment properties may come with higher down payment requirements, sometimes as high as 30%, compared to the standard 20% for primary residences. Each state's conventional loan program may have varying requirements, so it's essential to confirm the specifics in your local real estate market.
2. FHA Multi-Family Loan
Federal Housing Administration (FHA) loans are offered by traditional mortgage lenders and brokers. These government-backed loans typically have lower credit score and down payment requirements, making them more accessible. Rental income from existing properties can also be considered to meet eligibility criteria. However, FHA loans come with the requirement that the investor must live on the property for at least 12 months, making them suitable for multifamily housing investments.
3. VA Multi-Family Loan
The U.S. Department of Veterans Affairs (VA) offers government-backed loans through traditional lenders, banks, and credit unions, exclusively for active duty military personnel, veterans, and eligible spouses. VA loans have the advantage of not requiring minimum credit scores or down payments if eligibility criteria are met. Military borrowers can purchase up to seven units of multi-family property, provided they reside in one of them as their primary residence.
4. Hard Money Loan
Hard money loans are often used for flipping investment properties. They are known for their fast approval, short-term lending, and quick financing solutions for property transactions. Hard money loans are ideal for short-term investments, catering to homeowners and individuals seeking swift financing. These loans are typically easier to qualify for with the assistance of a broker and place more emphasis on a property's estimated after-repair value than on credit and income. However, hard money loans often come with high interest rates, additional upfront points, and increased closing costs. Lenders may also expect borrowers to repay the loan within a year or less.
5. Private Money Loan
Private money loans come from individuals rather than institutional lenders. Most private money loans are sourced from the investor's own relatives or close associates. When no family members can provide financial support, real estate networking events offer opportunities to connect with investors, seek funding, and inquire about loan options. Interest rates and terms for private money loans can vary, but caution should be exercised when accepting money from unfamiliar sources to avoid damaging relationships. These loans are often backed by a legal agreement that gives the lender the right to foreclose due to default.
6. Blanket Mortgage Loan
Investors looking to purchase and finance multiple rental properties under one loan may consider a blanket mortgage loan. These loans are available from both private lenders and mortgage companies, and terms vary by creditor. Rental properties under a blanket mortgage are often cross-collateralized, meaning each property serves as collateral. To prevent this, investors can request a release clause, allowing them to sell one or more of the properties covered by the blanket loan without needing to refinance the others.
7. Portfolio Loan
Portfolio loans are common for real estate investors, covering mortgages on small multifamily and single-family properties held by the same lender. While each unit may have a separate loan, lenders typically offer discounts for multiple loans. Portfolio loans can be customized to suit the borrower's needs, but they often come with higher fees and potential prepayment penalties, making them more suitable for investors with multiple properties.
8. Home Equity Loan / HELOC
Using the equity in one's primary residence is an alternative approach to securing funds for an investment property. Borrowers can tap into their home's equity through home equity loans, home equity lines of credit (HELOC), or cash-out refinances, allowing them to access up to 80% of their home's equity value. This capital can be used for property purchase, refinancing, or renovation. The choice between these financing options has pros and cons, with HELOCs offering more flexibility and cash-out refinances providing fixed rates but potentially extending the duration of the primary mortgage and accruing more interest.
9. Seller Financing
In some cases, property sellers can act as lenders, particularly if they own the property outright or have minimal mortgage debt. Through seller financing, the seller can become the lender, earning interest income and monthly mortgage payments instead of receiving all profits upfront. Seller financing is a suitable choice for landlords looking to spread their capital gains tax payments over time, as opposed to completing a 1031 tax-deferred exchange. However, it involves similar underwriting criteria.
10. Commercial Loans
Commercial real estate investments can be highly profitable. While the loan options mentioned earlier are suitable for residential properties, they may not be as accommodating for commercial properties. In addition to standard requirements such as good credit, commercial investment property loans often require a well-structured business plan. Various commercial loans, including conventional, hard money, and small business loans, can be used for office space, retail properties, and industrial facilities.
Securing financing for an investment property is an excellent way to diversify your portfolio and create a new source of income. Income-producing real estate offers monthly rent, property appreciation, and tax advantages that are challenging to find in other investments. With a wide array of loans available, investors can find a suitable solution for their investment needs.