Investing Property Financing: Programs, Qualifications, and How To Apply
Investing in real estate will generally require you to finance the purchase with a loan program. Dozens of loan programs are built specifically for investment properties, including short- and long-term rentals, fix-and-flip projects, mixed-use properties, and commercial properties. Talk to an experienced mortgage broker about making the strategic choice in financing your investment project.
Key Takeaways About Real Estate Financing Options
Need quick answers in your journey to building a real estate investment portfolio? Here are the key facts you’ll need to get started
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You can qualify for a rental property loan with the potential rental income, not your own personal income.
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Real estate investing can start small with a short- or long-term rental property to generate ongoing income.
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Many loan programs are designed to optimize an investment portfolio’s potential revenue and equity.
How Investment Financing Works
As the age-old wisdom will tell you, real estate is one of the best long-term investments you can make for both equity and income. Whether you plan to own a handful of rented houses or expand into a portfolio of commercial properties, the journey to owning real estate investments will always start with a single property. Everyone goes into real estate investing for different reasons, but the general goal is to develop two things: equity and ongoing income. Owning property can allow you to expand your net worth and also your options for financing future projects. Choosing properties that generate monthly income via rent or other revenue channels can help you supplement your main income. Many investors can leverage a portfolio of revenue-generating income into enough ongoing income to replace a 9-5.
No matter what your goals are, our team of investment experts and network of real estate agents can help you find your ideal property to begin your investment journey. Taking the first step to owning an investment property can seem daunting, but using an experienced mortgage broker can help you make the process simpler.
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Types of Investment Property Loans
When you think of a mortgage, most people assume all loans are processed as conventional loans. While many residential home purchases are done with conventional programs, lenders have evolved to include many other programs that are optimized for investment properties. Here’s an overview of the types of financing options you may have when buying your investment property:
Conventional Loans
Using a conventional home loan to finance an investment property can be a practical choice for investors who meet certain eligibility criteria. These loans typically offer competitive interest rates and are familiar to those who have previously financed a primary residence. Conventional loans for investment properties generally require a 20-30% down payment.
DSCR Loans
A DSCR (Debt Service Coverage Ratio) loan is a type of non-traditional mortgage that’s primarily used for financing investment properties. Unlike conventional home loans that focus on a borrower’s personal income and creditworthiness, DSCR loans assess a property’s cash flow potential to determine loan eligibility. Lenders will calculate the amount of a loan you qualify for based on the potential rental income a property can generate, with allowances for maintenance and other ongoing expenses.
Blanket Loans
A blanket mortgage is a financing option that allows an investor to cover multiple properties with a single mortgage. This can be particularly useful for developers, investors, and house flippers who are looking to manage several properties simultaneously without having to secure separate mortgages for each one. One of the primary advantages of a blanket mortgage is its convenience. It combines multiple property loans into one, simplifying the management of investments and potentially reducing closing costs compared to securing multiple separate mortgages.
VA Loans
While VA loans aren’t generally used for investment properties, there are certain circumstances that can qualify a property to be used with a VA loan. You can use a VA to purchase a multi-unit property, up to four units, using VA benefits. Depending on your lender, you might also be required to occupy the property. Some lenders also allow for rental income to help qualify the overall purchase.
Hard Money Loans
Hard money loans are secured by the property itself, with the loan amount typically based on the property’s value rather than the borrower’s creditworthiness. This makes them particularly suitable for investment scenarios such as fix-and-flips, short-term purchasing for renovation, or where quick funding is necessary. They are less about the borrower’s financial history and more about the property’s potential value and the deal’s feasibility.
HELOC Loans
A Home Equity Line of Credit (HELOC) on an investment property can be a flexible and strategic financial tool for investors looking to finance further property investments, renovations, or other large expenses. Unlike primary residence HELOCs, investment property HELOCs use the equity in a non-primary residence as collateral. Investors often use HELOCs to make down payments on additional properties or to buy properties outright if the credit limit is sufficient. While HELOCs on investment properties can provide substantial financial leverage and flexibility, they require careful consideration of the risks and costs involved.
FHA Loans
An FHA loan can indeed be used for investment property financing, but it comes with specific restrictions. Most FHA loans for investment properties are approved for multi-unit residences like duplexes, triplexes, and quadplexes. Many buyers purchase the entire property, live in one unit, and rent the others out to cover their mortgage and generate passive income.
Commercial Loans
Commercial loans are specialized financial products designed for purchasing, constructing, or renovating commercial real estate properties. These loans are not backed by government agencies like residential loans and often come with higher interest rates and different term structures. Types of commercial loans include traditional commercial mortgages, SBA 7(a) loans, and CDC/SBA 504 loans. Each type caters to different financing needs, from purchasing real estate to renovation and equipment purchases.
Private Money Loans
Private money can be a flexible and expedient financing option for real estate investments, particularly when traditional lending doesn’t fit the investor’s needs or timeline. This source of funding is particularly advantageous for real estate investors who may not meet the stringent requirements set by banks or who need quick access to capital to secure a deal. The terms of private money loans can be highly negotiable and tailored to the specific needs of both the lender and the borrower
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Preparing To Apply
Jumping headfirst into an investment property loan can seem exciting. Who doesn’t want to start earning regular, extra income as soon as possible? But taking the time to review your personal finances, strategize your debt, and make a thorough plan can make the difference between a weak portfolio and one that thrives.
When you work with our mortgage brokers, we walk you through a few core steps before we start shopping for a loan program for you. Here’s what we always recommend doing before starting down the investment property path:
Check and Improve Your Credit Score
Your credit score is crucial in determining your eligibility for a loan and the interest rates you will be offered. Start by obtaining your credit report from the major credit bureaus. Review your credit score and look for any inaccuracies or areas for improvement. Pay down high credit card balances, avoid taking on new debt, and ensure all your bills are paid on time to boost your score.
Assess and Build Your Cash Reserves
Lenders will want to see that you have enough reserves to cover the down payment, closing costs, and any unexpected expenses that might arise after purchasing the property. Generally, having at least six months’ worth of expenses in reserve is advisable. This includes not only the mortgage payments but also maintenance costs, taxes, and insurance.
Stabilize and Increase Your Income
A stable and reliable income is critical when applying for any mortgage. For investment properties, lenders might also consider the potential rental income; however, your primary income sources are more critical. If you’re employed, ensure you have a steady job history. If self-employed, maintain well-documented and consistent income records to present to lenders.
Understand Debt-to-Income Ratios
The debt-to-income ratio (DTI) is another significant factor lenders consider. It measures your total monthly debt payments against your gross monthly income. To improve your DTI ratio, pay down existing debts like car loans, credit cards, and other personal loans. A lower DTI ratio enhances your borrowing capacity.
Get Pre-Approved for a Mortgage
Before you start looking for investment properties, get pre-approved for a mortgage. This process involves submitting financial documents to potential lenders who will then provide an estimate of how much they’re willing to lend you. This not only helps in planning your budget but also strengthens your position when making offers on properties.
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Investment Property Loan Qualification Criteria
Many investment property loans require the same standard elements that are expected to qualify for a standard, residential home loan. While some components and thresholds can change, here are the key aspects you should expect to prepare in order to apply for a loan.
Credit Score and History
Landing that perfect investment property is exciting, but before you dive in, it’s crucial to ensure your credit is in top shape. Investment property loans typically have stricter credit score requirements than traditional mortgages. To prepare for success, get a copy of your credit report from all three bureaus and check your score. Aim for a minimum in the high 600s, but ideally the mid 700s and above for the best rates and terms. Review your report for errors and dispute any inaccuracies. Address any outstanding delinquencies or late payments. Finally, maintaining a healthy credit utilization ratio, which shows the amount of credit you’re using compared to your total credit limit, is essential. Aim for a ratio below 30% for a strong showing to lenders. By taking these steps, you’ll demonstrate your financial responsibility and increase your chances of securing a favorable investment property loan.
Income Verification
Before you embark on your investment property journey, it’s important to understand how lenders assess your ability to repay the loan. Unlike traditional mortgages, investment property loans often require more than just your W-2s to verify income. Lenders may request tax returns, bank statements, or other documentation to confirm your income streams. If you’re self-employed or have non-traditional income sources, be prepared to showcase profitability and stability through a longer history (up to 24 months in some cases). Demonstrating strong rental income potential for the property you’re eyeing can also strengthen your application. By having your financial documentation organized and readily available, you can streamline the application process and position yourself for a successful loan approval.
Cash Reserves
Securing an investment property loan involves showcasing your financial stability beyond just your income. Lenders want to see evidence of a healthy cash reserve to cover unexpected expenses or potential vacancy periods. This demonstrates your ability to weather short-term financial bumps without jeopardizing your loan payments. Gather documentation for your savings accounts, investment portfolios, or other liquid assets. Aim to have enough reserves to cover several months of mortgage payments and property taxes. A strong cash reserve position not only improves your chances of loan approval but can also qualify you for more favorable loan terms and interest rates. So, before diving into investment property ownership, ensure your financial fortress is prepared to handle the additional responsibility.
Debt-To-Income Ratio (DTI)
Lenders carefully evaluate your debt-to-income ratio (DTI) when considering an investment property loan. This ratio compares your monthly debt obligations to your gross income. Unlike traditional mortgages, investment property loans may have stricter DTI requirements. Having a lower DTI demonstrates your ability to manage multiple financial commitments. Gather documentation for all your existing debts, including mortgages, car payments, student loans, and credit card minimum payments. Reduce your DTI by paying down existing debt or by increasing your gross income through additional income streams. Optimizing your DTI ratio strengthens your loan application and positions you for potentially lower interest rates, saving you money in the long run.
Property Appraisal
While you won’t personally be responsible for the appraisal itself, understanding the property appraisal process is crucial for a smooth investment property loan application. Lenders rely on a professional appraiser to determine the fair market value of the property you’re interested in. This value plays a key role in how much they’re willing to lend you. In some cases, you may need to provide documentation related to the property, such as recent repairs or upgrades, to support the appraiser’s valuation. Ensuring the property value aligns with your purchase price and loan amount strengthens your application. If there’s a discrepancy, you may need to adjust your offer or discuss options with your lender. By understanding the appraisal process, you can be better prepared to navigate this step and secure the financing you need for your investment goals.
Investment Plan
Unlike traditional homeownership, investment properties require a well-defined plan to convince lenders of your success. This plan should showcase your investment strategy, including projected rental income, vacancy rates, and long-term goals for the property. Research rental trends in your target area to support your income projections. Be prepared to explain how you’ll manage the property, including maintenance and tenant screening. Demonstrating a clear understanding of the market and a well-thought-out management strategy assures lenders you’ve considered the key factors to ensure your investment’s financial viability. Having a strong investment plan strengthens your application and positions you as a serious and prepared investor.
Down Payment
Unlike traditional mortgages where a 20% down payment is common, investment property loans often require a higher upfront investment. The exact down payment requirement can vary depending on the lender, loan type, and your overall financial profile. However, securing a larger down payment (ideally 20% or more) offers several advantages. It reduces the loan amount you need to borrow, lowers your monthly payments, and demonstrates your financial commitment to the property. Gather documentation for your savings accounts, investment portfolios, or other sources of funds for your down payment. A higher down payment can also translate into more favorable loan terms and potentially lower interest rates, saving you money in the long run. So, plan your finances accordingly to put yourself in the best position for a successful investment property loan application.
Additional Collateral
In some cases, lenders might ask for additional collateral beyond the down payment to secure an investment property loan. This could be equity you have in another property you own or other valuable assets. While not always required, having additional collateral demonstrates a stronger financial position and your commitment to the loan. Gather documentation for any additional assets you plan to use as collateral, such as titles for vehicles or investment statements. Having this information readily available streamlines the application process and strengthens your case for securing the loan. Remember, the more you can assure the lender of your ability to repay, the better your chances of obtaining favorable loan terms for your investment property.
Legal and Tax Considerations
Diving into investment real estate requires navigating legal and tax hurdles alongside financing your dream property. Understanding landlord-tenant laws in your target area is critical. These dictate your rights and responsibilities regarding tenants, from screening and leases to maintenance and, if necessary, eviction.
Fair housing laws also play a role, so familiarizing yourself with them helps avoid legal pitfalls. Taxes are another key consideration. While you can likely deduct property-related expenses like repairs, interest, and taxes, capital gains taxes apply when you sell. An experienced mortgage broker becomes your secret weapon in navigating these complexities. They not only understand the intricacies of investment property loans but can also connect you with qualified tax and legal professionals.
This team approach ensures you make informed decisions about the legal and tax implications, while also securing the most favorable loan terms for your investment goals. By partnering with a mortgage broker, you’ll be well-equipped to minimize risks and maximize the potential of your investment property.
Quotes Are Cool, But Real Rates Are Better
The experienced team at Abo Capital will run your numbers and get you an accurate rate estimate to help you make an actionable mortgage plan. With a deeper understanding of all your numbers, we can guide you to the best mortgage choice for your short- and long-term goals.
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FAQs About Investment Property Loans
Can I put less than 20% down on an investment property?
While most lenders require a 20% or higher down payment for an investment property, you can find specialty programs that may allow for less. Talk to a mortgage broker about finding the right loan program fit for you.
What credit score is needed for an investment property?
When applying for a loan, you should always try to improve your credit score. However, some investment loan options are not as concerned with personal credit as they may be for primary residence mortgages. Talk to a mortgage broker about strategically choosing a loan for your credit situation.
Can an FHA loan be used for an investment property?
You can use an FHA loan program to purchase investment property. These will usually require you to purchase a multi-unit property (up to four) and live in one of the units for a minimum period of time to qualify for the perks of an FHA loan.