This comprehensive article provides an in-depth look at eight types of rental property loans, offering real estate investors a detailed analysis of each options advantages and disadvantages. It serves as a crucial guide for making informed financing decisions in the pursuit of successful property investment.By
As a real estate investor, finding “the one” is exciting â that property that checks all the right boxes and is just begging to become a rental. You can see the cash flow opportunities clearly and are ready to move further toward financial freedom.
But finding that perfect property is just the first step. There cant be a great rental property deal without reliable funding. That means your attention needs to turn toward finding a dependable lender to help you get into the deal.
You want to find the most competitive loan rates and favorable terms to maximize your return on investment (ROI), and several options are available for financing a rental property. Plus, each loan type offers its advantages and disadvantages.
What is the best option for you? Read on as we look at eight types of rental property loans and discuss their advantages and disadvantages for real estate investors.
Loans on rental property can be a great way for real estate investors to finance the purchase or improvement of an investment property. With the right loan investors can leverage other people’s money to expand their portfolios and cashflow. However navigating the world of rental property loans can be complex, with many options and factors to consider.
In this comprehensive guide we’ll provide an in-depth look at loans on rental properties to equip investors with the knowledge to make informed financing decisions.
What Are Loans on Rental Property?
Loans on rental property refer to mortgages and financing specifically designed for real estate investors purchasing or refinancing residential or commercial rental properties.
These loans differ from standard mortgages in a few key ways:
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Higher interest rates – Generally 0,5-1% higher than primary residence loans to account for the increased risk of rentals
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Larger down payments – Often 20-30% is required compared to as little as 3% for owner-occupied properties. Helps mitigate risk for the lender.
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Stricter qualification – Standards like minimum credit scores and debt-to-income ratios are usually higher. Ensures investors can manage the mortgage.
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Emphasis on property – Approval and terms depend heavily on the property’s financials like projected rents and expenses.
While obtaining financing as an investor requires some extra work, the benefits of using leverage in a strategic and conservative way can outweigh the costs.
Types of Rental Property Loans
Many loan products cater specifically to real estate investors. Here are some of the most common options investors should understand:
Conventional Loans
This refers to conforming mortgages that adhere to standards set by Fannie Mae and Freddie Mac. Down payments vary by lender but tend to be 20% or higher for investment properties.
Pros: Widely available, competitive rates with good credit, flexible use.
Cons: Strict qualification standards, high down payments, lots of paperwork.
FHA Loans
Insured by the Federal Housing Administration, these feature low down payments and flexible credit requirements. Can only be used on owner-occupied properties.
Pros: Down payments as low as 3.5%, forgiving of credit issues, low mortgage insurance.
Cons: Must live in 1 unit of multi-family property, strict property standards, max loan limits.
VA Loans
Offered by the Department of Veterans Affairs, these require no down payment and have competitive rates. Also limited to owner-occupied properties.
Pros: Zero down payment, lower rates, reusable benefit, foreclosure protection.
Cons: Residence requirement, funding fees, property eligibility limitations.
DSCR/Non-QM Loans
Qualification is based on the property’s projected net operating income rather than personal income or credit. Popular for investors.
Pros: Flexible income requirements, faster approvals, lower docs, focus on property potential.
Cons: Higher rates, strict property analysis, inconsistent standards between lenders, over-leveraging risk.
Hard Money Loans
Asset-based financing from private lenders and investors. Very quick approvals but short terms and high costs.
Pros: Speed, flexibility, easier standards, provides time to rehab and sell or refinance.
Cons: Astronomical rates and fees, short repayment terms, stringent requirements on experience and equity.
Blanket Loans
A single mortgage to finance multiple investment properties. Streamlines the process but has stricter terms.
Pros: Consolidation, flexibility, cost and time savings, simplified payments.
Cons: Higher rates and down payments, cross-collateralization, stringent requirements, limited availability.
Private Loans
Financing from private individuals rather than institutions. Offers flexibility but often unfavorable rates and terms.
Pros: Quick approvals, negotiable terms, easier to qualify, short-term solutions.
Cons: Much higher costs, shorter terms, reliance on personal connections, less oversight and regulations.
As we can see, each loan type has its own pros, cons, and specifics an investor must weigh carefully. Conventional loans offer competitive rates but stringent approval criteria, while alternative loans provide quicker access to capital but at higher costs.
What Do Lenders Look For?
When applying for a rental property loan, lenders scrutinize both the investor’s financial profile and the property’s potential income and expenses. Here are some key factors lenders evaluate:
Credit Score – A minimum of 620 is usually required, but scores of 700+ receive better loan terms. Shows responsibility.
Down Payment – 20-30% or higher down payments reduce the lender’s risk. More equity invested is better.
Debt-to-Income Ratio – Compares total monthly debt payments to gross monthly income. Below 50% is generally preferred.
Loan-to-Value Ratio – Compares loan amount to property value. Lower LTVs (below 80%) qualify for better rates.
Cash Reserves – Lenders often want to see 6-12+ months of mortgage payments in liquid reserves as a safety net.
Projected Property Income – Vetted by appraisers and underwriters. Must sufficiently cover mortgage payment and other costs. Higher coverage ratio is better.
Meeting these standards requires planning and diligence but results in more favorable loan terms and approvals. Leveraging tools to analyze factors like cash flow, cap rate, and debt-to-income ratio helps investors put together a compelling loan application.
Tips for Securing a Loan
For investors seeking rental property loans, here are some tips to boost your chances of getting approved and scoring better terms:
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Shop multiple lenders – Compare rates and requirements to find the best fit rather than going with the first option. Local banks and credit unions may offer investors flexibility conventional lenders cannot.
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Review credit report – Ensure no errors or surprises exist. Demonstrate responsible credit management over time.
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Pay down debts – Reduce credit utilization and other debt obligations to lower DTI.
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Make a sizable down payment – At least 20%, but ideally 30% or more. Lowers LTV ratio.
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Highlight experience – Emphasize past success with rental properties to reassure lenders.
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Provide detailed business plan – Clearly demonstrate how property income covers all costs plus a safety margin.
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Get pre-qualified – Gives an idea of eligibility and cost before submitting a formal application and paying fees.
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Ask about discounts – Many lenders offer rate discounts for multiple properties, automatic payments, etc.
With proper preparation and an eye for the best deals, investors can secure financing to strategically grow their rental portfolio.
What are Some Alternatives to Loans?
If securing a mortgage or loan proves overly difficult, investors have some other options to fund rental properties:
Hard Money Loans – Asset-based lending with much higher costs but easier approvals. Can be used short-term before refinancing.
Partners – Joining forces with other investors to combine down payments and expertise. Make sure partnership details are formalized.
Home Equity Loans – Tapping equity from an existing property. This strategy should be used judiciously to avoid over-leveraging.
Private Money – Seeking financing from family, friends, business partners, etc. Ensure terms are formalized.
Cash-out Refinance – Refinancing and pulling cash out of a currently owned property. Depends on sufficient equity.
Crowdfunding – Pooling small investments from a large number of backers. Complex with less control but expanding options.
Seller Financing – Purchasing with the help of the seller carrying back part of the price through a separate loan.
Depending on circumstances and deal specifics, these alternatives can provide the funding needed to build a rental portfolio. But their limitations and risks mean conventional financing should be pursued when possible.
FAQs About Rental Property Loans
How much does it cost to get a loan on a rental property?
Costs vary by lender and loan type but expect 1-2% of the purchase price in upfront costs like origination fees, appraisal, legal fees etc. Ongoing costs include mortgage interest, property taxes, insurance, maintenance and property management fees.
What credit score is needed for a rental property loan?
Most lenders require a minimum credit score between 620 and 650. However, an ideal score is over 700 to get the best terms. Managing credit wisely is key for real estate investors.
How difficult is it to get approved for a rental property loan?
Approval is more challenging than a primary home mortgage since lenders view investment properties as riskier. Expect a higher down payment, lower DTI, and excellent credit. But for qualified investors, financing deals is certainly feasible.
Should I get pre-qualified for a rental property loan?
Pre-qualification allows you to confirm eligibility and estimated rates/costs before formally applying. The hard credit check only occurs with the full
Blanket mortgage loan
A blanket mortgage loan purchases multiple properties under the same investment loan terms. When investing in multiple assets, real estate investors and developers use them to save time and money.
With a blanket loan, each of the multiple investment properties is cross-collateral for the loan. However, investors can sell off individual properties without closing the entire loan. These loans usually have comparably higher investment property loan rates and down payments than conventional loans.
Blanket mortgages are not meant for primary residences, vacation homes, or brand-new landlords who are just getting started. Large commercial lenders are more likely to approve established real estate companies and seasoned investors buying properties in bulk.
Typically you must already have a real estate or investment portfolio and sizable assets, including a good portion of cash on hand, to be approved.
- Consolidation: Finance multiple properties under one mortgage.
- Flexibility: Sell individual properties without refinancing the entire mortgage.
- Time and cost efficiency: Fewer closing costs and paperwork compared to multiple separate loans.
- Cash flow management: Simplify payments with one monthly mortgage instead of multiple.
- Higher rates: Typically comes with higher interest rates compared to traditional loans.
- Cross-collateralization: If one property faces issues, it might impact the entire portfolio under the loan.
- Stricter lender requirements: Often requires a proven track record and sizable assets.
- Limited availability: Not all lenders offer blanket mortgages.
- Higher down payment: A larger down payment is typically required compared to individual property loans.
A portfolio loan is similar to a hard money loan or a blanket loan in that multiple properties are held by the same lender. The lender originates and retains the loans and doesnt sell them to the secondary market â the loans stay within the lenders portfolio.
Because the lender holds the loan, they decide the qualifying standards and terms. Additionally, the lender can offer more flexible terms than a conventional or blanket loan, like easier qualification, customized loan terms, optional mortgage insurance, and less strict property condition requirements.
And, since the lender assumes more risk by holding onto the loan, they may take steps to modify that risk by imposing higher investment property loan rates or higher fees and penalties.
- Flexibility: Since the loans are held by the lender (not sold on the secondary market), they might offer more flexible terms and criteria.
- Customization: Lenders can often tailor the loan to the borrowers needs or situation.
- Alternative qualification: It might be easier to qualify for a portfolio loan if you dont meet conventional lending standards.
- Diverse portfolio: Suitable for investors looking to finance multiple types of properties.
- Higher rates: Interest rates may be higher than traditional financing options.
- Lenders risk management: Because the lender retains the risk, they might impose stricter requirements or more considerable penalties.
- Limited availability: Not all banks or lenders offer portfolio loans.
- Balloon payments: Some portfolio loans may have short terms with a balloon payment at the end.
A private loan is issued by a private company or an individual lender instead of a bank, credit union, or federal institution. Lenders generate profits from the interest and often offer private loans to family, friends, or someone they have a personal relationship with.
Some investors consider this option if they may not qualify with a traditional lender or want to close a deal quickly with less red tape. Private loans make qualifying easier, have a shorter approval process, and offer flexibility.
While private loans are less regulated than bank or federal loans, they must still follow certain federal and state laws. With a private loan, the lender maintains a lien on the property. Failure to make payments or default on the loan could result in legal action or seizure of the home â and damage a personal relationship.
- Speed: Often faster approval and funding process than traditional banks.
- Flexibility: Terms can be negotiated based on personal relationships or specific deals.
- Easier qualification: Less stringent credit and income requirements.
- Short-term solutions: Ideal for bridge financing or quick-turnaround investments.
- Higher interest rates: Typically come with higher rates than traditional financing.
- Shorter terms: Often structured as short-term loans requiring refinancing or paying off quickly.
- Personal relationships: Borrowing from personal connections can strain relationships if issues arise.
- Potential for less regulation: This could result in less protection for the borrower than institutional loans.
Owner financing is another alternative to a traditional mortgage in which the homeowner whos selling the property finances the purchase for the buyer. The seller sets the loan terms, allowing you to skip a lengthy mortgage process.
The loan process of owner financing is quicker and easier than applying for a loan through a financial institution. Unlike a traditional mortgage, the seller doesnt give money to the buyer. The seller extends credit to the borrower that covers the price of the home, and the buyer makes the monthly payments until the amount is paid in full.
There are risks involved with owner financing, however. The interest is typically higher on these types of loans for investment property, and theres often a balloon payment at the end of 5 or 10 years. Also, if you dont obtain title insurance, the property title could have mortgages, outstanding taxes, and liens that are your responsibility as the buyer to repay.
There could also be property line disputes and erroneous square footage listings that affect the homes value as an investment property.
- Speed: Often faster to close than traditional mortgages.
- Flexibility: Terms can be mutually negotiated between buyer and seller.
- Less red tape: Typically fewer administrative hurdles and credit requirements.
- Potential cost savings: May avoid some bank fees or lender charges.
- Higher interest rates: May have a higher rate than bank-financed loans.
- Balloon payments: Some owner-financed contracts require large lump-sum payments after a few years.
- Dependence on sellers terms: Unlike banks, individual sellers might be less flexible if financial hardships arise.
- Potential for unclear terms: Without proper due diligence, terms might be less clear or unfavorable.
Is it hard to get a loan for investment properties?
Securing a loan for an investment property can be more challenging than obtaining a mortgage for a primary residence. Lenders perceive investment properties as riskier, often requiring investors to meet stricter criteria.
These include a higher credit score, a larger down payment (usually 20-30%), and a lower debt-to-income ratio than standard home loans. Lenders closely scrutinize the propertys potential income, expecting it to cover mortgage payments comfortably.
While these requirements can make closing investment property loans seem daunting, investors with solid financials and a well-chosen property often successfully secure funding. Exploring various loan types, from conventional to more specialized options like hard money loans, and leveraging financial management tools can also enhance an investors ability to acquire suitable financing.