The Best Type of Loan for Investment Property in 2023

Investing in real estate can be an excellent way to grow your wealth over time. However, coming up with enough cash to purchase an investment property outright is difficult for most people. This is where taking out a loan can help you get started in real estate investing sooner.

But not all loans are created equal when it comes to investment properties You’ll want to choose the right loan type for your specific situation to get the best terms and position yourself for long-term success

In this comprehensive guide, I’ll walk you through the pros, cons, and key considerations for the best types of loans for investment properties in 2023.

Overview of Loan Options for Investment Properties

There are several loan types to choose from when financing an investment property:

• Conventional loans – These are traditional mortgages that conform to guidelines set by Fannie Mae and Freddie Mac. They typically require higher down payments and strong credit.

• FHA loans – Insured by the Federal Housing Administration, these allow lower down payments but charge mortgage insurance.

• VA loans – For qualifying military members these require little or no down payment and no mortgage insurance.

• USDA loans – For properties in rural areas, these have 100% financing and no mortgage insurance

• Portfolio loans – Offered by banks and credit unions, these aren’t bound by conforming loan limits.

• Hard money loans – Short-term financing from private investors, useful for rehabs and flips.

• Seller financing – The seller carries back part of the mortgage, allowing easier qualification.

The best type for you depends on your financial situation, the property, and your investing strategy. I’ll explore the pros and cons of each option in more detail.

Conventional Loans

Conventional mortgages from private lenders represent the most common option for financing investment property. They come in two main flavors:

Conforming Loans

These adhere to limits set by Fannie Mae and Freddie Mac. The current conforming loan limit for most areas is $726,525 for single-family homes.

Pros

• More widely available and easier to qualify for than jumbo loans
• Lower interest rates than non-conforming loans
• Can be fixed-rate or adjustable-rate

Cons

• Typically require higher down payments, 15-25%
• Have stricter credit score and debt-to-income requirements
• Loan amounts limited by conforming limits

Jumbo Loans

Jumbo loans exceed the conforming limits and so aren’t constrained by them. However, they come with higher qualification standards.

Pros

• Finance luxury or high-cost investment properties
• No limits on loan amounts

Cons

• Often require down payments of at least 20-25%
• Only available to borrowers with excellent credit
• Higher interest rates than conforming loans

FHA Loans

These are a popular option because the Federal Housing Administration insures the mortgage, allowing easier qualification terms:

Pros

• Only 3.5% down payment required
• Minimum credit score of 580
• Lower monthly mortgage insurance

Cons

• Upfront and recurring mortgage insurance premiums
• Must be owner-occupied with no more than 4 units
• Lower conforming loan limit of $420,680

While FHA loans require owner-occupancy, you can still rent out any additional units if your property contains 2-4 dwellings.

VA Loans

If you or your spouse served in the military, VA loans are worth considering:

Pros

• No down payment or mortgage insurance required
• More flexible credit score and debt requirements
• Can be used on 2-4 unit owner-occupied properties

Cons

• Must be eligible veteran with service requirements met
• Residual income rules apply
• Additional occupancy and veteran status documentation

As with FHA loans, you can use a VA loan to purchase a duplex, triplex, or fourplex and rent the extra units out while living in one.

USDA Loans

For investment properties located in designated rural and suburban areas, USDA loans offer tempting 100% financing:

Pros

• 100% financing means no down payment
• No monthly mortgage insurance payments
• More flexible credit score requirements

Cons

• Property must be in an eligible rural or suburban zone
• Income and purchase price limits apply
• Upfront guarantee fee of 1% of the loan amount

USDA loans can only be used on single-family homes, not multi-unit properties. But they provide an affordable path to real estate investing for qualifying borrowers.

Portfolio Loans

Local banks and credit unions offer portfolio loans they keep on their own books:

Pros

• May feature lower down payments, around 10%
• Not limited by conforming loan caps
• Often have more flexible qualification criteria

Cons

• Rates may be higher than conforming mortgages
• Loan terms not as standardized
• Smaller lending market – fewer options

Portfolio loans represent a smaller niche but can provide an alternative if you don’t fit conforming loan requirements. Shop around at local banks and credit unions.

Hard Money Loans

If you’re looking to rehab and quickly flip a property, hard money loans from private investors fill a valuable niche:

Pros

• Fast funding, often within days of approval
• Based more on property value than your credit or income
• Interest-only payments keep costs lower

Cons

• Very high interest rates, often 11-15%
• Strict 1-year repayment requirement
• Large origination and other fees

Hard money works best for experienced investors with a solid exit strategy. The high payments provide motivation for a fast rehab and resale.

Seller Financing

Occasionally, seller financing provides a viable means to purchase:

Pros

• May allow purchase with only 5-10% down
• Seller carries the mortgage instead of a bank
• More flexibility on credit scores and qualifying

Cons

• Very property-specific, depends on seller
• Risks if the seller defaults on payments
• May lack protections of traditional loans

Seller financing is relatively uncommon but can facilitate deals on a case-by-case basis, especially if the seller owns the property free and clear.

Key Considerations When Choosing a Loan

As you weigh your options, keep these important factors in mind:

Down payment – The more you can pay up front, the better the loan terms you can qualify for. But don’t stretch yourself too thin.

Credit and income – Lenders will scrutinize your credit score, debt-to-income ratio, and employment history. Know where you stand.

Loan limits – Conforming, FHA, and USDA loans have caps on how much you can borrow. Plan accordingly.

Cash reserves – Most lenders require reserves equal to 6-12 months of mortgage payments.

Occupancy requirements – FHA, VA, and USDA loans require owner-occupancy for 1-unit properties.

Investment strategy – Fix and flip? Long-term hold? Your plans impact ideal loan features like term, fixed/ARM, prepayment penalties.

Finding the Best Loan for Your Investment Property

As you can see, choosing the optimal loan type involves weighing several variables. Here are some final tips on landing the best financing:

• Get pre-approved to see what you qualify for and compare options
• Shop around with multiple lenders to pit them against each other
• Look beyond big banks at credit unions and local lenders
• Ask about special investor loan programs – many exist!
• Seek loan officers experienced in investment properties
• Negotiate the lowest rates/fees possible for any loan type
• Optimize terms for your investing strategy – flipping vs. long-term

It’s worth taking the time up front to educate yourself on all the possibilities and land the best loan for your investment property. The right financing can save you thousands in interest, avoid headaches, and set your new real estate venture up for success!