Unlike investing in the stock market, which can be done for very little money, investing in real estate has a generally high start-up cost. Once you have decided that investing in real estate is right for you, done your research, and found a good deal, you need to consider how to secure financing for your investment property.
Four types of loans you can use for investment property are conventional bank loans, hard money loans, private money loans, and home equity loans.
Investment property financing can take several forms, and there are specific criteria that borrowers need to be able to meet. Choosing the wrong kind of loan can impact the success of your investment, so it’s vital to understand the requirements of each kind of loan and how the various alternatives work before approaching a lender.
Getting a conventional loan to purchase an investment property can be a great way to expand your real estate portfolio. Conventional loans typically offer lower interest rates and more flexible terms compared to other financing options.
However securing a conventional loan for an investment property can be more challenging than getting one for a primary residence. Lenders view investment properties as riskier, so you’ll have to meet stricter requirements.
In this comprehensive guide, we’ll cover everything you need to know about getting a conventional loan for an investment property, including:
What is Considered an Investment Property?
Investment properties are properties purchased with the intention of earning rental income, flipping for profit, or holding for appreciation This includes
- Single family homes
- Duplexes
- Triplexes
- Fourplexes
- Condos
Lenders do not consider second homes or vacation properties to be investment properties, even if you plan to rent them out occasionally.
You must prove that you do not intend to live in the property and that it will generate rental income instead.
Conventional Loan Limits for Investment Properties
The loan limits for conventional loans are the same whether you are purchasing an investment property or primary residence. Here are the current limits:
- Up to $726,525 for a single family home in most areas
- Up to $970,800 in high cost areas like San Francisco and New York City
- Up to $1,723,250 for a 2-4 unit multifamily property
However, keep in mind that lenders often impose lower loan-to-value limits for investment properties than for owner-occupied homes.
Down Payment Requirements
Lenders require higher down payments on investment properties to mitigate risk. Here are the typical minimum down payment requirements:
- 15-25% for a single family home or condo
- 25% for a duplex, triplex, or fourplex
With a larger down payment of 25-30%, you may qualify for a better interest rate. VA and FHA loans allow down payments as low as 3.5% if you purchase a multifamily property and live in one of the units.
Credit Score Requirements
You’ll need a good credit score to get approved for a conventional investment property loan. Here are typical credit score requirements:
- 620 for a 15% down payment
- 680 for a 10-20% down payment
- 720 for investors with 7+ properties
The higher your score, the better your chances of getting approved and securing a low interest rate. Taking steps to boost your credit before applying can pay off.
Debt-to-Income Ratio Limits
Lenders analyze your debt-to-income (DTI) ratio to ensure you can manage the new mortgage payment along with your other debts. Typical DTI limits are:
- 36% maximum for total debt
- 28% for non-mortgage debts
A lower DTI ratio of 30-35% may improve your chances of approval and interest rate. Using rental income can help you meet DTI requirements.
Required Reserves
You’ll need 6-12 months of mortgage payments in reserves for the investment property, along with 2-6 months of reserves for your primary residence if you have a mortgage. Cash reserves provide a safety net in case you experience a gap in rental income.
Using Rental Income to Qualify
The potential rental income can help you qualify for a higher loan amount. Lenders generally allow you to use:
- 75% of expected rents if you don’t have experience as a landlord
- 100% of expected rents if you have 1+ years of experience
Provide evidence like existing lease agreements and an appraisal showing fair market rents. This extra income can help you meet debt-to-income ratio requirements.
Interest Rates for Investment Properties
Interest rates for investment property loans are usually 0.25-1% higher than primary residence loan rates. You’ll pay a mortgage insurance premium if your down payment is less than 20%.
Aim for a 25-30% down payment and excellent credit to qualify for the lowest investment property interest rate possible. Compare rates from multiple lenders to find the best deal.
Alternatives to Conventional Investment Property Loans
If you don’t qualify for a conventional loan, some alternatives include FHA, VA, and USDA loans, portfolio loans from community banks, hard money loans, home equity lines of credit, and seller financing.
However, you’ll often get saddled with higher rates, fees, and down payment requirements than with a conventional loan. Conventional loans offer the most competitive terms for real estate investors in most situations.
Finding the Right Conventional Lender
As with any mortgage, finding the right lender is key to getting approved and securing the best interest rate. Look for lenders who specialize in investment property lending. They will understand the unique requirements and underwriting nuances.
Ask friends who own investment properties for referrals. Online comparison tools can help you shop dozens of lenders at once to find competitive offers.
The Bottom Line
Conventional loans remain the top choice for real estate investors looking to finance investment properties with low rates and costs. While you’ll face stricter approval criteria compared to buying a primary residence, the long-term savings can make the extra effort worthwhile.
Following the guidelines above will help ensure your loan application is primed for success. With a strategic approach and persistence, you can secure financing that positions your next investment property purchase for optimal returns.
Option 2: Hard Money Loan
A hard money loan is a short-term loan. It is most suited to flipping an investment property, rather than buying and holding it, renting it out, or developing on it.
It is possible to use a hard money loan to purchase a property and then immediately pay it off with a conventional loan, private money loan, or home equity loan. However, starting with one of the other options is more convenient and cost-effective if you are not intending to flip your property.
The upside of using a hard money loan to finance a house flip is that it may be easier to qualify for than a conventional loan. While lenders still consider things like credit and income, the primary focus is on the property’s profitability.
The home’s estimated after-repair value (ARV) is used to gauge whether you’ll be able to repay the loan. It’s also possible to get loan funding in a matter of days, rather than waiting weeks or months for a conventional mortgage closing.
The biggest drawback of using a fix-and-flip hard money loan is that it won’t come cheap. Interest rates for this kind of loan can go as high as 18%, depending on the lender, and your time frame for paying it back may be short. It is not uncommon for hard money loans to have terms lasting less than a year. Origination fees and closing costs may also be higher compared to conventional financing, which could chip away at returns.
Option 4: Tapping Home Equity
Drawing on your home equity is a fourth way to secure an investment property. You can do this through a home equity loan, home equity line of credit (HELOC), or cash-out refinance. In most cases, it’s possible to borrow up to 80% of the home’s equity value to use toward the purchase, rehabilitation, and repair of an investment property.
Using equity to finance a real estate investment has its pros and cons, depending on which type of loan you choose. With a HELOC, for instance, you can borrow against the equity the same as you would with a credit card, and the monthly payments are often interest-only. The rate is usually variable, however, which means it can increase if the prime rate changes.
A cash-out refinance would come with a fixed rate, but it may extend the life of your existing mortgage. A longer loan term could mean paying more in interest for the primary residence. That would have to be weighed against the anticipated returns that an investment property would bring in.
Conventional Lending Guidelines for Investment Property – How do I get a Loan?
FAQ
Can a conventional loan be used for an investment property?
Can I put less than 20% down on an investment property?
What is the lowest amount down on a conventional loan for an investment property?
Is it harder to get a mortgage for an investment property?
Do you need a conventional mortgage for investment property?
For most investment property loans, a conventional mortgage is needed. The majority of these mortgages are considered ‘conforming’ because they conform to the lending rules established by Fannie Mae and Freddie Mac.
Should you buy a home with a conventional mortgage?
Conventional loans are a popular choice for buying investment properties due to their more favorable interest rates than alternative mortgage options. However, you will pay a higher rate than on a primary residence purchase. This premium is because of the inherent risk associated with investments and an uncertain income stream.
Do you have to pay PMI on a conventional loan?
You’ll need to pay Private mortgage insurance (PMI) if you put down less than 20% on a conventional loan for an investment property. This additional cost can eat into how much you can afford to invest. Investment property loans and conventional loans can both be used to finance investment properties, but they differ in a few key ways.
Can you get a conventional loan for a rental property?
Conventional loans can be used for purchasing a rental property and typically offer the lowest closing costs and interest rates. However, borrowers can still get approved for a conventional loan for a rental property if they meet the requirements. There are several conventional loan alternatives for those who cannot get approved through conventional lenders or need funding faster.