Using other people’s money by getting a loan on a rental property can be a good way to increase potential returns as long as you conservatively balance risk with reward.
In this article, we’ll look at the options for getting a rental property loan and discuss how to analyze cash flow and property value to help you make the best investment decision.
Getting a loan to purchase your first rental property can seem daunting, but it doesn’t have to be! With proper planning and preparation financing your first rental investment can be straightforward. In this comprehensive guide, we’ll walk through everything you need to know to get a rental property loan as a first-time real estate investor.
Overview of Rental Property Loans
When you get a mortgage loan for a rental property rather than an owner-occupied home there are some key differences to be aware of
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Higher interest rates – Generally 0.5% to 1% higher than owner-occupied loans This accounts for the increased risk lenders take on with rental properties.
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Larger downpayments – Expect to put down 20-25% as a minimum. Again this reduces risk for the lender.
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Lower debt-to-income ratios – Lenders will want to see you have enough income to comfortably handle the new mortgage payment.
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Proof of reserves – Expect to have 6-12 months of mortgage payments in liquid reserves.
The good news is that with proper planning, these guidelines are very achievable for the first-time rental property buyer.
8 Common Loan Types for Rental Properties
There are several loan programs available for financing rental properties. Here are the most common options:
1. Conventional Loans
These are traditional mortgages from banks and credit unions. They offer competitive rates and terms if you have good credit (680+ score). Down payments are typically 20-25%.
2. FHA Loans
Insured by the Federal Housing Administration, FHA loans allow down payments as low as 3.5%. Credit scores of 580+ may qualify. Great for first-time buyers.
3. VA Loans
For qualifying military service members, VA loans require no down payment or minimum credit score. Can be used to purchase a duplex or fourplex rental property.
4. Portfolio Loans
Offered by private lenders who fund mortgages from their own capital. Good option if you have multiple investment properties.
5. Blanket Loans
Allow you to finance multiple rental properties in one single loan. Streamlines the process for larger real estate portfolios.
6. Private Loans
Loans from individual investors rather than institutions. Terms are often more flexible than traditional lenders.
7. Seller Financing
The seller carries back a portion of the mortgage, allowing you to buy with less cash or financing.
8. HELOCs
Use the equity from an existing property to tap funds via a line of credit for a rental property purchase.
As you can see, there are many options available, so do your research to find the best loan for your situation.
Tips to Get Approved
Here are some key tips to ensure your rental property loan application gets approved:
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Buy first home as owner-occupied – Get much better terms by living in the property first before renting it out.
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Have excellent credit – Aim for a score of 720 or higher to get the best rates and approval.
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Make a large down payment – At least 20-25% down to lower your risk profile for lenders.
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Show strong reserves – Have 6-12 months of mortgage payments in your bank account.
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Use a lower debt-to-income ratio – Keep your total monthly debt under 36% of gross monthly income.
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Provide existing rent rolls – If you already own rentals, include this on your application.
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Run property numbers – Show lenders your expected cashflow, expenses, and ROI projections.
Follow these tips, and you’ll be well on your way to getting approved!
What Documents Do You Need?
When applying for a rental property loan, here are some of the key documents you should prepare:
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Two years of tax returns – Shows your income and financial history.
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Two years of rental property Schedule E – Documents income from existing rentals you own (if applicable).
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Two months of bank statements – Proves you have funds for downpayment and reserves.
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Two years W-2s and paystubs – Verifies your employment.
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Credit report – Shows your score and payment history. Get a copy from annualcreditreport.com.
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Purchase contract – If you are already in escrow, provide the purchase agreement.
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ID and Social Security card – Standard requirement to confirm legal residency.
Having these documents ready will help speed up the loan review process.
What Expenses Should You Count On?
When budgeting for your rental property purchase, account for these common fees and closing costs:
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Downpayment – Plan on 20-25% of purchase price.
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Closing costs – Usually 2-5% of loan amount. Includes origination fees, appraisal, credit check and more.
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Repairs and maintenance fund – Budget for immediate updates, repairs and future capital expenditures.
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Property management fees – Either 8-10% of rent or a fixed monthly amount if using a property manager.
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Vacancy costs – Even good landlords deal with 1-2 months vacancy per year. Budget for this lost rent.
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Capital expenditures – Plan on setting aside funds each month for future roof, HVAC, appliance replacement, etc.
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Utilities – If you cover heat, electric, or water as the landlord.
Carefully projecting all these costs will help you set realistic cash flow expectations.
How Can You Find the Best Loan Terms?
Follow these tips to make sure you get the most favorable loan terms:
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Shop multiple lenders – Compare quotes from banks, credit unions, mortgage brokers, and online lenders.
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Ask about discount points – Paying points upfront can lower your interest rate over the life of the loan.
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Buy down the rate – Pay a fee to temporarily reduce the rate for 1-3 years, then it bumps back up.
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Check for first-time buyer programs – Many banks offer special mortgages for those new to home buying.
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Consider an adjustable-rate – Could get a lower rate in exchange for potential increases later.
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Review closing costs – Compare itemized fees across lenders to avoid excess charges.
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Negotiate prepayment terms – Try to avoid penalties if you sell or refinance the property later.
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Ask about portfolio discounts – Some lenders offer better pricing if you have multiple mortgages with them.
Taking the time to research and negotiate can potentially save you thousands over the loan term.
How Can You Determine If a Property Pencils Out?
Before taking on a mortgage, properly analyze the potential rental property to ensure it will generate enough cash flow to support the loan payment. Here are some key metrics to look at:
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Gross Rental Yield – Monthly rent divided by total property cost. Shoot for 1% or higher.
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Cap Rate – Net operating income divided by property price. Look for 4-6% minimum.
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Cash-on-Cash Return – First year cash flow divided by total cash invested. Target 8% or more.
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Debt Service Coverage Ratio – Monthly NOI divided by loan payment. Look for 1.25 or higher.
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Vacancy Rate – Research the area vacancy rates. Budget for 1-2 months of lost rent per year.
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Management Costs – Factor in either 8-10% of rent or a fixed monthly fee if using a property manager.
Running these numbers will give you confidence that your rental property investment can cash flow positively.
Final Tips for Getting a Rental Property Loan
Here are a few final tips for ensuring a smooth loan process:
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Hire a knowledgeable real estate agent who can help you find and evaluate rental properties appropriate for financing.
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Connect with a loan officer early on to review your finances and credit so you know where you stand.
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Consider getting pre-approved first so you can shop with confidence for the right investment property.
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Make sure to purchase available tenant and landlord insurance to protect your new asset.
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Inspect the property carefully yourself or hire a professional inspector before closing.
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Have an emergency maintenance fund for unexpected repairs that pop up.
With proper diligence upfront, your first rental property loan can be the first step to building an income-producing real estate portfolio. Get educated, run the numbers, find the right property, and choose a loan that aligns with your investment objectives and financial capabilities. You’ll be well on your way to successful rental property ownership.
Options for a Rental Property Loan
It’s much easier and less expensive to find a loan option for a residential rental property like a house or a duplex compared to a large apartment building or commercial property. If you’re shopping around for a rental property loan online, you can get a free rate quote from an experienced mortgage professional on Stessa.
Here are some of the options to look at when you need a loan for buying a rental property or refinancing an existing mortgage:
Conventional or conforming loans are mortgages that most people are familiar with. They are offered by traditional lenders like banks or credit unions, and also by mortgage brokers who work with a variety of lenders and can help you find the best deal.
Interest rates are usually lower than other options provided you have a good credit score, and down payments may be less than 25%. Conforming loans must meet Fannie Mae or Freddie Mac guidelines. While Fannie and Freddie allow up to 10 mortgages by the same borrower, banks often set a lower limit of around four loans total.
Federal Housing Administration (FHA) loans are also offered by traditional lenders and mortgage brokers. Credit score requirements and down payments are usually lower than a conventional loan, and income from an existing rental property can be used to help qualify.
FHA loans are a good option for multifamily property investors looking for a rental property loan for a new purchase, new construction, or renovating an existing property. To help qualify for an FHA multifamily loan, the investor will need to use one unit as a primary residence for at least one year.
Veterans Affairs (VA) multifamily loans are a third option for rental property loans offered by banks, credit unions, and mortgage brokers. Mortgages backed by the U.S. Department of Veterans Affairs are available to active-duty service members, veterans, and eligible spouses.
There are several benefits to using a VA loan for a rental property if you qualify. There is no minimum down payment or minimum credit score, and you may be able to purchase up to seven units. However, one of the units must be your primary residence.
Portfolio loans are mortgages on individual single-family or small multifamily properties by the same lender. Although each property has its own loan, the mortgage brokers and private lenders who offer portfolio loans may offer the borrower a ‘group discount’ for multiple loans.
Loan terms such as interest rate, down payment, credit score, and loan length can be customized to fit the specific needs of the borrower. However, because portfolio loans can be easier to qualify for when an investor has multiple properties, there may also be higher fees and prepayment penalties.
A blanket loan is a good option for real estate investors who want to purchase several rental properties and finance all of them using a single loan or refinance a portfolio of existing rental homes. Mortgage brokers and private lenders are two sources for finding a blanket mortgage loan for any type of income-producing property.
Interest rate, length of loan, down payment, and credit score vary from lender to lender, and loan terms can often be customized to meet the needs of the borrower and lender.
Rental properties in a blanket loan are usually cross-collateralized, which means that each individual property acts as collateral for the other properties. However, you can ask for a release clause that allows you to sell one or more of the group of properties under the blanket loan without having to refinance the remaining properties.
Private loans are offered by experienced real estate investors and business people pool their capital and offer debt financing to rental property owners. Because these private investors know how the real estate business works, they often offer loan terms and fees customized to match the deal potential and the experience of the borrower.
Some private lenders may even take a small equity position in the project and accept future potential profits in exchange for lower fees or interest rates. If the investment performs according to plan, private lenders can also be an excellent source of funding for future rental property investments.
Sellers who own a property free and clear (or with very little mortgage debt) are sometimes willing to act as a lender. By offering owner financing or a seller carryback, property owners who finance a sale to the buyer can generate interest income and earn a regular monthly mortgage payment instead of receiving the sales proceeds in one lump sum.
Seller financing can be a good option for owners who want to spread out capital gains tax payments over the life of the loan as an alternative to conducting a 1031 tax-deferred exchange. However, because the seller is offering the mortgage, borrowers should expect similar underwriting requirements such as credit checks and minimum down payment.
A home equity line of credit (HELOC) and a home equity loan are two options for pulling money out of an existing property to use as a down payment for another rental property loan. This strategy is an example of the waterfall technique where investors use the cash flow and equity build-up from existing rental properties to fund future purchases.
A HELOC acts as a line of credit secured by the equity in an existing property that an investor can tap into at any time, and repay the loan with monthly payments similar to the way a credit card works. On the other hand, a home equity loan is a second mortgage that provides funds to the borrower in one lump sum.
With both a HELOC and a home equity loan lenders generally set a borrowing limit of between 75% – 80% of the property equity. Interest rates and fees may also be higher compared to doing a cash-out refinancing using a conventional loan.
Reduce Rental Property Loan Costs
The lower your loan costs are, the larger your cash flow could be. Here are some of the best ways to keep your loan costs low when applying for a rental property mortgage:
- Research the best loan terms and conditions by speaking with lenders and mortgage brokers who know the local real estate market.
- Maintain a good personal credit score and use a conservative LTV with a down payment of around 25%.
- Prepare your mortgage application docs ahead of time – items such as W-2s, bank statements, and tax returns – to show the lender you’re a serious real estate investor.
- Generate income statements, net cash flow, and capital expense reports for any existing properties by automatically tracking income and expenses on Stessa.
How To Get Approved For A Loan To Buy Rental Property (How I Got 40 Rental Properties!)
How do you finance a rental property?
The answer, for most people, is the same way you finance the purchase of your own home: with a mortgage. Whether you plan to live in the property or not, a mortgage is the most secure method of financing a rental purchase because it’s secured by the home. Use custom filters to find the property that is right for you.
How do I qualify for a rental property loan?
To qualify for a rental property loan, you generally need to meet the following criteria: Down Payment: A 20-25% down payment for a single-family home or 30% or higher for a rental property with 2-4 units. Some programs like Fannie Mae/Freddie Mac may offer options with a 10% down payment.
How do I apply for a rental property loan?
Liquid Reserves: A minimum of six months’ worth of liquid reserves, though this can vary by lender. To apply for a rental property loan, you typically need to provide the following documents: Loan Application: The formal application for the loan. Credit Report Authorization: Allow lenders to check your credit report.
How do I choose the best loan for a rental property?
Choosing the best type of loan for a rental property depends on the specific nature of the property, its intended use, and the investor’s financial situation. Traditional mortgages can be ideal for Single Family Rentals (SFR) and smaller multifamily properties.