How to Qualify for an Investment Property Loan in 2023

Investment properties can be an excellent way to generate passive income and build long-term wealth. However, financing an investment property is different than getting a mortgage for your primary residence. Lenders view investment loans as riskier, so you’ll need to meet stricter eligibility requirements.

In this comprehensive guide, I’ll explain everything you need to know to qualify for an investment property loan. I’ll cover

• The benefits of real estate investing
• Types of investment properties
• Loan options for investment properties
• Down payment and credit score requirements
• Debt-to-income ratio limits
• How to calculate your rental income
• Tips for improving your chances of approval
• Alternatives if you don’t qualify for financing

Why Invest in Real Estate?

Before we dive into qualifying for a loan let’s briefly go over the main benefits of owning investment property

• Generate passive income – You can collect steady rental income each month with minimal effort after securing tenants This extra cash flow can supplement your wages

• Benefit from appreciation – Real estate values tend to increase over time. As your property appreciates, you build equity that you can tap into later via a cash-out refinance or sale.

• Tax advantages – Investment property owners can write off expenses like mortgage interest, property taxes, maintenance, repairs, and depreciation to reduce their taxable income.

• Build wealth – Equity in investment property can be a crucial part of your retirement strategy. Upon selling, you can realize significant gains.

• Leverage other people’s money – You can finance an investment property with a small down payment, allowing you to purchase a more valuable asset than you could pay for in cash.

• Hedge against inflation – Real estate tends to hold its value better than stocks and bonds during inflationary periods.

Types of Investment Properties

There are a few main options when it comes to investment property type:

• Single family home – The most common type of rental property is a standalone house. These are fairly easy to finance as primary residences or investment properties.

• Multi family home – Duplexes, triplexes, and quadplexes allow you to collect rent from multiple units while only having one mortgage.

• Condo – Condos can generate strong rental demand in urban areas and are easier to maintain than single family homes. Just be aware of condo association fees.

• Raw land – Undeveloped land can be a smart long-term play but doesn’t generate rental income. It’s riskier and may be harder to finance.

For your first investment property, I’d recommend starting with a single family home or small multi family building of 2-4 units.

Loan Options for Investment Properties

When financing investment real estate, you have a few main mortgage loan options:

• Conventional loans – The most common loan type is a conventional mortgage from a private lender like a bank. These typically require 20-25% down and have stricter credit standards.

• FHA loan – FHA allows down payments as low as 15% and lower credit scores. But they charge an upfront mortgage insurance premium and higher ongoing costs.

• Portfolio loan – Local banks may offer portfolio loans with more flexible underwriting guidelines. However, interest rates are often higher.

• Hard money loans – These short-term, high-cost loans are a last resort for investors who don’t qualify for other financing. I don’t recommend them for first-timers.

For most buyers, a conventional mortgage will provide the best terms. FHA and portfolio loans can be a good option if you need flexibility.

Next, let’s look at the specific requirements to qualify for a conventional investment property loan.

Down Payment Requirements

One of the biggest hurdles when financing investment real estate is the larger down payment required compared to owner-occupied homes.

Here are the typical minimum down payment requirements:

• Conventional loan – 20-25%
• FHA loan – 15%
• VA loan – 25%
• USDA loan – Not available for investment properties

As you can see, conventional loans often require at least 20% down. So if you purchase a $500,000 property, you’ll need to put at least $100,000 down.

Coming up with this substantial amount of cash is difficult for many first-time investors. But the larger down payment helps mitigate the lender’s risk.

If you don’t have 20-25% to put down, an FHA loan can be a good alternative because it allows 15% down. You’ll pay mortgage insurance premiums, but it makes ownership more attainable.

Credit Score Requirements

Lenders also scrutinize your credit profile more carefully when you apply for an investment property versus owner-occupied mortgage.

Here are typical credit score requirements:

• Conventional – 680+
• FHA – 640+
• VA – 680+
• USDA – N/A

A score of at least 680 will give you the best shot at approval for a conventional loan. But requirements vary by lender. Some may approve credit scores as low as 660.

Other aspects of your credit history like length, mix of accounts, and payment history also play a role in the decision.

If your score falls between 640-679, an FHA mortgage is a good option because they are more lenient with credit.

Debt-to-Income Ratio Limits

Lenders analyze your total monthly debt obligations versus gross monthly income, called your debt-to-income ratio (DTI), when approving investment property loans.

Here are typical DTI limits:

• Conventional – 43% max
• FHA – 43% max
• VA – 41% max
• USDA – N/A

You want to keep your DTI as low as possible when applying for financing. Most lenders set a 43% limit on total debt vs. income.

The lower your ratio, the better because it shows you can comfortably handle the new mortgage payment. Aim for a DTI of 36% or less when possible.

Documenting Rental Income

A unique aspect of investment property qualification is the need to verify future rental income.

Lenders want to see you have a reasonable plan to generate enough rents to cover the mortgage, taxes, insurance and other ownership costs.

Here’s how they evaluate potential rental income:

• Review leases – If the property is already occupied, the lease terms establish a history of rents received.

• Appraise as-is value – For vacant properties, the appraisal estimates market rents based on location and condition.

• Require larger down payment – On speculative projects, lenders may want 25-35% down and 6+ months of reserves.

• Use 75% of projected rents – A conservative estimate accounts for vacancy and maintenance costs.

Having an executed lease or appraisal showing strong rental demand in the area will bolster your loan eligibility.

If financing a rehab or speculative purchase, be prepared to make a larger down payment and have reserves.

Tips for Improving Your Chances

If your qualifications fall short of investment property loan requirements, here are some tips to improve your chances of getting approved:

• Pay down revolving debt to decrease your DTI

• Add an authorized user with good credit to boost your score

• Hold off until you have a 20% down payment

• Start with a lower-priced property

• Bring on a co-investor to combine resources

• Purchase in a market with high rental demand

With some discipline improving your financial profile, getting approved is very feasible.

Alternatives if You Don’t Qualify for Financing

If you need more time to boost your credentials, a few options besides traditional financing include:

• Partnering with other investors – Join forces with more qualified investors to pool resources.

• Seller financing – Some sellers may be willing to act as the bank and hold a mortgage.

• Home equity loan – Tap equity in your primary residence to acquire another property.

• Hard money loans – Expensive but easy to qualify for short-term financing.

• Lease-to-own – Rent a property with the option to purchase once you meet requirements.

With persistence and creativity, you can overcome challenges securing investment property financing.

Wrap Up

• Understand conventional loan standards – 20-25% down, 680+ credit, <43% DTI

• Consider FHA for lower down payments and credit scores

• Document future rental income from leases or appraisal

• Improve your financial profile to boost approval odds

While it may take some time and effort to get approved, the long-term rewards of rental property ownership make it worthwhile. Use this knowledge to map your path to smart real estate investing success!