Using a Personal Loan to Finance an Investment Property Purchase

Buying an investment property can be a great way to diversify your assets and earn passive income through rentals. However, coming up with the down payment on an investment property purchase can be challenging, especially if you don’t have tens of thousands of dollars in cash saved up. This is where a personal loan can come in handy.

In this comprehensive guide, we’ll discuss how you can use a personal loan to finance an investment property purchase. We’ll cover the pros and cons of using a personal loan, how to qualify for one, alternative financing options, tips for getting approved, and more.

What is a Personal Loan?

A personal loan is a type of installment loan that you can use for almost any purpose. Personal loans are unsecured, meaning you don’t have to put up any collateral. This makes them different from mortgages and home equity loans/lines of credit, which use your home as collateral.

With a personal loan you receive the full loan amount upfront as a lump sum payment. You’ll then make fixed monthly payments over a set repayment term, usually between 2-7 years. Personal loans can be obtained from banks, credit unions, and online lenders.

Key features of personal loans

• Loan amounts from $1,000 up to $100,000
• Fixed interest rates from around 6% to 36%
• Set repayment terms, often 3-5 years
• Unsecured – no collateral required
• Funds can be used for any purpose

This flexibility makes personal loans a viable option for financing an investment property purchase.

The Pros and Cons of Using a Personal Loan

Using a personal loan to buy an investment property has several potential benefits

Pros

• Fast financing – can get funds in a week or less
• Fixed rates and terms help with budgeting
• No collateral required
• Can be used with low down payments
• Interest may be tax deductible

However, there are also some drawbacks to be aware of:

Cons

• Higher interest rates than mortgages
• Large monthly payments if loan is too big
• Shorter repayment terms than a mortgage
• Prepayment penalties may apply
• Won’t build home equity like a mortgage

As you can see, personal loans offer quick and flexible financing. But the higher rates and faster repayment timeline means your costs will likely be higher compared to a mortgage.

What Credit Score is Needed?

When applying for a personal loan, your credit scores play a major role in determining if you’ll get approved as well as what interest rate you pay.

Here are the typical credit score requirements:

• Good credit: 670+ – The best rates, usually under 10% APR
• Fair credit: 580-669 – Approved but will pay higher rates
• Poor credit: Below 580 – Harder to get approved, rates over 25%

So before applying for a personal loan, it’s wise to check your credit reports and scores. This allows you to confirm everything is accurate and take steps to improve your credit standing if needed.

Shoot for a score of at least 670 or higher before applying. This will make it easier to get approved and secure the lowest interest rate possible.

How Much Can You Borrow?

Most lenders let you borrow between $1,000 up to $100,000 with a personal loan. How much you can actually qualify for will depend on factors like:

• Income – Lenders want to see you earn enough to afford the payments
• Credit scores – Higher scores mean larger loan amounts
• Debt-to-income ratio – Lenders limit how much total debt you can have compared to income

A good rule of thumb is you can typically borrow up to 40% of your annual income with a personal loan. So if you earn $60,000 per year, you may qualify for around a $24,000 personal loan.

Some lenders may allow you to borrow up to 50% of your income if you have great credit scores. But it’s wise to be conservative when borrowing to keep payments comfortable.

Using a Personal Loan for a Down Payment

One of the most common uses for a personal loan is to fund a down payment on a home. This same concept can work when financing an investment property.

Personal loans allow you to borrow money for any use. So you can use a personal loan to cover the down payment on an investment property, which is typically 20-25% of the purchase price.

Then you could take out a separate mortgage for the remainder of what you need to buy the property. This allows you to buy the investment property you want even if you don’t have the full down payment amount in cash.

Example:

• Investment property purchase price: $200,000
• 25% down payment amount: $50,000
• Personal loan amount for down payment: $50,000
• Mortgage amount: $150,000

Now let’s look at some real numbers to see how this could work…

Sarah wants to purchase a duplex for $250,000. Here is how she can buy it with a personal loan for the down payment:

• Property price: $250,000
• 25% down payment: $62,500
• Sarah takes out a $62,500 personal loan at 8% APR over 5 years. Her monthly payment is around $1,200.
• Sarah takes out a mortgage for the remaining $187,500 at 4% over 30 years. Her monthly mortgage payment is about $900.
• By using the personal loan for the down payment, Sarah’s total monthly housing costs are only $2,100. This fits comfortably within her monthly rental income from the duplex.

As you can see, the personal loan makes it possible to buy the investment property despite not having the full down payment amount in cash.

Alternative Financing Options

A personal loan isn’t the only way to finance an investment property purchase with less cash upfront. Here are a few other options to consider:

Hard Money Loans

These non-bank loans are based on the property’s projected value rather than your credit. Rates are high but usually no down payment is required. Best for short-term financing.

Seller Financing

The seller finances a portion of the purchase price directly. You’ll make payments to the seller instead of a bank. Allows for creative, customized financing terms.

Home Equity Loan/Line of Credit

Lets you tap your home equity to get funds for the down payment. Interest is usually tax deductible. Application process is quicker than refinancing.

401(k) or IRA Loans

Allows you to borrow against your own retirement savings. Interest and payments go back into your account. No credit check needed but taxes and penalties can apply if you default.

Crowdfunding

Reaching out to private investors, friends/family, or crowdfunding platforms to raise money for the down payment. Allows you to pool funds from multiple sources.

VA Loan

VA loans allow active military and veterans to purchase investment properties with 0% down. But a funding fee is required.

Tips for Getting Approved

If you’ve decided a personal loan is the right financing option for your situation, here are some tips to improve your chances of getting approved:

• Shop around – Apply with multiple lenders to compare loan offers. Each lender has its own underwriting standards.

• Reduce debt – Pay down existing balances like credit cards to lower your DTI ratio before applying.

• Add a co-signer – Ask a cosigner with good credit to apply with you to improve your approval odds.

• Offer collateral – Some lenders may accept collateral like stocks or bonds to approve you for a larger loan amount.

• Clean up credit – Removing negative items can give your credit scores a quick boost before applying.

• Increase income – Work overtime or consider adding a side income stream to qualify for a larger personal loan.

Taking these steps beforehand improves your chances of a quick approval. Be sure to compare multiple lender offers to find the best possible rate for your situation.

Is Interest Tax Deductible?

With certain types of loans, the interest you pay can be tax deductible. This helps reduce your taxable income to lower how much you owe.

Unfortunately most personal loans do not offer tax deductible interest. The IRS only allows deductions on loans secured by property, like mortgages and home equity loans.

However, if you use a personal loan alongside a mortgage, the interest on the mortgage would be tax deductible. So there could still be tax benefits to combining a personal loan with a mortgage.

Is a Personal Loan Right for You?

Deciding if a personal loan is the right financing option for your investment property purchase depends on your unique situation.

The main advantages of using a personal loan are fast funding, flexible use of proceeds, and potentially lower monthly payments than other financing options.

However, higher interest rates and shorter repayment terms mean your total costs will be higher compared to alternatives like mortgages.

Here are a few signs a personal loan may be a good fit:

• You need funds quickly – Personal loans fund in days or weeks