Types of Investment Loans: A Guide to Financing Your Next Real Estate Purchase

Investing in real estate can be an excellent way to build long-term wealth. However most real estate investments require a substantial amount of capital upfront. Fortunately there are several types of loans available that allow investors to leverage other people’s money to purchase investment properties.

In this comprehensive guide, we will explore the most common types of investment loans, their key features, eligibility requirements, and pros and cons.

Conventional Mortgage Loans

The most popular loan for financing real estate investments is the conventional mortgage. These are loans that conform to the underwriting guidelines set by Fannie Mae and Freddie Mac.

Conventional loans come with several key benefits for real estate investors:

• Lower Interest Rates – Conventional mortgage rates are typically 0.5% to 0.75% lower than rates for other investment loans. This can significantly impact your profit margins.

• Long Repayment Terms – Conventional mortgages come with extended repayment terms up to 30 years. This keeps monthly payments manageable.

• Easier to Qualify – Conventional loans have more flexible underwriting than other types of investment loans. Minimum credit scores can be as low as 620 with a sizable down payment.

However, conventional mortgages also come with stricter eligibility requirements compared to owner-occupied loans:

• Higher Down Payments – Expect to put down at least 15-25% of the purchase price. Some lenders may require as much as 30%.

• Higher Debt-to-Income Ratios – Your total debt obligations usually can’t exceed 36% of your gross monthly income.

• Larger Cash Reserves – Most lenders want to see at least 6 months of mortgage payments in liquid cash reserves.

The bottom line is that conventional loans offer the best rates and terms for real estate investors who meet eligibility requirements.

Hard Money Loans

Hard money loans are a type of short-term financing perfect for quick real estate deals like fix-and-flips. Instead of focusing on your finances, hard money lenders base approval primarily on the profit potential of the deal itself.

Pros of hard money loans include:

• Fast Funding – Many hard money lenders can fund deals in as little as 1 week.

• Less Red Tape – Hard money lenders focus more on the deal/property and less on your personal finances.

• Specialized for Investors – These lenders specialize in working with real estate investors.

However, hard money loans also come with significant drawbacks:

• High Interest Rates – Expect rates from 10% to 15+%.

• Large Origination Fees – 5%+ origination fees are common.

• Short Repayment Terms – Most hard money loans have terms of 1 year or less.

While expensive, hard money can be the right solution for experienced investors who need funds fast or can’t qualify for conventional financing.

Private Money Loans

Private money loans are financing agreements between individuals rather than institutions. Common sources of private funding include:

• Friends and Family
• Other Real Estate Investors
• Accredited Investors

The benefits of private money include:

• Faster Approval – Private lenders can approve deals much quicker than banks.

• Less Strict Criteria – Private lenders often use more flexible underwriting standards.

• Better Rates Than Hard Money – Interest rates are often 2-5% lower than hard money loans.

The downsides include:

• Difficult to Find – You need an existing network of potential lenders.

• Risk of Default – Defaulting can ruin personal relationships.

• No Foreclosure Protection – Private lenders can immediately foreclose if you miss payments.

Over all, private money works best for experienced investors who already have a network of potential lenders in place.

Home Equity Loans

Many real estate investors tap home equity to fund deals. There are three options for accessing home equity:

Home Equity Loan – This provides a lump sum of cash upfront. The fixed interest rate and term make payments predictable. However, total costs are higher compared to other options due to compound interest.

HELOC – A home equity line of credit (HELOC) works like a credit card. You can draw equity as needed and only pay interest on what you use. However, rates are variable making monthly payments unpredictable.

Cash-Out Refinance – Refinancing and taking cash out provides funds upfront like a home equity loan. But with a lower fixed rate and single repayment term, it ultimately saves on interest costs. Closing costs are also lower.

Benefits of using home equity include:

• Fast Approval – Home equity lenders can fund loans quicker than mortgage lenders.

• Predictable Payments – Fixed rates on equity loans and cash-out refinances make payments consistent.

Downsides include:

• Variable Rates – HELOC rates can fluctuate suddenly putting financial pressure on investors.

• Costs – Regardless of option used, tapping home equity adds fees and interest costs.

Overall, home equity financing works best for investors who have significant equity accumulated and want funds quickly.

The Bottom Line

There are several sources available for financing real estate investments. Conventional mortgages offer the best long-term financing solution for investors who meet eligibility requirements. Hard money and private money loans allow investors to act quickly on deals but come with higher costs. And home equity loans can provide fast access to funds for those with equity available.

The key is matching the right loan to your specific investing strategy and financial situation. Be sure to consult with a qualified lending professional to determine the best option for your next investment property purchase. Leveraging the right financing can help accelerate your investing success.