What type of Loan is best for an Investment Property?

Purchasing an investment property allows you to make passive income either through rentals or by holding onto the property and flipping it when it appreciates. When looking to finance an investment property, you can access several types of loans to help offset the hygge costs associated with the process.

There are various types of investment property loans with varying terms and use cases. If you’ve been wondering what the best type of investment property loan is,  you’re in luck as you’re in the right place. Here, we will take a look at the various loan options for investment properties, break down the pros and cons of each and help you decide which loan is the best for your purchase.

Investment Property Loans

Investment property loans are loans taken to finance the purchase, development. or renovation of an investment property. Investment property loans are similar to residential property loans in terms of the application process and documents required to make an application. However, lenders consider investment properties a big risk since the property owners will often place their residential mortgages over their investment property mortgages. Thus, lenders place steeper requirements on investment property loans compared to residential loans. These steeper requirements include;

• Higher down payments: While you can get a residential loan with a down payment of about 5-10%, lenders require you to make a down payment of at least 15%, but typically between 20 and 25% for an investment property. The exact down payment depends on the property and the lender’s specific terms.
• Higher interest rates: Investment property loans typically have higher interest rates to cover the additional risk that lenders face.
• Higher credit score requirement: With a credit score of 620, you can get a residential mortgage. However, you need higher credit scores, often as high as 700 points, to qualify for an investment property loan.
• A maximum debt-to-income ratio of 36%
• Sufficient cash reserves to cover mortgage payments for up to six months

These steep requirements are implemented to ensure that only borrowers with the highest potential to repay can access investment property loans.

Types of Investment Property Loans

Several loan options are available to suit your unique circumstance if you’re considering financing an investment property. Each loan has specific requirements, though they may still vary between different lenders. These loans are provided by various lending institutions, from traditional banks and credit unions to private individuals and lenders who specialize in portfolio loans. Here are some of the most common loan options for investment property financing;‍

Conventional Mortgages                    

Taking a conventional mortgage loan is the most common means for investors to finance their investment properties. You may be familiar with conventional mortgages if you already own a home. By definition, conventional mortgages are loans provided by private companies, including banks, credit unions, and mortgage brokers, to enable individuals and cooperatives to fund their property purchases. Conventional loans are not backed by the government, i.e., they are not subsidized, and the government does not protect lenders against defaults on payments. Instead, these loans adhere to the Fannie Mae or Freddie Mac guidelines and restrictions.

The requirements for obtaining a conventional loan for an investment property vary from one lender to another and from state to state. However, there are some general requirements for you to qualify for these loans. First, conventional loans require that you make a down payment of at least 20% of the property’s value. If, for example, the property is worth $100,000, you will need to have at least $20,000 to make a down payment. Some lenders may require you t have higher down payments of up to 25%. This large down payment fosters trust as investors tend to stay committed to their mortgage, having made a substantial down payment. Another advantage of having higher down payments is that it can significantly reduce the rates, helping you to save more money.

Banks or other financial institutions will take your credit score and final history into account before offering you a conventional loan. For an investment property conventional loan, you will need a minimum credit score of 620. However, the rates you will get with such a credit score are typically not worthwhile. To get a brilliant rate, you will require a credit score of at least 740. You will also need to prove to the lender that you have adequate cash reserves to cover the mortgage payment for at least six months, even if the investment property does not generate income.

FHA multi-unit loan

Federal Housing Administration (FHA) loans are government-backed loans provided by traditional lending institutions such as banks. These loans typically have a more lenient down payment and credit score requirement and allow you to use the property’s potential rental income to meet the loan’s income requirements. One major requirement of FHA loans is that you must reside on the property for at least 12 months since the loan is insured by the federal government. This requirement thus makes FHA loans more suitable for multiunit houses, where you can have tenants in other units and use their rents towards qualifying for the loan.

VA multi-unit loan

Veteran Affairs (VA) loans are provided by the U.S. Department of Veterans Affairs and offered by traditional lending institutions like banks and credit unions. These loans are provided exclusively to military personnel on active duty, veterans, or qualifying spouses. VA loans are particularly advantageous as they do not have any minimum down payment or credit score requirements. Once you qualify for a VA loan, you can buy up to seven units of property, with the only requirement being that you must reside on one of those properties as your primary residence. VA loans also have relatively lower rates.

Hard money loans

Hard money loans are also common options for investors who want to finance investment properties. These loans are particularly useful when looking to fix a property and flip it for a profit in the short term; as such, they are also known as fix-and-flip loans.

Hard money loans have some advantages which make them particularly attractive. For one, these loans are easier and faster to secure. Unlike conventional loans, hard money loans are rarely offered by banks and have more lenient credit score requirements and a faster process from application to disbursement. Hard money lenders are often more concerned about the property’s potential and your market experience.

Conversely, hard money loans have several drawbacks. One of their most significant drawbacks is the high-interest rates associated with hard money loans. The interest on hard money loans is usually up to 10% higher than that of conventional loans. Hard money loans also have higher down payments, up to 25%. Furthermore, these loans are short-term, usually less than 36 months, meaning that you pay a lot of money in a short time. As such, hard money loans are an excellent financing option for property owners who want to acquire low-cost investment properties, renovate them, and quickly sell them for a profit to pay off the loan.

Private money loans

Another financing option for a real estate investor is through private individuals with cash to spare. These individuals are not professionals in the business, and often, all they require is a good relationship with you and the assurance that your investment is a good one. A private money lender can be anyone from a family member to a  friend, neighbor, coworker, or even fellow property investors and other contacts of yours.

Private money loans are usually beneficial when you do not meet the requirements for conventional or hard money loans. They come with fewer formalities, and the terms are usually very lenient. On the flip side, you may get predatory rates and terms, especially when the lender senses your desperation. Pirate money loans are usually secured through a  promissory note or the existing mortgage on the income property. Thus, private money lenders can foreclose the investment property if property investors don’t repay the loan in due time.

Home Equity Loans

A great alternative for financing your investment property is to use your home equity on your current mortgage. Home equity loans are a financing option that allows you to borrow against your home’s current equity to help finance your purchase of another property.  Home equity refers to how much of your home you own and is obtained by subtracting your mortgage balance from the fair value of your home. Many lenders allow investors to borrow up to 80% of their home’s equity value.

Using home equity loans for investment properties has various benefits and drawbacks. Lenders typically conduct credit checks and home appraisals to determine your true home valuation and assess your creditworthiness. Home appraisals are carried out to determine that your property valuation matches the property’s fair value on the current market. Home equity loans are rather easy to obtain and provide an easy source of cash for investors to buy other properties.

Home equity loans typically have higher interest rates than that on your first mortgage. Should an investor default on payment, the lender can keep all the money earned on the initial mortgage payment, property, and interest paid on the home equity loan. Home equity loans are, thus, most suitable for responsible investors with a solid source of income to repay the loan along with the existing mortgage on time.

Blanket mortgage loan

A blanket mortgage loan is an option for real estate investors who want to acquire many rental properties. Rather than obtaining several different loans for each property, they can obtain a blanket loan to cover all properties at subsidized rates and better terms. 

These loans are made available by both individual lenders and mortgage firms, with terms varying from one lender to another. When an investor takes a blanket loan, each property acts as collateral under the loan. However, depending n the terms of the loan and whether you have a release clause, you can sell one or more (but not all) of the properties under the loan while still maintaining the terms of the loan without having to refianince the other properties.

Seller Financing

There are instances when sellers can serve as lenders. This is true for sellers who own the home or have a low mortgage obligation. Instead of receiving earnings all at once, the lender can generate interest income and a mortgage payment using seller financing. Thus, instead of the investor signing a mortgage with a traditional bank or credit union, they sign the mortgage with the seller. Although seller financing can have good terms, it is not a frequently utilized financing option.

Commercial investment property loans

A final type of investment property loan is the commercial loan specifically meant for financing properties that serve a business purpose (such as malls, office spaces, and large residential apartments) rather than financing residential properties. There are different commercial loans, each with its own requirements and terms. Commercial loans typically have steeper terms, including higher interest rates and shorter terms than loans for residential investment properties.

For more information on commercial loans, please read here.

Comparing the different Investment Property Loans

Weighed against each other, every investment property has its pros and cons. The table below provides a quick comparative guide of the different loan types, considering their terms and requirements.

As seen, these different loans have their unique attributes and circumstances that make them desirable. It is always best to run your numbers properly before settling on a loan

How to choose an Investment Property Loan

Getting the right type of loan can make all the difference between a good investment and a poor one. Here are some points to consider before choosing an investment loan

• Determine your investment strategy: the type of loan you would choose depends on your investment strategy. Do you want to buy and hold or buy and flip? Or do you want to build equity that you can tap into in the future? Answering these questions will help you choose the best loan type
• Research the different loans and understand the intricacies: While some loans offer interest-only payments others offer principal and interest payments. Different loans also offer varying interest rates and terms. Research widely on the different loan types and learn the terminologies associated with them
• Choose and apply for the best loan: Once you have defined your investment strategy, and researched the loan types, you should settle on one that suits your need. If you do not qualify for the loan, you should work towards meeting the qualifications in the shortest possible time.

Bottom line: So which is The Best Loan for Investment Properties?

The best loan for an investment property depends on your specific need. Ideally, FHA loans provide simple requirements with low costs and slightly higher down payments than conventional loans. Thus, they may be good when you’re only looking to invest in smaller multi-unit properties where you would also reside. However, with a good enough credit score, you can get awesome rates on conventional loans and can even get better rates when you refinance in the future. Hard money loans are often predatory, while private money loans are hard to come by and could sever your relationship if terms are not upheld. Furthermore, you need to have built equity on a current property before you can access home equity loans.

Verdict – Conventional Loans

In the case where you do not qualify for any of the above-covered loans, you can look towards a non-QM loan, as explained here. At Aurum & Sharp, we offer the best rates and flexible terms on non-QM loans for investment properties. We also offer the best options for refinancing all types of loans. We put you first, ensuring that you get the best deal possible So pick up your phone now and contact us at 9177404325 to book an appointment today or use the online form to get in touch.

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