When looking to buy an investment property, one of the most difficult parts of the process is accessing funding to buy the asset. Investment property financing is difficult for good reasons. Lenders expose themselves to a lot more risk when financing an investment property than when issuing loans for a primary residence.
For that reason, it is in the interest of a lending institution to do all it can to ensure the borrower is competent and trustworthy. In order to protect their capital and ensure they make a profit from the arrangement, lenders will impose more stringent conditions on people who are borrowing to buy a rental property.
They do this because they want to:
- Evaluate the individual’s competence in managing money. This information is derived from the way the person manages their own finances; usually evident from their credit score and history.
- Be sure the prospective borrower has enough financial stability to accommodate the additional strain of a second mortgage payment, plus the cost of managing a rental home.
- Know if the individual has enough assets to cushion the effects of financial shock from unexpected sources and shield the lender from the impact of those unforeseen events.
Due to the measures lenders put in place to ensure the above, gaining access to funding when buying an investment property can be tough. The Upkeep Media Team says prospective investors can improve their chances of getting a loan if they know of more than one way to access financing when buying an investment property.
If you are a would-be or even an established property investor, this list of different types of financing options for investment properties is for you.
1. Conventional mortgage loans
As a property investor, you are already familiar with this type of loan; it is the same type of mortgage you used when you bought your home. These loans are issued by conventional financial institutions like banks and mortgage providers.
Their requirements follow the guidelines created by Fannie Mae or Freddie Mac; borrowers must make a 20% down payment (or purchase PMI if they pay less than 20% down), have a minimum credit score of 620, show proof of sufficient income, and have six months’ cash reserves to pay their mortgage.
2. Home equity loans
This is one of the best ways to finance an investment property. The option is for investors who have built up sizeable equity in their primary homes. Mortgage companies will let homeowners borrow against the equity on their homes. Homeowners can borrow the difference between the home’s market value and their equity in the property, up to 80%.
This money can be used to flip homes or as a down payment on a rental property. Getting a home equity loan is easier than getting a standard conventional loan. But they are still subject to some of the same conditions as conventional loans.
3. Hard money loans
Hard money loans are issued by professional lenders – individuals and non-conventional lending organizations. Since they are not regulated like conventional loans, hard money loans have more flexible terms. The borrower’s credit score is not as important. They use the property the borrower is negotiating to buy as security and basis to determine the loan amount.
Hard money loans take a shorter time to process (days instead of weeks). The main challenge with this source of funding is the higher interest rates (up to 10%) and short loan repayment periods (usually no more than 36 months).
4. Private money loans
These are not professional leaders, but ordinary individuals – friends, family, or acquaintances – who have extra money and are willing to lend some of it out. These loans have the most flexible terms of all the financing options since they depend on the individual lender and the borrower’s relationship with them.
However, just like the other loan types, in case of default, the lender can foreclose on the property. The loan is usually secured by a promissory note which gives the lender the right to claim the asset.
5. Fix-and-Flip loans
Fix-and-flip loans are a type of hard money loan but they have even shorter repayment periods than the standard hard money loan (often less than a year). Additionally, the interest rates are higher, as much as 18%.
Fix-and-flip loans are used by investors who buy rundown homes which have potential, renovate them and sell them immediately afterward. The main thing lenders look at for fix-and-flip loans is the after-repair value of the home.
6. Commercial investment property loans
This loan type is for advanced investors who buy commercial properties. Commercial property loans have the toughest requirements of all conventional investment property loans.
Lenders typically expect the investor to submit a business plan showing projected cash flow from the property and how they will achieve it. The down payment for such loans is between 15% and 35%. The loan repayment period can be as short as 1 year and interest rates as high as 13%.
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