If you’re in the market for an investment property loan, you’ll have to go through the same process as you would for a traditional home loan. However, you’ll likely find that there are a few more hoops to jump through as the rules are more stringent. In addition, it’s possible that some lenders will offer you a higher interest rate if approved for a loan to offset the risk of default posed to the lender.
This guide breaks down how investment property loans work, what to expect when applying and where to look for funding when you’re ready to move forward.
What is Considered an Investment Property by Mortgage Lenders?
An investment property is a home that’s acquired solely to generate income. So, instead of living in it, you will rent the property out or make renovations and flip it to earn a profit. If you list one of your spare rooms on Airbnb and make money from your primary residence, it does not count as an investment property. You may turn a room in your home into an income source or even rent it out for a few days, but this activity does not turn your house into a rental property.
Investment Properties vs. A Second Homes or Vacation Home
The terms second home and a vacation home are often used interchangeably. However, they’re not the same, and different rules apply to each. The primary difference between the two is how they’re occupied.
You’re required to live in what’s deemed a “second home” for some portion of each year you own it. But there’s no occupancy requirement for “vacation homes” since their sole purpose is to generate income.
What Type of Loan Do You Need for an Investment Property?
When you’re ready to purchase an investment property, you can choose from several types of loans.
Conventional Bank Loans
Conventional bank loans are the most common loan options. They’re offered by traditional banks, credit unions and online lenders and conform to Fannie Mae and Freddie Mac lending standards, which limit the amount you can borrow. The conforming loan limit changes every year, typically increasing based on rising demand and inflation. For example, the limits for 2023 are $726,200 for single-family homes in most areas. The limit jumps up to $1,089,300 for high-cost areas.
Conventional bank loans require good credit. You will need a 620 credit score to qualify and an even higher score if you want to buy a property with a 3% down payment. Most investors choose the 15-year or 30-year mortgage loans. The 15-year loan gets you out of debt faster but increases your monthly payments. The 30-year mortgage costs more in the long run, but it lowers your monthly payment, which means more cash flow from your rental property.
Investors with more than four properties have different credit score requirements. You will need a credit score above 720 if you want to finance the 5th property. The same credit score requirement applies for Properties 5-10. You can only use Fannie Mae and Freddie Mac for up to 10 properties. If you want an 11th property and have not fully paid off any of your mortgages, you will have to look for another type of loan.
FHA Loans
The Federal Housing Administration offers financing for people who don’t have the best credit. You can get financing for a home with a credit score as low as 500. Borrowers must make a 10% down payment if they only have a 500 score, but if you have a 580 credit score, you can get an FHA loan with a down payment as low as 3.5%. Of course, the lower down payment will increase your monthly payments and mortgage rates, but it’s nice to know you don’t need much capital or the best credit to get started.
FHA loans have several restrictions, with the most notable being that you can only use an FHA loan to purchase a primary residence. This may sound like a no-go for investment properties, but you can buy a multifamily property with up to four properties using an FHA loan as long as you live in one of the units. An FHA loan can be your starting point for homeownership and property investing, but you will have to look beyond this loan option if you want to scale your real estate portfolio.
Hard Money Loans
Hard money loans typically cater to investors looking to flip properties. However, you’ll likely need a hefty down payment of 25 percent or more, and the interest rates are often steep. These are non-confirming loans that don’t have Fannie Mae and Freddie Mac restrictions. Traditional banks typically do not offer these loans.
Hard money loans also process more quickly than traditional loans. While it can take over a month to get a traditional loan, you can get approved for a hard money loan and have the funds in your bank account within a few days. As a result, hard money loans are a great haven for flippers who do not need lengthy loan terms or real estate investors who want rental property loans but don’t have good enough credit to get traditional loans.
However, the short loan terms for these financial products can hurt if it takes a while to flip your property or your rental property has a slow start. These are riskier loans, and lenders will also consider a home flip asset’s value after repairs to determine if you can repay the loan.
Private Money Loans
As the name suggests, these loans are funded by private entities. You can get a private loan from an online lender, friend, or any other private entity. Private money loans have more variety, and you can get extremely friendly or predatory rates depending on who lends you the money. You may get a good rate from a family member or friend who has the cash to spare. You can also get a good rate from some online lenders, but others charge predatory fees and interest rates.
Use Your Home Equity
If you have a sizable amount of equity available in a property you own, consider converting a portion of it to cash to fund the purchase of an investment property. A home equity loan or home equity line of credit (HELOC) can make this possible – both act as second loans on your existing mortgage. Or you can take out a cash-out refinance if you’d prefer to avoid managing two loans at once.
Home equity loans and lines of credit are popular funding sources for rental property investors. They can take out home equity from multiple properties to fund another purchase. The rental income from their existing properties exceeds the mortgage and other costs, allowing them to scale up with this strategy. Most lenders let you have a loan-to-value ratio (LTV) of 85% between your mortgage and home equity financing. For example, if you have a $1 million investment property and owe $600,000 on the loan, you can take out a $250,000 home equity loan or line of credit to reach the 85% LTV threshold. Some lenders even let you reach a 95% LTV ratio for your property financing.
The only risk with excessive leverage is that investors can leave themselves exposed if several tenants leave at the same time, and it takes a few months to fill vacancies. However, investors with stable cash flow from reliable tenants often use home equity financing to acquire more properties.
When you are ready to meaningfully pay off your debt, you will have more rental properties generating cash flow. Some investors figure out how many properties they need to retire, acquire the necessary assets, and then solely focus on debt repayment.
Margin Loans
Real estate investors with stock portfolios can take out margin loans to get additional capital. The margin loan’s amount depends on your stock portfolio’s value. Therefore, the maximum amount you borrow will fluctuate each day as stock prices go up and down. Margin loans let you hold onto your stocks and benefit from appreciation and dividends while giving you a way to fund your next investment property.
However, margin loans can turn sour if your stock portfolio takes a hit. Your broker can issue a margin call if your portfolio falls below a certain balance and liquidate some or all of your portfolio to return your portfolio above the maintenance margin. Each brokerage firm has different rules on when margin calls take place and different ways you can protect yourself from that scenario.
Using leverage for stocks is riskier than leverage for real estate. With real estate, you can do your research, calculate a flip’s return on investment, and generate cash flow from a rental property that exceeds your expenses. Unfortunately, stocks fluctuate more dramatically and can lose their value quicker than real estate, especially if you use high-risk stock investing strategies. However, a margin loan can provide the funds you need to cover an expense outside of your portfolio.
Owner Financing
Owner financing takes place when the seller essentially becomes the bank. You will have to reach an agreement with the seller and make monthly payments until you pay for the home in full. Interest rates and other terms vary greatly since each seller gets to decide on financing, but if you default on the loan, the seller regains access to their property.
Many owner financing arrangements include a balloon payment at the end of the loan. These loans typically have lower monthly payments in the beginning, but the balloon payment at the end represents the remaining loan balance. The balloon payment can catch many buyers by surprise and put them in an unfavorable position. They may have to refinance the loan, have enough cash to cover the remaining loan balance or default on the loan.
The balloon payment method is better for flippers, which can usually get a deal done before the balloon payment is due. Most loans with balloon payments have 5-year or 10-year terms.
Investor Cash Flow Loans
The Investor Cash Flow Loan is offered by Angel Oak Mortgage Solutions, a full-service mortgage lender that provides an assortment of flexible home loan products. It’s designed for real estate investors and doesn’t require lengthy tax returns or income statements to qualify for funding. Instead, the lender will review the projected cash flow of the investment property to determine if you’re a good fit for a loan. Instead, the lender will review the projected cash flow of the investment property to determine if you’re a good fit for a loan.
You could be eligible for a loan from $75,000 to $1.5 million, and there’s no limit on the number of properties you can acquire. Furthermore, you’re allowed to purchase properties in the company’s name. Finally, you can take out an investor cash flow loan with a 40-year term and a fixed interest rate.
Submit an inquiry to learn more about this innovative funding opportunity.
Is It Typically Harder or Easier to Secure a Loan for an Investment Property?
It can be challenging to secure a loan for an investment property, especially if you’re searching during an economic downturn when lending criteria are more stringent. But even in times when the housing market is performing well, you could still face obstacles as there are fewer lenders to choose from. Furthermore, these loans are riskier since the likelihood of default is higher, making them harder to qualify for in some instances. It may be difficult to get capital for an investment property, but it’s possible to get the financing you need.
How Much Down Payment Do You Need on an Investment Property?
You’ll generally need a down payment of at least 15 percent – it could be 20 percent or more with some lenders. However, keep in mind that putting down 25 percent may make you eligible for a lower interest rate, and you could get away with a less-than-perfect credit score.
Tips to Secure an Investment Loan
Looking to secure an investment loan? These tips will help.
Get Your Finances in Order
Lenders will only give you the capital you need if they believe you can repay the loan. Having a solid income and fewer expenses puts you in a better position to get the financing you need. Check credit card statements to see what subscriptions and other costs you can remove. Trimming your expenses will make it easier to pay off your financial obligations, so you have a more attractive debt-to-income ratio.
Do Your Due Diligence
You should look through several investment properties and develop criteria for your assets before buying a rental property or fixer-upper. Doing your due diligence helps you achieve a positive return on your investment, and each successful real estate investment improves your chances of getting future loans. Some lenders consider your results with past real estate investments before giving you the capital for your purchase.
Build Your Credit Score
Your credit report gives lenders an idea of what to expect if they give you money for your investment. Lenders don’t want to lose their capital, and it’s the main reason they impose credit score requirements. A higher credit score will increase your likelihood of getting approved and result in a lower interest rate.
Make a Larger Down Payment
Your down payment reduces a lender’s risk. While most buyers won’t make an all-cash offer, putting down more than 20% can help you get a better loan and keep your monthly payments low. Investors in the early stages may not have as much flexibility to make a large down payment, but as the rental income or capital gains from property flips grows, it becomes easier to make 20%-30% down payments. That higher down payment will increase your chances of approval and help you secure better rates.
Put More Years on Your Loan
Your debt-to-income ratio is a critical component lenders use to assess your application. Opting for a loan with more years on it will reduce your monthly payments and result in a more favorable debt-to-income ratio. It’s for this reason that it’s easier to get a 30-year mortgage than a 15-year mortgage. The longer mortgage has lower monthly payments since the borrower spreads the loan’s principal across more intervals.
Get a Loan for Your Investment Property
If the Investor Cash Flow Loan seems like it could be a good fit for you, reach out to Angel Oak Mortgage Solutions right away. Simply complete the short online form, and a loan officer will contact you to discuss your unique funding needs and how to move forward with the application process.
