To qualify for an investment property loan, you must have adequate cash flow and be able to forecast the potential financial performance of the property.
You can use an investment property loan to purchase a new rental property, renovate an existing one or prepare a property for the market.
In addition to traditional loans, you may be able to use home equity loans, home equity lines of credit or home equity agreements to obtain funds for an investment property.
Real estate can be a very profitable investment for some people. However, purchasing an investment property requires greater start-up costs than other investments.
Several private lenders, banks, credit unions and government lenders provide investment property loans. These loans are like a mortgage for a primary residence that you can use to finance an investment property purchase.
As with mortgages, investment property loan lenders want to minimize risk and maximize profits. The loan's conditions and terms depend on the lender, but you can expect to pay a higher down payment and higher interest than with a primary residence mortgage.
Like other investments, purchasing a rental property comes with risk for both the lender and purchaser. For you, defaulting on a mortgage allows the lender to foreclose. Statistically, a rental property owner is more likely to default than a mortgage on a primary residence for the lender.
Because rental property loans are riskier for lenders, borrowers must usually put down a larger down payment and accept a higher interest rate. Like other mortgages, though, the loan is still amortized over 15 or 30 years. One advantage is that you may be able to write off interest payments as a tax deduction.
Rental property loan qualifications typically include:
A credit score of 620 or higher
A down payment of at least 25%, although this will vary depending on credit history and the property itself
Cash reserves to pay for a minimum of six months of mortgage payments
A maximum debt-to-income ratio of 36%
Even if you don't have to provide a larger down payment, you should consider paying at least 20% down to avoid private mortgage insurance.
Lenders will also consider the potential cash flow from the property. Factors include:
The gross potential rental income
Any fees, such as homeowners’ association (HOA) fees, leasing or property management fees
Operating expenses, which are usually up to 20% of gross rental income
Utilities (if a large property with a master meter)
The mortgage payment
When searching for an investment property loan, it's important to consider your options to find the best terms.
WATCH: Loan Options for Real Estate Investors
Like obtaining a mortgage for a primary residence, you can also get a mortgage for an investment property from a bank, credit union or mortgage broker. The better your credit score, the more favorable the terms and the lower the required down payment.
Unlike a conventional mortgage, the FHA provides government-backed home loans. These loans usually require lower credit scores and lower down payments than with conventional mortgage loans. The catch is that you must pay private mortgage insurance until you establish 20% equity in the home.
These loans are favorable for multifamily property investors. You must live in one unit as your primary residence for at least one year to qualify.
The VA provides favorable home loans to certain individuals. To qualify, you must be:
An active-duty service member
An eligible spouse
A VA loan requires no minimum down payment or credit score if you fit one of these criteria. You can also use a VA loan to purchase up to seven units so long as one is your primary residence.
This option works best for an investor seeking to purchase multiple properties. The lender provides a portfolio of individual mortgages tied to the individual properties you want to buy. While each property has its own loan, the lender typically offers a discount for purchasing the group of mortgages.
Each loan also has its own terms. This means you could have one mortgage at one interest rate and down payment, and another mortgage with a different rate and down payment.
Though these loans can be favorable for buying multiple properties, the lender may impose higher origination fees and a prepayment penalty.
The portfolio mortgage is like a folder holding multiple loans on multiple properties. In contrast, a blanket mortgage is one loan that covers multiple properties.
Terms vary from lender to lender, but these loans are usually cross-collateralized. This means that each property serves as collateral for the others.
You may also secure financing from individuals. Real estate investors or business people offer loans to other real estate investors when they believe in the project's profitability. Private-money loans come with customizable terms intended to match the borrower's abilities.
Private-money lenders may offer a loan in exchange for a stake in the property. These lenders are more likely to finance future projects when the first project goes well.
Like private-money lenders, sellers who own their properties outright may offer financing to prospective buyers. The seller receives income from the interest payments and monthly installments rather than from a single lump-sum buyout.
This also allows the seller to defer or incrementalize capital gains tax payments over the loan period.
Finally, home equity could be used to finance other investment property purchases. If you already own other investment properties or a primary residence, you may be able to obtain a home equity loan (HEL), a home equity line of credit (HELOC) or a home equity agreement (HEA).
While each option is unique, each works by providing you cash in proportion to the amount of equity you've established in the property.
If you're ready to purchase a real estate investment property, access your home equity to do it. When you choose a home equity agreement from Unlock, you receive cash in exchange for a share of your home's future value. Unlike a loan, there are any interest or monthly installment payments.
Contact us today to get started.
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