The Smart Guide to Investment Property Financing

Two young women take notes as they research investment property financing options on a laptop on a kitchen countertop.

Key Takeaways

  • An investment property is real estate you buy with the goal of renting it out or reselling it at a higher price. 

  • Investing in real estate can be profitable, but requires a considerable amount of cash up front. You’ll also be responsible for ongoing maintenance and repair costs, property taxes insurance, and other management expenses for the property.

  • If you can’t pay these expenses out of pocket, you may be eligible for investment property financing options such as conventional mortgages, hard-money loans or home equity-based loans.

  • Down payments and interest rates are considerably higher for investment property than residential home loans, so you need to be financially stable to qualify.

  • If you don’t meet the criteria for conventional investment property financing, consider non-debt-based products such as home equity agreements.

Are you looking to buy an investment property? Financing a venture like that can be tricky, especially for first-time buyers. 

Interest rates on some loan types can get as high as 18%, and down payments of 30% of the purchase price are not uncommon.

The good news is that with a bit of research, you can get financing that meets your needs and is cost-effective.  

Here’s where this guide comes in. 

It lays out what you need to know at the start of your journey in financing an investment property: what financing options there are, how much it costs to take out a loan, how to increase your chances of getting a good offer and more.

What is an investment property?

An investment property is real estate you buy with the goal of making a return on your investment. 

One way to do that is by renting the property out, which can generate a steady stream of income over time.

Alternatively, you can resell the property at a higher price than what you bought it for, and get your return as a lump sum. A property’s value can increase due to changes in the housing market or following renovation. “Flipping” is a term used when buying a property, and renovating it with the intent to resell at a profit.

 A step-by-step guide to due diligence when buying an investment property.

How much can you make with an investment property?

If you plan to rent out, you can calculate the potential return on investment (ROI) in three simple steps:

  • Estimate your annual rental income: Search for similar properties, find out the average monthly rent and multiply it by 12.

  • Estimate your net operating income: This is equal to the annual rental income minus your annual operating expenses, such as property taxes, insurance, maintenance and repair expenses, and any homeowners’ association fees. These expenses don’t include loan payments or interest. 

  • Calculate your ROI: Divide your net operating income by the total amount of your mortgage or loan.

For example, if your property is worth $100,000 and you rent it out for $500 a month, the annual rental income would be $500 x 12 = $6,000.

Let’s also assume that you spend about $150 a month in operating expenses, which comes to $1,800 per year. In that case, your net operating income would be $6,000 - $1,800, which is $4,200.

This makes for an ROI of $4,200 ÷ $100,000 = 0.042, or 4.2%. 

Whether this is a good return depends on your financial goals and the property type. If the property is in a good area and your tenants are reliable, a 4.2% ROI may be great. However, if the area has considerable tenant turnover, a 4.2% ROI may not be as worthwhile.

What options for investment property financing are there?

Investing in real estate can be a great way to turn a profit, but it requires a certain amount of cash up front. If you can’t pay out of pocket, you can seek funding elsewhere. Investment property financing options fall into three broad categories:

1. Conventional mortgages

Conventional mortgages work in much the same way as residential mortgages, and comply with Fannie Mae or Freddie Mac guidelines. 

However, unlike VA, FHA or USDA loans, conventional mortgages aren’t government-backed. You should also expect to make a significantly higher down payment – potentially up to 30% of the purchase price.

Whether you can get approval, and what interest rate will apply, depends on your credit score, credit history, income and assets. For a one-unit investment property, most fixed-rate mortgages require:

  • At least a 15% down payment

  • A minimum credit score of 680

For a two- to four-unit investment property, you typically need:

  • At least a 25% down payment 

  • A minimum credit score of 680 

  • Multiple-unit properties come with higher interest rates as well.

Additionally, you must show that you can afford both the monthly payments on the investment property and your existing mortgage, if any. Keep in mind that lenders don’t factor future rental income into the calculation, and most expect you to have a minimum of six months’ worth of cash to cover both mortgages.

If you don’t want to take out a mortgage on your investment property, and you are a homeowner, you could consider doing a cash-out refinance on your existing home mortgage. This loan type replaces your mortgage with a new one that has a larger loan amount and more favorable terms. You can use the extra cash to fund your investment property. However, bear in mind that this option can extend the term of your home mortgage.

2. Hard-money loans

Investors primarily use hard-money loans to fund real estate transactions, with the property serving as collateral. The lenders are typically companies or private individuals, not banks. 

Hard-money loans allow you to raise capital faster than conventional financing. You can get approval in days rather than weeks or months.

It’s also often easier to qualify for a hard-money loan than a conventional one. While lenders still consider your income and credit history, the deciding factor is the property’s estimated after-repair value (ARV). 

Fix-and-flip loans are a type of hard-money loan you can use to renovate and put a property back on the market as quickly as possible. The downside is the cost. Interest rates can go as high as 18%, and origination fees and closing costs may be higher than those of conventional mortgages. 

The time frame for paying back may be short as well. It’s not uncommon for hard-money loans to have pay-back terms of less than a year, which is why some people refer to them as short-term bridge loans.

Pros and cons of hard-money loans

3. Equity financing

Another option to consider is tapping into your home equity. Your equity is the difference between the current market value of your home, and your remaining mortgage balance and any other liens on the property.

Home equity loans (HELs)

When you take out a HEL, you borrow a lump sum against the equity you’ve built in your home, with the property serving as collateral. You can typically borrow up to 80% of the property’s appraised value. 

Most HELs have fixed interest rates. This means the rate will remain the same over the lifetime of the loan, allowing you to plan with a high degree of certainty.

To qualify for a home equity loan, you typically need:

  • At least 15-20% equity in your home

  • A credit score in the mid-600s

  • A debt-to-income (DTI) ratio of 43% or lower

Home equity lines of credit (HELOCs)

HELOCs are similar to home equity loans. The main difference is that instead of receiving a lump sum up front, you get access to a rolling line of credit. Think of it as a credit card, where you borrow money when and as you need it (within your credit limit) and repay only the amount you’ve used plus interest.

Another difference is that HELOCs typically have variable rates that may go up over the life of the loan.

Home equity agreements (HEAs)

Unlike HELs and HELOCs, HEAs aren’t loans. You get a lump sum up front, and the HEA provider gets a set percent of the proceeds when you sell your home at the end of the term, usually in 10 years. You are selling future equity in your home in exchange for cash now.

In the meantime, you get to live in your home and enjoy all the benefits of ownership. There are no monthly payments or interest. However, you’re responsible for homeowners’ insurance, property taxes and maintaining the property in good order.

If you want to continue living in your property at the end of the term, you can. You just need to buy the HEA provider out. 

To qualify, you typically need at least 20% home equity and a minimum FICO score of 500. Income requirements are flexible.

How much do you have to put down for an investment property?

The odds of default and foreclosure are higher with investment properties. This explains why you may buy a home you’ll live in with as little as a 3% down payment (even 0% for certain specialty loans). But most lenders require you to put down at least 15% for investment property mortgages. In some cases, that figure can go as high as 25-30%.

Keep in mind that you should budget for other expenses, too, in addition to the down payment. These include closing and origination costs, insurance and property taxes. Local authorities set their own property tax rates, so the exact amount will depend on the property’s location and any exemptions you may qualify for. A local real estate agent or mortgage lender can help you calculate how much you’ll have to pay.

Many states require investment properties to undergo inspections before tenants move in, so you may need to set aside funds for that, too. Advertising the property and carrying out tenant credit checks cost money as well.

As a rental property owner, you’re also responsible for ongoing maintenance and repairs. These can be expensive, but you must take care of them promptly. Tenants in some states can withhold rent payments if you don’t do necessary repairs on time.

How much money do you need to buy your first rental property?

Investment property financing FAQs

Here are the answers to common questions about investment property financing.

Should I hire a property management company?

That depends on whether you have the time, energy and know-how to manage tenants and handle maintenance and repairs. If you’re new to renting properties, don’t have home repair skills, have a busy schedule or live far away from the property, consider working with a property management company. 

Professional property managers can take care of:

  • Regular maintenance

  • Emergency repairs

  • Property checkups

  • Arranging viewings 

  • Rent collection

  • Tenant placement services 

  • Eviction processing 

Is it better to buy with a partner?

Investing in real estate with a partner can be a great way to pool resources, split costs and improve your eligibility for financing.

However, you will share both the profits and the legal liability. This means that if a tenant alerts your partner to a problem and your partner doesn’t fix it promptly, the tenant may sue you both. With that in mind, make sure that any potential partner is trustworthy, reliable and responsible before investing together.

Is investing in real estate right for you?

Real property investing can be very profitable, but comes with considerable costs, so you should be financially stable before considering this step. Managing real estate can also be time- and effort-intensive, even if you hire a property management company. Make sure you’ll have enough time to manage your investment. 

Another thing to consider is housing market trends. You want to invest in real estate that will rise in value, so you need to carefully analyze potential areas, monitor rental trends and housing market indicators, and watch the direction of property prices and taxes over time. This can be a lengthy process, so make sure you have enough time for research.

Before taking out a loan, consider alternatives to investment property financing

Loans don’t work for everyone. If you don’t meet the criteria for debt-based products or don’t want to tie yourself to a loan, though, you may still be able to invest in real estate.

Alternative, non-debt-based products such as home equity agreements enable you to draw on your home equity without taking out a loan, making monthly payments or incurring interest. 

You’ve spent years building equity in your home. It’s time to unlock it and make it work for you. Start the process here with Unlock.