Investment in real estate is a good way to ensure supplemental income if the investment decision as far as funding one’s properties is the right one. There are several types of loans for investment properties, each with pros and cons and a suitable fit for a particular investor.
Time to learn how to improve your application chances and get an investment property loan that will help you invest – whether it’s a rental home or flipping a fixer-upper.
What is an investment property loan?
Loans for an investment property are mortgages used to buy an income-generating property. This includes properties you intend to rent or a home you want to fix up and sell for profit, known as “house flipping.”.
Strictly speaking, investment property loans are just mortgages with an invested intention to serve for financing such kinds of properties. And you have other options that allow for cash to be paid in lump sums-but then again, they aren’t particularly suited for real estate investing. So let’s examine both types below.
Most investment property loans have stricter qualifying requirements, higher down payments, and higher interest rates than an average mortgage.
What is an investment property?
An investment property is a real estate you purchase to earn income rather than live in. We are focusing on residential real estate loans for this article, which typically only finance properties with one to four units. Residential investment home types include:
- Condominiums
- Duplexes
- Manufactured homes
- Multifamily houses
- Cooperatives
Types of loans for an investment property
Investment property loan options
| Loan Program | Description | Number of Units Allowed |
|---|---|---|
| Conventional Loans | Standard way to buy an investment property without living there. | One to four |
| FHA Loans (Owner-Occupied) | Buy a home and rent out other units; must live in one for 12 months. | One to four |
| FHA Loans (Multifamily) | Financing for properties with five or more units; requires no major repairs. | Five-plus |
| VA Loans | For eligible military; live in one unit and can buy up to seven. | Two to four for one borrower; two to six for two veterans |
| Nonqualified (Non-QM) Loans | Loans for those who can’t provide full income docs; usually more expensive. | Varies by lender |
| Owner Financing | Loans for those who can’t provide full income docs; are usually more expensive. | Varies by seller |
Other Ways to Finance an Investment Property
| Loan Program | What It Is | How It Works |
|---|---|---|
| Home Equity Loan / HELOC | Borrow against your home equity. | Use cash from equity for a large down payment. |
| Cash-Out Refinance | Take out a mortgage for more than owed. | Use the extra cash for a down payment on an investment property. |
| Hard Money Loan | Quick loans from private investors. | Secured by the property; short-term with high costs. |
For your investment property, what kind of loan is best?
Type of LoanThe very best case scenarioConventional loan
- You don’t like to stay at the place.
- You possess a good credit profile along with a well-documented income.
- You can lay 15% to 25%
FHA Mortgage-owner occupied
- You are ready to spend a minimum of a year residing in one of the apartments.
- The down payment you want to make is not too large.
- You want to find a property that has no more than four units.
FHA loan (multifamily)
- You need to finance a property that has five or more units.
- Its property doesn’t require massive repairs.
VA loan
- You’re a service member, veteran, or military family member with a qualifying certificate of eligibility (COE)
- The intention is to be completely debt free.
VA “joint” loan
- You also want to become co-borrowers with someone, and at least one of you will utilize your VA loan entitlement.
- Your ideal property would have six or more residential units.
Non-QM loan
- You need a loan that will not oblige you to share your income or credit information
- You could almost afford a huge down payment
Owner-financed loan
- You like the idea of keeping the financing in between you and the seller, rather than bringing a third party into it.
- You are sure you can repay fully within five to 10 years.
Home equity loan, or HELOC
- The equity in your house is substantial.
- The borrower doesn’t want to substitute the loan on the house with another.
- You feel at ease having three mortgages open at once: the investment property loan, the home equity loan, or HELOC.
Cash-out refinance
- You own a home with an equity part.
- You may qualify for switching your existing home loan.
Hard money loan
- You are seeking a temporary solution.
- The equity in your house shouldn’t be depleted.
- You do not mind that it costs more in comparison with other available loans.
Minimum investment property loan requirements
Down payment
You can finance a multifamily house with an FHA loan with as little as 3.5% down or a VA loan with 0% down if you’re going to live in one of the units. Although conventional wisdom permits down payments for investment properties as low as 15%, the majority of lenders require at least 20%.
→ How to bolster your down payment: Down payments can be partly composed of gift funds if you are using an FHA or VA loan. Family members, your employer, a union, or a charitable organization are all permissible sources. Not so when purchasing with a conventional loan for a rental home-the money all must be yours.
Cash reserves
This cash, which is more widely known as “mortgage reserves,” is what the lender wants to see on deposit. Depending on the kind of loan program, it’s normally equivalent to between one and six months’ worth of mortgage payments.
→ How to build your reserve funds: Traditional and FHA financing guidelines do allow you to use gift funds toward your mortgage reserves; however, FHA borrowers are required to apply the gift funds toward closing costs first. VA loans do not allow gift funds to be applied toward your reserves.
Income
Additionally, just like with any mortgage, you’ll need to demonstrate that you earn enough money each month to cover your obligations. Conventional lenders cap you at a 45% DTI ratio.
→ How to increase qualifying income: The rental income from the house you are buying can be included in your qualifying income, either actual or estimated. Conventional, FHA, and VA For loans, you can deduct rent from the apartments you don’t live in from your total income. Generally, the lender will request copies of current leases, a rental history, or tax returns, which show rental income.
Credit score
You’ll need a minimum credit score of 620 to qualify for a traditional loan, though the bar rises a tad higher if you can’t put down at least a 25% down payment: subsequently, a credit score of 700 is required.
FHA loans are a bit more generous. You can qualify with a 500 credit score if you put 10% down, or with a 580 if you make at least a 3.5% down payment. VA loans have no minimum, but 620 is generally considered normal by VA lenders.
→ How to raise credit score: Here are some effective and fast ways to raise one’s credit scores, from requesting increases in a credit line to paying for a few outstanding debts.
How to get an investment property loan
It involves a little more process than getting an investment loan.
- Shop around for a mortgage lender. Most lenders have some type of investment property loan, but rates can vary widely between companies. Not all lenders offer non-QM loans, so you may have to make some more phone calls if that’s what you need. Hard money lenders are often private individuals or partnerships; you can ask your real estate agent or other real estate investors for names.
- Fill out a loan application. The application procedure is the same for any other loan type if you’re applying for a standard loan program (such as a conventional, FHA, or VA loan). However, non-QM lenders and hard money lenders may have their own application process or system.
- Extra asset documentation. You will likely need to provide bank statements and current leases or rental information on the property you are purchasing. Lenders generally allow you to use a percentage of your retirement or 401 (k) vesting towards your reserve requirement; have a recent statement available for presentation.
- Pay for an appraisal. A third of the home appraisal process is the average collected rent on similar homes in the area. In some cases, the rental income from this report can be beneficial for you in the qualification process of the loan.
- Review the closing disclosure. The lender is going to provide a closing disclosure three business days before closing. Review it just to make sure that all your numbers are what you anticipated. If you are going for a hard money loan, pay particular attention to any prepayment penalties or “guaranteed interest” language in the closing disclosure. Hard money lenders usually want to make a set amount of interest, no matter how fast you pay off the loan.
- Gather your funds and close. You’ll send a wire or bring a cashier’s check for your closing funds. Your loan funds are disbursed and the property is registered in your name as soon as the mortgage closing documents are signed.
How much do investment property appraisals cost?
The appraisal fees are relatively higher because extra effort has to be given to value the property and the average value of the rent. For a multifamily house, you will have to pay an additional $100 to $300 over the usual $300 to $400 because each unit has to be appraised.
Investment property mortgage rates
Investment properties come with an additional risk that the loan will default, so lenders need to mark up mortgage rates on investment property. Rates for investment properties typically exceed those for primary residences by 0.25 to 0.75 percentage points.
Lenders will also factor your credit score as well as down payment into their decisions. In some cases, low-credit-score borrowers may also have to buy mortgage points to secure an investment property loan.
FAQs
Which loan document indicates the property is an investment property?
It is an affidavit certifying whether a borrower will use the property as their primary residence or a rental.
What is the best investment property mortgage rate possible?
Take the time to improve your credit score, and make the largest down payment possible. Your best chance of obtaining a low investment property rate will be aided by these factors.
How many investment properties can I own?
You can buy as many properties as you can afford, but you are limited to 10 properties with traditional financing.
How does the IRS define an investment property?
Normally, you are required to report all types of rental income, but these, once again, could be reported in different ways, depending on whether you or how frequently you, use the rented property for your personal consumption. If you are not sure how to account for your rental activities, seek professional tax advice.
