Investment property financing allows you to acquire residential real estate for investment purposes. This can be in the form of a short- or long-term investment, such as a fix-and-flip or fix-and-hold property.
Different types of loans can be considered for investment property financing. Common examples include conventional mortgage loans, owner financing, home equity loans (HELOANs), and hard money loans. Commercial real estate (CRE) loans are a popular alternative to investment property financing, although the programs typically carry less favorable rates.
If you’re looking for investment property funding, we recommend RCN Capital. It offers competitive rates, fast approvals, and flexible qualifications.
Common Uses of Investment Property Financing
Investment property financing is commonly used in three scenarios: conducting a fix-and-flip, acquiring a property as a fix-and-hold investment, or retaining long-term ownership for income purposes.
- Fix-and-flip: Investors conducting a fix-and-flip typically acquire a property in need of repairs at a below-market price. They will then conduct repairs before reselling the property at a higher price. Ideally, the new sales price will leave the investor with a net profit once the cost of repairs and the initial cost of acquiring the property have been taken into account.
- Fix-and-hold: This is similar to a fix-and-flip, but instead of reselling the property after repairs have been completed, the investor will retain the property to be used for income purposes, such as a rental property.
- Long-term income generation: Properties that do not require any repairs can be purchased by an investor for income generation. This commonly takes place in the form of a rental property.
Common Types of Investment Property Financing
Different types of loans can be used for investment property financing. Below is a list of popular options that you can use and may be best for your circumstances.
Conventional mortgages often provide the best rates and terms for long-term financing, but you’ll typically need to have good credit, income, and a strong down payment. They are commonly backed by government-sponsored entities, such as Fannie Mae and Freddie Mac. As a result, qualification requirements will be similar across lenders. These loans are offered by many types of banks, credit unions, online lenders, and loan brokers.
Government mortgages are insured by the US government and include loans issued by the Federal Housing Administration (FHA), the US Department of Agriculture (USDA), and the Department of Veterans Affairs (VA). Since loans are insured, lenders are at lower risk in the event of a default. As a result, rates can be lower than many other types of loans.
A downside to these loans, however, is that eligibility can sometimes be limited. For example, VA loans are typically only issued to individuals with qualifying military service.
If you own a home and have sufficient equity, these options will allow you to get funding by tapping into your property’s equity. A HELOAN provides a single lump sum of funds, while a line of credit gives you the flexibility to draw funds on an as-needed basis. Each requires your home to be pledged as collateral.
Some lenders may only consider your primary residence when it comes to issuing these types of loans. If you have a nonowner-occupied property, you’ll need to consider an investment property line of credit.
A hard money loan often has more flexible qualification requirements compared to other loan programs. This can be beneficial for those with bad credit or finances. It can also allow you to get a property in need of repairs if it otherwise would not qualify for conventional methods of financing.
You can view our picks of the best fix-and-flip loans, as hard money loans are popular with many fix-and-flip investors.
Owner financing allows you to borrow from the seller of a property rather than a bank or other lending institution. Since no bank is involved, this can be a good option for borrowers who are unable to get approved from a lender—you’ll just need to find a seller willing to offer this option. It can also be a good avenue for buyers who want loan terms not typically offered by a traditional lender. Payments are made to the seller until the debt is satisfied.
A balloon mortgage is typically a short-term loan with low or no monthly payments. At the end of the term, you’ll be required to make payment in full to satisfy the entire loan balance. Investors often make this final payment by refinancing to another type of loan.
Interest-only mortgages are structured such that payments only consist of accrued interest charges. In other words, the principal balance of your loan will remain unchanged. This is beneficial as it can provide lower monthly payments. At the end of the loan term, however, you’ll often be required to pay off the entirety of the loan balance. This can be done by refinancing or getting a new loan.
A blanket mortgage can be used to acquire multiple properties with a single loan. This can save time from having to apply separately to finance each home. With it, you can also get the flexibility of selling an individual property without needing to pay off the balance of the loan.
Who Should Consider Investment Property Financing
If you think that you can get a good return on investment (ROI), investment property financing can give you the funds needed to acquire a particular piece of property faster. While there are some potential risks to consider, the benefits of this type of financing could outweigh the risks if you fall into any of the following scenarios:
- The property has a high expected ROI: Your ROI can be based on the monthly cash flow you expect to receive or the amount of profit you’ll get if you are reselling the property. You should factor in expenses like monthly housing payments, vacancy rates, property taxes, homeowner’s insurance, and repairs. It’s also a good idea to consider its impact on your taxable income.
- You are willing to use cash for a large down payment: You’ll typically need a down payment of at least 20% or more to get investment property financing. Although that goes toward your ownership of the property, it can take time to convert the equity to liquid funds. For this reason, you should see to it that you have other easily accessible funds to meet your other personal and business expenses.
- You can carry additional debt: Getting a loan for investment property financing carries the risk that your ROI may be less than expected. Regardless of whether you are a fix-and-flip or fix-and-hold investor, ensure you can afford the monthly payments if a property sits vacant or is unable to be resold as quickly as you anticipated.
- You are a new investor with no prior business history: Since many lenders that offer investment property financing place a larger emphasis on your personal finances, it’s very common for new investors to be able to get approved for a loan with no prior business experience.
How to Finance an Investment Property
From your investment property financing loan options, you should look at which ones will help you meet your goals. You can consider loan terms such as length of repayment, loan amounts, rates, and fees. Other loan terms to think about can include whether there are any balloon payments, prepayment penalties, or interest-only payments.
Also, consider whether you prefer a fixed-rate loan or an adjustable-rate mortgage (ARM). ARMs often offer a lower initial rate that is fixed for a short period, usually one to seven years. At the end of the introductory period, the rate will then be subject to change based on market conditions.
The best loan for you must be one that you can get. For this reason, you should check to see if you meet the eligibility criteria. While specific qualification requirements can vary from lender to lender, some loan types have a standard set of criteria that all lenders will require you to meet.
Common qualification requirements can include the following:
- Credit score
- Time in business
- Annual revenue
- DTI ratio
- Debt coverage ratio
- Down payment
Depending on the type of loan you’re looking to get, your available options may include banks, credit unions, brokers, and online lenders. Each has its own set of pros and cons.
- Banks can have a wide variety of loan options but often have strict requirements to get approved. Using a local bank also gives you the ability to speak with someone in person to answer any questions or concerns you may have. View our recommendations of the leading banks for small businesses.
- Credit unions operate as not-for-profit financial institutions. As a result, rates and fees can be more competitive compared to a bank. Many credit unions are also known for delivering a high level of customer service and can provide more flexibility in qualification requirements. Our roundup of the best credit unions for small businesses can help you find a provider that fits the bill.
- Brokers have a network of lenders that can be used to give you more loan options which can be helpful if you’re having trouble getting approved. By applying with a loan broker, you can save time from having to apply separately with multiple lenders. However, brokers often charge a small fee in exchange for this service. Check out our top-recommended business loan brokers.
- Online lenders can offer some of the most competitive pricing in terms of rates and fees because they do not have as many costs associated with leasing physical office space. Online lenders can also be banks, credit unions, or brokers. For example, Lendio is a broker that operates primarily online and has been consistently selected as a top pick of ours for many different types of loans. Visit Lendio for more information.
Once you’ve found a lender, your next step will be to submit an application. To verify the information on your application is correct, lenders will request certain documents from you. These items will vary based on the lender and loan program, but commonly include:
- Personal tax returns (most recent 2 years)
- Business tax returns, if applicable (most recent 2 years)
- Pay stubs (covering the most recent 30 days)
- Form W2 (covering the most recent 2 years)
- Bank statements (most recent 3 months)
- Copy of loan statements or promissory notes for new credit recently obtained
- Proof of current housing expenses (mortgage statement, homeowner’s insurance, and homeowner’s association bills)
Commercial bridge loans and other CRE financing programs are popular alternatives to investment property financing. Some notable differences will determine which is best for you.
- Property type being acquired: Investment property financing can be used to acquire residential properties such as single-family homes, condominiums, and townhomes. Properties with two to four units can also be funded with multifamily financing. CRE financing, on the other hand, is used to acquire or make improvements to a commercial property that will be used for business purposes.
- Interest rates: Commercial real estate loan rates tend to be higher than investment property financing. This is partly due to the fact that many loans have more strict qualification requirements, and therefore present a lower risk for the lender.
- Loan amount: You’ll usually be able to get a larger loan amount on a CRE loan. Many lenders offer loans up to $20 million and higher. Most investment property financing companies, however, must conform to the guidelines set forth by the Federal Housing Finance Agency. Loans exceeding those limits are categorized as jumbo loans, which carry higher rates, fees, and qualification requirements.
- Credit score: Investment property financing typically requires higher credit scores than CRE financing and a minimum score of 680 is recommended. However, exceptions do exist, and some forms of investment property financing have similar requirements to CRE financing of around 600 and above.
- Time in business: Many investment property financing loans have no minimum requirement for your time in business as long as you can demonstrate a stable source of income for the past two years. That source of income will be used to determine your capacity and ability to repay the loan. Although not required by all lenders, it is more common for CRE loans to require some experience with managing investment properties.
- Tax treatment: The loan you choose can impact which tax benefits you are eligible for. This can depend on things like your business structure and whether you plan on using any other tax benefits, such as selling other properties and deferring gains or losses in a 1031 exchange. Due to the complexity of tax rules and regulations, it’s recommended that you contact a tax professional before making any decisions.
Bottom Line
Investment property financing will allow you to acquire residential property for income purposes. You can choose between several different types of loans, and the best one will depend on your goals and whether you meet the eligibility criteria. It’s important to understand your options before applying and shop rates with multiple lenders. It’s also a good idea to check with a tax advisor or other professional to determine how purchasing an investment property could affect your finances.
