As you work to get a foot in the door as an investor, you may have asked yourself, “How can I get financing for a rental property?” This is a common concern among prospective investors with the U.S. single-family residential (SFR) rental property market being $4.5 trillion and growing.
A hot market might make you want to invest, but it can be difficult to know where to begin without making costly mistakes.
The demand for single-family residential continues to rise as more than 70 million millennials get married and start families, over 70 million baby boomers retire and reduce their expenditures and members of Generation Z as they begin their education or enter the job market.
Rental SFRs are commonly owned by other real estate investors in the area, and they can provide many advantages, such as:
- A stable passive income each month
- Appreciation
- Equity for future loans
- Protection against inflation and recession
- Various tax breaks
Yet, how do you get started?
What Is A Rental Property Loan?
As the market for SFRs continues to grow, it’s essential to understand the distinctions between conventional mortgages and SFR loans. A rental property loan is essentially a first lien mortgage loan that holds the property as collateral in which the tenant, rather than the owner, resides.
In terms of duration, the renter is normally required to be long-term, while this sort of loan may also be utilized for short-term rentals such as vacation rentals like Airbnb.
What Qualifies As An Investment Property?
Any property purchased with the intention of earning a profit, most often via rental, is known as an investment property. However, only single-family homes , condominiums, and townhouses with four units or fewer are qualified for rental property loans.
One of the key conditions for this loan is that the property has to be rent-ready, which means that fixer-uppers won’t make the cut, even if you want to rent it out later.
Investment Property Vs. Second Home Loans
Since second home loans often have lower interest than investment property loans, you may be wondering if they would also be doable if they want to also use it as a vacation home.
To be classified as a second home, you must have exclusive use of the property and utilize it primarily for your leisure. This means that you can’t rent out the property or get into any timeshare agreements with other people over the property.
On the other hand, if you take out a loan to purchase an investment property, you can charge rent to others while simultaneously using the space for your enjoyment.
Knowing this distinction can help you choose the best loan.
How To Finance A Rental Property
Several requirements must be met before you are approved for financing on an investment property. Knowing which kind of loan is best for you is essential as the wrong type of loan could have a negative influence on your success.
You may finance investment properties using one of four financing options:
- Conventional bank loans
- Hard money loans
- Private money loans
- Home equity loans
1. Conventional Bank Loans
Despite their familiarity with traditional mortgage loans, which largely come from their own experience as property owners, investors don’t always give them the attention they need. Conventional mortgage loans can be obtained via a variety of channels and per Fannie Mae and Freddie Mac’s guidelines.
When compared to other loan options, agency loans have the lowest interest rates but are often the most complicated to get.
Considerable paperwork, a lengthy and unpredictable screening process, and large reserve requirements that rise with the number of loans outstanding are only some of the downsides of these loans.
Other drawbacks of these loans include:
- Large down payments (20-30%) that increase with the number of mortgages you have
- Restricted cash-out refinancing
- Mandatory legal entity to prevent you from borrowing from the property to protect your other assets and personal finances. Meaning, if you stop paying your mortgage, you can’t keep the rental payments
- High credit score requirements
- Clean credit history
2. Hard Money Loans
Hard money loans are the best option for those who need a quick fix to flip a property or to bridge the gap until they can qualify for a more permanent loan. Hard money loans might be used as a temporary fix until an investment loan can be secured on the property as you’re getting the property rental ready.
When compared to traditional loans, hard money loans are distinct in that you make interest-only payments rather than principal repayments. Loan terms may be as long as 36 months, but interest rates can go as high as 18%.
Compared to conventional loans, the origination fees and closing charges on a hard money loan can pile up rapidly, making it an expensive temporary solution.
However, since your property is used as collateral and your credit history is assessed, hard money loans might be the most difficult to qualify for, even though they can be granted in as little as a few days. The ability to repay a loan is calculated using the ARV (after repair value) of a house.
3. Private Money Loans
Private money loans are loans between two persons, such as friends, family members, or coworkers. If you don’t have friends or relatives who can lend you money but still want to take advantage of private money loans, you could join real estate investing networking events.
Depending on your connection with the private lender, the exact terms and interest rates of private money loans could range from advantageous to predatory. Nevertheless, these loans are often secured by a formal contract that permits the lender to foreclose on the property and seize it as collateral if you default on your payments.
Consider your relationship with the private lender as not everyone has your best interests in mind. If you default on your payments, the nature of your relationship with the lender may change too, especially if it’s a loved one.
4. Home Equity Loans
If you currently own a house, you could consider tapping into its equity through a home equity loan, a home equity line of credit (HELOC), or a cash-out refinance. You can borrow up to 80% of the equity value for the purchase of the investment property and/or its maintenance and repairs.
Each option has its benefits and downsides, which may vary depending on the circumstances and your goals. HELOCs allow you to borrow against the equity in the property similar to how you would with a credit card; however, the monthly payments are often interest-only, like hard money loans.
As rates are often variable, they might rise if the prime rate increases, making this form of loan much riskier.
On the other hand, a cash-out refinancing comes with a fixed rate, but it may prolong the term of your existing mortgage. This might imply that you will likely pay a higher interest rate on a longer-term mortgage for your primary residence.
Here, you would need to ensure that the projected returns on investment (ROI) justifies this action before you take the step.
Is It Hard To Get An Investment Loan?
Generally speaking, investment property loans are more difficult to be approved as they’re considered riskier than conventional loans. This means that the lender needs to see various kinds of proof to feel comfortable enough to take the risk.
Each lender and loan kind will have distinct criteria and advantages, which must be weighed against one another. This also implies that the difficulty of obtaining a loan for each form of loan will depend on your circumstances. What is your credit score? Your debt-to-income ratio? Personal assets and cash? Existing mortgages?
Here are some general guidelines:
- A high credit score with a minimum of 720
- A low debt-to-income (DTI) ratio 43% or under
- A high down payment of at least 20-30%
- Substantial cash reserves
- A low loan-to-value ratio (LTV) on the property
For instance, private lenders may simply ask that you have an established connection with them, while hard money lenders may only want a hot real estate market and a high predicted after-repair value (ARV).
On the other hand, home equity loans need a home equity line of credit (HELOC), while traditional loan lenders have the most rigorous income and credit score requirements, but are often the least expensive alternative.
Nonetheless, consider planning about 45-60 days to get a rental property loan depending on the type of loan as bank loans are the most difficult to be approved for followed by agency loans.
Can You Get A 30-Year Loan On An Investment Property?
Many aspiring investors may wonder whether they can secure a 30-year loan on an investment property.
Yes, to put it briefly.
Even though loans with terms of 10, 15, 20, or 25 years are also available, 30-year mortgages are by far the most popular option for second homes.
Although it is possible to get various loan terms, they typically rely on the purchase price, interest rate, and monthly budget. In contrast, higher interest rates or shorter loan periods will result in larger monthly payments, the amount of which will depend on your income and ability to pay.
In contrast, 30-year loans on your investment property will often result in lower monthly payments, but you will pay more interest over the life of the loan.
What Is Required To Be Approved for Investment Property Financing?
Having a high enough credit score, sufficient assets, and a pristine credit history will increase your chances of getting approved for such a loan.
Although similar, it is vital to remember that various loan providers may have varying criteria. This highlights the need of hunting out different lenders to get the most beneficial conditions. Because some lenders are more interested in working with investors and others with first-time buyers, the outcome may also rely on the specific lender you go with.
Although qualifying criteria and loan conditions are important, the type of lender and whether or not you fit their target demographic are typically more decisive.
Your Long-Term Goals
If you’re concerned about being approved for a loan because of your financial situation, a well-thought-out plan for the investment property you’re after may increase your chances.
Give the lender a clear picture of your long-term plan, including the expected return on investment (ROI).
Especially for long-term loans involving investment properties, many lenders would prefer to see your strategy on how you intend to manage, as well as what you are already doing to boost your prospects. This may include actions taken to increase one’s credit score, decrease your DTI ratio, or increase your wealth.
Lenders are human too, they know that people make mistakes and that life has a way of throwing curveballs, making plans and strategies to showcase your effort more important than ever.
Being Realistic About The Property
One of the most important considerations in getting a loan for an investment property is the sort of property you want to buy. This includes questions of cost and potential danger in obtaining it.
Questions to ask yourself:
- Is it move-in ready?
- Can any maintenance be done?
- Is there a sufficient rate of return to justify taking on the debt?
When applying for a mortgage, it might be more challenging to be approved if you apply for a loan for a property that is far outside your financial means.
Picking a property that is just on the edge of your control might be risky, but if you have conviction in this investment and can demonstrate it with a strategy or blueprint for your investment, you may improve your chances of approval.
Your Investment Budget
Your investment blueprint should also include a prospective budget to demonstrate that you have considered and can afford the fees involved and that you have a backup plan if the investment does not pan out.
Including a budget in your approach might indicate that you have thought through the financial understanding of purchasing this/these investment properties and are committed to seeing them through.
Consider including aspects in your budget if you are unable to make loan payments or if your ROI is much lower than expected.
You also need to factor in the possibility that the rental property would sit empty for a while, perhaps even months, before you find a tenant. Regarding the interim, how do you propose to pay for things?
Having these questions answered before presenting your plans to a lender will save time for both of you, and might be the deciding factor in whether or not you are approved.
Getting Approved For Financing For A Rental Property
You can see that getting a loan for an investment property is more difficult, but not impossible. Credit history, credit score, personal assets, and even having an investment plan all play a role in the approval process.
The most important thing is to do your homework, take your time, and compare several lenders to choose the one that best meets your requirements.
You may be dying to take advantage of the current market conditions, but haven’t taken the first step of actively searching for potential homes. New Western has off-market property for you to finally enter the real estate investment world. We are proud of our hassle-free investing opportunities, cutting-edge investment ideas, and streamlined closing procedure.
