Financing an investment property has several lucrative benefits to offer. For example, it can act as a hedge against inflation. Or it can also bring in rental income for investors.
Regardless of the motive, real estate property investments are sure to take a significant toll on capital holdings for investors. Although most investors prefer keeping ample capital storage, it is pretty easy to fall short now and then with the lucrative options.
This is when investment property loans come to save the day.
As the name suggests, investment property loans are custom-created plans for real estate investors.
But, the real question is- How do you secure one? Or, more importantly, how do you know which option is better for you?
Worry not. We’re here to help.
Keep scrolling to find out the options that you can choose for your investment property loan.
Options for Financing a Real Estate Investment
There are primarily three types of loans or mortgage options for real estate investors. They are – Conventional bank loans, hard money loans, and home equity loans.
It is noteworthy that financing for property investors can take several forms. It is better to Prequalify yourself and check your mortgage availability before applying for an investment loan. Depending upon the type of investment, the financing options may also vary.
For example, a fix and flip investment financing might not be the same as rental investment financing.
Thus, you need to choose the correct loan type to gain the desired profits out of your investment.
Let’s learn in detail about the three financing options.
Conventional Bank Loans
You’d probably own a home that you’ll be using as your primary residence. In that case, you’ll most likely be familiar with conventional housing finance.
The federal government does not usually back a conventional loan. But, instead, it conforms to the guidelines set by Fannie Mae or Freddie Mac.
That being said, for taking out a typical mortgage or bank loan, investors need to pay 20% of the home’s purchase price as a downpayment. The rest, 80%, can then be financed.
Whereas when you’re seeking finance for investment purposes, the downpayment may increase up to 30%.
Besides, conventional loans determine the approval based on the credit score or history of the applicant. And when seeking a loan for investment, the lenders may also consider other factors.
For example, a lender may wish to review the borrower’s income and expenses. The lender may additionally want to look at the assets and other stock holdings of the borrower.
In short, for availing of a conventional bank loan, the investors would need to prove and assure the lender that they can repay the mortgage.
It is also noteworthy that some lenders may require borrowers to have at least six months of cash to cover mortgage obligations. This ensures that even if the property is not sold or rented out, the borrower can repay the loan. For this, the borrowers usually factor debt-to-income ratio.
Rental income isn’t factoring in the debt-to-income ratio.
Hard Money Loans
Rental property investments indeed have their perks. But, it’s not for everybody.
Some investors are more interested in earning a lump sum profit on their investment in one go rather than waiting for a rent check every month.
Yes, we are talking about house flippers.
Typically, flippers buy a property that needs minor or mendable fixes, restore it to suit marketable conditions, and sell it out.
Now, for such investors, conventional bank loans might not be a good option. Instead, they can find a short-term loan known as a fix-and-flip loan.
Also known as hard money loans, these allow the borrower to complete the renovation work and put it back on the market as soon as possible.
They are called hard money loans because the investment property itself secures these. So, failing to repay the loan may lead to foreclosure of the property by the lender to fill up the lost payments.
The bright side of using a fix-and-flip loan to finance an investment property is that it’s easier to qualify than conventional bank loans.
Although the lenders would still consider the borrower’s credibility, their primary focus is on the profits that a property can make.
Typically, the lender would use the home’s estimated ARV (after-repair value) to review the borrower’s ability to repay the loan.
However, there’s a downside too. Generally speaking, hard money loans come with higher interest rates (it can go as high as 18%), depending upon the loan amount, lender, and the repayment period.
Origination fees and closing costs may also be higher for hard money loans.
Home Equity Loans
The other option to secure financing for real estate investments is refinancing or cashing out on home equity.
For investors who already own a real estate property, this might seem the easiest option.
Perhaps, using a home equity loan can guarantee a longer-term repayment at lower interest rates. Indeed, real estate investors for long-term rental or fix-and-flip properties can borrow up to 80% of their primary property’s equity.
That being said, using equity to finance a real estate investment does not come without any cons. Depending upon the type of loan, the interest rate or the term of the loan can vary.
For example, using a home equity line of credit (HELOC) to finance real estate investment comes with monthly payments. But, notably, these payments are usually only the interest. Meaning, HELOC works similar to a credit card, which comes with a variable rate of interest.
In contrast, cash-out finance comes with a fixed rate of interest. However, it would also mean a longer repayment term for an existing mortgage.
In short, it is advisable to weigh anticipated returns against the repayments to be made against the existing mortgage.
Variable HELOC rate may also lead to an increase in payment amount with a change in the prime rate.
Real estate property investments are risky ventures. However, if done right, these investments have great potential.
Finding the money to take advantage of such a lucrative investment opportunity doesn’t have to be a hurdle. All that’s needed is to know where to find the money the right way.