There are more ways to finance real estate investments today than ever before. You have different financing options depending on the:
- type of property,
- amount you need to borrow, and
- condition of your investment.
Investors just getting started may have fewer choices available. But as your portfolio grows, more options open up. This could make it easier to meet the needs of specific fix-and-flip or rental investments.
Financing options for real estate investors fall into several different buckets. They range from various types of investment property mortgages to hard-money lending and portfolio loans. You can even turn to peer-to-peer lending platforms or crowdfunding to get the money you need.
The best real estate financing options depend on the project. It pays to know the possibilities.
1. Investment property mortgages
A conventional mortgage tailored to investment properties may be the best choice for new real estate investors. Investment property mortgages operate the same way as a first mortgage on your home. Lending requirements may be more stringent and interest rates can be higher, though.
Borrowers may be able to find loans requiring just 10% down for an owner-occupied property. You could pay even less if you get a Federal Housing Administration (FHA) loan. But most investment property loans require 20% down. Multi-family properties, from duplexes to luxury high-rise apartments, might require 25 to 30% down.
Investment property loans carry higher interest rates than conventional mortgages for owner-occupied properties. They may also carry fees of 3.75% or higher. You can offset the fees, which are due at closing, by paying more in interest. In general, each percentage point in fees will add 0.125% to 0.250% to your interest rate.
Consumers buying a mortgage for a primary residence often opt to do the reverse. Homebuyers can buy points to reduce the interest rates and save thousands of dollars over the life of the loan. But investment property mortgages are often shorter than consumer mortgages. And, many times, they're paid off before they mature. For these loans, paying more in interest might make sense.
It’s important to do the math and determine whether it’s worthwhile to pay the fees or pay a higher interest rate.
As with conventional first mortgages, most lenders look for a FICO credit score of 620 or higher to qualify you. Mortgages on rental properties often require a credit score of 640 or higher. In either case, you could pay higher interest rates if your score is below 740.
Lenders will also request W-2 forms showing at least two years of steady employment.
If you have any shortcomings in your credentials, like a low credit score or lack of employment history, you may be able to offset them with a higher down payment.
Before borrowing for an investment property, lenders consider whether you have the cash to maintain the property. You should have four to six months' worth of cash on hand to cover principal, interest, taxes, insurance, and any homeowners' association payments.
Do you have multiple investment properties? The lender might want to see more cash on hand to cover the expenses associated with those properties, too.
You can use conventional mortgages to borrow money for up to four investment properties at any given time. If you want to mortgage a fifth property, you’ll need to consider a portfolio loan or commercial residential real estate loan.
2. Government-backed loans for investors
Homeowners often turn to government-backed FHA or VA loans to buy their first home or subsequent owner-occupied properties. These loans are enticing, with low interest rates and down payments as low as 3.5%.
You may qualify for an FHA loan at 3.5% down if you have a credit score of at least 580. Borrowers with scores of 500 to 579 may still qualify if they can put 10% down. You’ll need to pay a mortgage insurance premium (MIP) on top of your principal, interest, and taxes if you put down less than 20%.
To qualify for an FHA loan, the home you’re purchasing must be your primary residence for at least 12 months. You must also move in within 60 days of closing.
It sounds counterintuitive to seek out an FHA loan for an investment property. After all, you’re purchasing property with the intent to fix and flip (often in less than 12 months) or rent it out. However, if you purchase a duplex or larger dwelling, you can live in one of the units and rent out the rest.
You can also use an FHA or VA loan for house flipping as long as you hold the property and live in it for at least 12 months.
An FHA or VA loan may not be the ideal way to launch your career as a real estate mogul, but it can give you a jumpstart if you're short on funds for a down payment or your credit score is less than stellar.
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3. Home equity loan or home equity line of credit (HELOC)
What if you don’t have six months' worth of cash or liquid assets to back an investment property mortgage? You might consider borrowing against the equity in your primary residence. You can use a home equity loan or HELOC to finance your investment properties.
Keep in mind that whenever you borrow money against your home, you risk losing it if you can’t make the payments. But a cash-out refinance could actually lower your mortgage payments. So you might come out ahead regardless of how your new investment performs.
As long as you aren’t counting on the rental property income from your new investment to pay your primary mortgage, you can minimize the risk inherent with a home equity loan.
If you don’t have enough home equity to finance an investment property in full, consider using a home equity loan or tapping into a home equity line of credit to borrow 20% of the investment property purchase price. Then use that money as a down payment to secure an investment property loan.
4. Commercial residential real estate loans
Seasoned investors may consider commercial residential real estate loans. Don’t let the name confuse you. These aren't loans for commercial properties such as shopping centers or big-box store properties. They're residential loans for investment pros, typically with multiple properties in their portfolio. These loans are designed for landlords and people who continually fix and flip homes.
Due to shorter terms and higher interest rates, many of these loans are considered "hard money" loans. Some lenders eschew this designation and simply call their offerings "mid-term loans."
Hard money loans have gained a reputation of having high interest rates and predatory terms. But when the lending environment is more competitive, many "hard money" lenders offer favorable interest rates and flexible terms.
Non-conforming loans, or loans that don't meet conventional bank criteria for a mortgage, typically require 15–20% down. Rather than evaluating your job history, lenders look at the income of your other rental properties and your investment history to qualify you for the loan.
Your credit score will also come into play to varying degrees. But the profitability of the property and your overall investment portfolio is key to getting the best rates on hard money deals.
Typically, private lenders that issue hard money and mid-term loans want to see that you have at least two investment properties under your belt. It's even better if you have four or more.
Commercial residential investment loans can help you grow your portfolio. If you’re looking to fix and flip a property, you may not need a conventional mortgage with a term of 15–30 years.
You can save substantial amounts on interest by turning to a bridge loan or mid-term loan. These are two types of hard money loans with terms from six months up to nine years.
Unlike conventional loans, which can take weeks to close, some mid-term lenders promise closings in as little as 48 hours to one week.
5. Portfolio loans
Like hard money loans for single properties, portfolio loans are for seasoned investors looking to invest in multiple properties at the same time.
Consider a portfolio loan if you’re looking to invest in a new community of single-family rentals or a block of homes.
Just like you can save money when you buy in bulk at a warehouse club, mid-term lenders offer savings if you mortgage more than one property at the same time. You’ll also reduce paperwork and save time since you’re only going through one loan application and one closing to borrow money for multiple properties.
6. Peer-to-peer lending
Peer-to-peer (P2P) lending has been gaining momentum for individuals and real estate investors alike. Online P2P lending can often generate funds faster than conventional lenders with less red tape and fewer regulations.
P2P lending connects borrowers with investors willing to fund their projects through a non-traditional loan. Some P2P lenders require low loan-to-value ratios of 65%, so you may not be able to borrow all the money you need for your investment project. Additionally, there's no guarantee with P2P lending that your loan will get funded even if you meet the criteria.
Creating an enticing loan listing and knowing how to market it will help you stand out in a sea of investors seeking funding for their next fix-and-flip or rental property. This type of loan isn't right for everyone.
Which real estate financing options should you choose?
One or more of these financing options may appeal for different properties at different times. Use this table to compare your choices:
|Investment Type||Best For||Down Payment|
|Investment property mortgage||New investors, less than 4 properties at a time||20–30%|
|FHA/VA loans||Veterans, new investors, one property at a time||3.5–10%|
|Home equity loan or HELOC||New investors, investors with no liquid cash who own at least one property||As low as 0%|
|Commercial residential loan||Seasoned investors||15–20%|
|Portfolio loans||Seasoned investors, less than 4 properties at a time, multiple dwelling units||15–25%|
|Peer-to-peer lending||New or seasoned investors, single or multiple properties||Up to 35%|
Whatever type of financing you choose, make sure you’re comparing apples to apples when it comes to terms, fees, and interest rates.
You don’t want to fall short on funds when it comes time to buy out a bridge loan or face prepayment penalties to pay off a conventional mortgage before it's due. Use a mortgage calculator to find out your possible monthly payments before you apply.
You don’t need to be independently wealthy to start investing in real estate. But you do have to understand the choices available to get the financing you need. Find a lender or trusted financial advisor to guide you through the process to ensure you’re choosing the right loan for your specific situation.