Investment Property Financing: What It Is & Who It’s Right For
Tricia has nearly two decades of experience in commercial and federal government lending. Her expertise is highlighted throughout small business loan content on Fit Small Business.
Andrew has over a decade of experience in finance and mortgage lending. He shares his expertise in Fit Small Business’s financing content.
This article is part of a larger series on Business Financing.
Investment property financing is used to acquire residential real estate for income purposes. Financing options can include conventional mortgages, owner financing, home equity loans, and hard money loans. Income is commonly earned by using the property as a rental or by conducting renovations and reselling it for a profit.
Properties that can qualify for investment property financing include single-family homes, condominiums, townhomes, manufactured homes, and multiunit properties. Compared to commercial real estate (CRE) loans, the rates and fees tend to be lower. Many lenders also have qualification requirements that place a larger emphasis on your personal finances rather than your business.
If you’re unsure where to start looking for a provider, you can check out our guide to the best investment property loan providers. Many of the companies mentioned, such as PennyMac, offer competitive rates, fast approvals, and easy qualification requirements.
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 make sure you have other easily accessible funds to meet your other personal and business expenses.
- You have the ability to carry additional debt: Getting a loan for investment property financing carries a risk that your ROI may be less than expected. Regardless of whether you are a fix-and-flip or fix-and-hold investor, make sure you can afford the monthly payments in the event that 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.
Common Types of Investment Property Financing
You’ll have many different options when it comes to choosing the type of loan you need for investment property financing. The best one for you will be the one you can get approved for, as each type of financing has its own set of qualification requirements and loan terms.
Conventional Mortgage Loan
A conventional mortgage loan is one of the most common types of investment property financing. These loans aren’t insured by the government and are offered by many banks, credit unions, and online lenders. Qualification requirements are fairly standard across lenders as many require these loans to adhere to criteria set forth by government-sponsored enterprises such as Fannie Mae and Freddie Mac.
Government Loans
Government loans are insured by the United States government. Some examples include loans issued by the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), and the US Department of Agriculture (USDA). Compared to conventional loans, government loans tend to be easier to qualify for. However, rates and fees can be higher and have more restrictions on who is eligible. VA loans, for instance, are only issued to individuals with qualifying military service.
Home Equity Loan & Investment Property Line of Credit
If you currently own property, you can use a home equity loan to tap into your property’s equity for funding. With a home equity loan, you’ll get a lump sum of funds deposited into your bank account.
You can also consider a home equity line of credit (HELOC), which is a revolving line of credit that allows you to draw funds on an as-needed basis, usually for up to 10 or 15 years. In exchange for that flexibility, however, HELOCs typically have variable interest rates where monthly payments can fluctuate.
Most home equity loans are issued only on owner-occupied properties. An investment property line of credit is often needed if you want to tap into the equity of a nonowner-occupied home. Investment property lines of credit function the same as a HELOC, although rates may be higher.
Hard Money Loans
Hard money loans are a form of short-term financing, usually with a term of fewer than 18 months. This type of loan is often used by fix-and-flip or fix-and-hold investors who are unable to get financing elsewhere due to bad credit. It can also be used if you want to acquire a property that isn’t eligible for other loans due to its poor condition.
Fix-and-hold investors utilizing a hard money loan to acquire a property will often replace this short-term loan with a more permanent source of financing once the property is repaired. They will then resell the property for a profit once the repairs and upgrades have been completed.
If you’re thinking about flipping properties for profit, you can look at our list of the best fix and flip loan providers to get you the funding you need.
Owner Financing
Owner financing allows a buyer to acquire a property without borrowing money from a lender. Instead of having a buyer make payments to a lender, the payments are made to the owner of the property until the debt is satisfied. Terms can vary on a case-by-case basis and require the buyer and seller of the property to agree on loan terms, such as the amount to be financed and the required installment payment amounts.
Balloon Mortgage Loan
Balloon mortgages are typically short-term loans that offer low monthly payments and require payment in full after a short period of time—usually between five and seven years. Loans can be repaid by making a lump-sum payment, selling the property and using the net proceeds to satisfy the loan, or refinancing into another loan.
Interest-only Mortgage Loan
With an interest-only mortgage, loan payments will only cover the interest charges. While you’ll have lower payments, one drawback is that the principal balance of the loan remains unchanged.
At the end of the loan term, you’ll be responsible for paying off the entire balance of the loan. This can be done by selling the property and using the net proceeds to pay the loan, getting another type of loan to satisfy the balance, or making a lump-sum payment from your bank account.
Blanket Mortgage Loan
A blanket mortgage can be used to acquire multiple properties using the same loan. This can simplify payments and save you time from having to apply for multiple mortgage loans for different properties. A blanket mortgage also gives you the flexibility to sell a property without invoking the due-on-sale clause in the mortgage, something that would otherwise require the loan to be paid in full upon selling a property.
You can save time by gathering the necessary paperwork before applying for a loan. You can also improve your chances of getting approved by learning what the qualification requirements are for a specific loan. For a streamlined experience, you can read our guide on how to get a small business loan.
Summary of Terms & Qualification Requirements
Terms and qualification requirements can vary depending on the type of loan you’re getting. However, there is a range of rates and fees you can typically expect to see from investment property financing providers.
CRE financing, including short-term loans like commercial bridge loans, has some similarities to investment property financing, so we’ve included typical terms and eligibility criteria to help you compare the two and decide which one is best for you.
Investment Property Financing | CRE Financing | |
|---|---|---|
Interest Rates | 6.5% to 8.5% | 7% to 15% |
Typical Loan Term | Up to 30 years | Up to 25 years |
Loan Amount |
| $20 million and up |
Minimum Credit Score |
| 600 |
Minimum Time in Business | Typically none required with a 2-year history of stable income | Varies, but 6 months is recommended |
Income and Debt Requirements | 45% or less DTI ratio | 1.25x DSCR |
Down Payment | 15% to 30% | 10% to 25% |
Investing Experience | None | None |
Funding Speed |
| 10 to 60-plus days |
Investment Property Financing vs CRE Financing
The type of investment you choose will be one factor in determining whether CRE financing or investment property financing is the best choice for you. Here are some of the major differences between the two:
- 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’ll be used for business purposes.
- Interest rates: CRE 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 providers offer loans up to $20 million and higher. Most investment property financing providers, however, must conform to the guidelines set forth by the Federal Housing Finance Agency (FHFA). Loans exceeding those limits are categorized as jumbo loans, and these 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 providers, 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.
How To Finance an Investment Property
From your investment property financing loan options, look at which ones will help you meet your goals. You can take into consideration 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, 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
- Debt-to-income (DTI) ratio
- Debt service coverage ratio (DSCR)
- 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: 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.
- Credit unions: 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.
- Brokers: Loan 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 to multiple lenders. However, brokers often charge a small fee in exchange for this service.
- Online lenders: Companies that operate primarily online can offer some of the most competitive pricing in terms of rates and fees because they don’t have as many costs associated with leasing physical office space.
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 two years)
- Business tax returns, if applicable (most recent two years)
- Pay stubs (covering the most recent 30 days)
- Form W2 (covering the most recent two years)
- Bank statements (most recent three 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)
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 shopping 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.
