You’re ready to purchase your first investment property. You’ve already bought a house yourself — but you know that it’s probably going to be a different situation as an investor. What do you need to know about investment property loans?
First: You’re Going to Need a Larger Down Payment
As a first-time homebuyer, you can get a loan at 3.5% down. In fact, you can even get a loan at 0% down if you’re able to secure a VA loan. Investor loans require more — from 10% to 20%, depending on the loan product. Expect to pay a greater portion of the loan.
Investor loans are considered higher risk, so the bank wants to make sure you’re invested. When you’re purchasing a personal house, your own housing is at stake. When it’s an investment property, you can walk away much easier. So, expect to pay more for the mortgage.
Investment Property Mortgage Rates Are Higher than Residential Rates
Of course, the rate itself will depend on your credit score — and that makes having a good credit score even more important for an investor. If you’ve been an entrepreneur for some time, you may have already taken out business loans, business credit, lines of credit, home equity loans, and so forth.
Some quite reliable business owners don’t have excellent credit scores because of this constant churn. Take care of your credit before you apply for an investment property mortgage — or it could cost you a lot over the term of the loan.
There’s a Greater Variety of Alternative Investment Products
For a conventional, residential mortgage loan, you usually have only a few options. You can get a conventional, FHA, VA, USDA loan for 15 to 30-year terms. The residential mortgage industry is highly regulated, as it’s in the government’s best interest to make sure that you’re able to stay in a house once you get into a house.
But investment mortgages are a little broader. There are many investment products, such as “hard money loans,” which can have radically different terms — such as not requiring a credit score or income, but needing to be returned within 5 years. These products are higher risk, but they’re open to more investors, especially investors who are certain of their opportunities.
Investors who can’t get traditional rental property loans should consider working directly with firms that finance investment properties. These real estate investment loans are backed by the value of the property, so they’re still easier to get than personal or unsecured loans. However, you may need to have a business plan ready.
There are even companies that specialize in helping you purchase properties and then renting them out. You send in the down payment, they arrange for the mortgage, and then they arrange for a property management company to take care of the property — even if the property is in another state entirely. These types of real estate investment firms provide an easy way to invest in properties with almost no barrier to entry.
Some other alternatives for investing:
- Personal loans. If you’re purchasing some form of non-traditional property, such as an empty lot that you want to develop, a personal loan could also work. This is also true if you’re purchasing a very affordable rental, such as a small condo.
- Home equity loans. If your existing home is paid off, and you’re having trouble finding investor loans, it is possible to fund the purchase of your investment through a home equity loan on your existing property.
- IRAs. This is a little more complex, but it’s also possible to purchase a property through a self-directed IRA. A self-directed IRA can be used to purchase many types of assets, including investment properties, but you need to purchase it with your IRA money. This can be tremendously useful if you have a well-funded, self-directed IRA because you’d be purchasing property with tax-advantaged money.
Rental Properties vs. Flipped Properties
When investing in real estate, you’re usually doing two things: renting properties or flipping them. Rental property mortgage rates and other investment property mortgage rates are going to be understandably high. Flipped property rates may be higher than rental property mortgage rates because they’re both higher risk and more short-term.
For a flipped property, you could have a loan that’s as short as a year. You are not planning on holding the property, so you’re making larger payments while rehabilitating the property. For a rental property, you’re more likely to have a traditional 15 or 30-year mortgage, because you plan on purchasing the equity over time.
Real estate investment loans will consider the usage of the property that you’re purchasing, so you need to have a plan in mind before you purchase the property.
Qualifying for Investment Home Loans
Understandably, the qualifications for investment property loans tend to be higher than the qualifications for a traditional residential loan, which is why there are so many alternative methods of investment. Real estate investment financing companies will want to see a high credit score and a not-insignificant amount of personal equity, such as equity in a primary residence.
Once you have investment properties, you’ll be able to show that your rental income covers your investment properties — and you’ll have more equity overall. This is what makes it easier to accumulate properties as you go. Your first investment property is going to be the hardest to qualify for. As you qualify for additional properties, you’ll become less of a risk.
Improving the Terms of an Investment Loan
Let’s say that you have access to an investment loan, but the rate is quite high, or the deposit amount is unfeasible. What do you do? There are ways to improve the terms of an investment loan just like there are ways to improve the terms of a residential loan.
First, you can pay for points. That means paying more today for a better interest rate, which will save you money throughout the loan. Understandably, you don’t want to do this for a flipped property (you’re going to be paying back the loan early regardless), but for a rental property, it can increase your profit by a great deal.
You can also get a co-signer. Getting a co-signer for an investment loan can be a challenge, but if you have a business partner who has better credit, higher income, or more equity in their properties, it can vastly improve your chances of getting a business loan.
And, of course, you can also negotiate. If you have a better deal from one lender, don’t be afraid to try to negotiate with the first lender. The first lender may be able to drop your loan down in terms of interest rates or even reduce your loan origination fees.
Renovation Loans for Investors
Sometimes you may be buying a property that’s currently worth $50,000, but could be worth $150,000 with the right work. That’s what renovation loans are for. A renovation loan will give you a certain amount of money for the property, and a certain amount of money on top of that for the renovation. But there are a few things you need to keep in mind:
- A renovation loan usually won’t go over a percentage of the property’s current value. As an example, a 200% loan-to-value ratio means that if the property is worth $50,000 now, the renovation loan won’t go over $100,000.
- Renovation loans generally require that most of the work be done by licensed contractors. You can do some small percentage of work yourself, but you will need professionals to complete the rest of the work.
- Most renovation loans will require that you have a plan and a proposal. You should be able to show that you can increase the property’s value by a certain amount, and be prepared to back this up.
Renovation loans are extremely useful, but they can also be more difficult to acquire than a traditional investor loan. If you have a property that needs a lot of rehab, it’s worth a try.
The Process of Buying an Investment Property
Assuming that you go through a traditional lending process for your mortgage loan, the actual process of purchasing an investment property is going to be almost identical to purchasing a residential property. The lender will check your financial documents, extend the mortgage, and then you’ll go through escrow to acquire the property. Once you’ve acquired the property, all you need to do is keep making the payments!
Buying an investment property requires that you have all your ducks in a row. You need to be prepared for higher investment property rates and higher down payments, you need a good credit score, and you should ideally hold equity in something like a primary residence. But when all of those things are aligned, you’ll find that getting real estate investment financing is a fairly simple process, much like purchasing a residence.
Now that you know the differences between purchasing an investment property and a residential property, how do you get started?
Here’s what you need to do:
- Run your numbers and see how much you can afford. Buying an investment property is tricky because it could remain vacant for some time (if a rental) or take longer than you thought to remodel (if a flip). Don’t forget that purchasing a property costs money, too. You’re going to need to pay for loan origination fees, home inspections, and so forth.
- Check your credit score. For an investor loan, you should have a better-than-average credit score, something around 740 to 760. If your credit score is weak, that doesn’t mean that you can’t get an investment loan, but it does mean that your loan is likely to be sub-optimal. Improve your credit by paying off your debts, paying your debts on time, and making sure that you have a low balance on your credit cards.
- Get a preapproval. Ask mortgage lenders how much they can offer you for an investment property. If you can’t get approval, touch base with investment firms and ask them whether you might be able to be approved (most investment firms will need to see the property itself before they can approve you).
- Look for a property you want to buy. Consider the amount of work that you need to put into the property, the comparable properties available, and the current real estate market. Here is where a professional real estate agent will be able to help.
- Contact multiple options, including traditional mortgage options and alternative investors, to get quotes. Think about the bottom line: how much money is each of these options going to cost you? When comparing these rates, don’t forget to make sure that you can pay the loan off early. If you make more money than you expected, or you flip the house quickly, you want to be able to pay the loan off without penalty.
- Secure your loan. Once the loan is secured, the property transfer can be completed. Make sure the loan is paid on time so you avoid any damage to your credit, even if you’re flipping the house.
It’s that simple. The hardest part of purchasing an investment property involves finding the right property, which is something a realtor can help with. Everything else is going to be up to the banks and your qualifications.
Qualifying for an investment mortgage is going to be a little more challenging than a residential loan, so you should get started immediately. By repairing your credit (if necessary), you can gain access to better options.