A Guide to the Different Types of Investment Property Financing

A Guide to the Different Types of Investment Property Financing

Approximately 44 million people in the United States rent their residences. Some say they do so because leases are flexible, while others like that they don’t have to pay property taxes.

Many renters surveyed in 2022 also plan to continue renting their homes. Over 1 in 3 even said they prefer it over buying a home.

All that makes the U.S. rental market competitive to both renters and property investors.

So if you’re looking for viable investment properties, consider real estate rentals. However, if you are like most buyers, you’d still need investment property financing.

Fortunately, there are several property financing options you can apply for. This guide covers the most common ones, so keep reading. 

Conventional Mortgage

Conventional mortgages, like those used for first homes, are available for investment properties. Most lenders that make primary residence mortgages offer this type of loan.

Like first home mortgages, conventional investment property loans require high creditworthiness. This includes having a good to excellent credit score, ranging from 700 to 800 or higher.

The higher your credit score, the better your chances of securing financing. You can also expect most lenders to offer you lower mortgage rates.

Likewise, having an excellent credit report makes you more creditworthy to lenders. This includes consistently paying debt on time and having a low debt-to-equity ratio. It also helps to have older credit accounts and a few inquiries for new credit.

However, most conventional investment property lenders also require higher down payments. So if they usually expect first-time home buyers to make a 20% down payment, they expect investors to put down 30%. Thus, if the property you’d like to finance costs $400,000, prepare to make a down payment of $120,000.

Your income and assets will also affect your eligibility for a conventional mortgage. They’d play even more significant roles if you’re still paying for your first home loan. Lenders want to ensure you can afford to pay for multiple loans simultaneously. 

Home Equity Financing Programs

Suppose you already have a primary residence, but you’re still paying its mortgage. Let’s also say your home is now worth $300,000, but you still owe your mortgage lender $50,000.

In the example above, your equity, or the value of your interest in your home, is $250,000. In percentage form, your equity is 83.33% ([$250,000 / $300,000] X 100%).

You can use that equity to finance the purchase of a real estate investment property in two ways. The first is through a home equity loan, while the other is through a home equity line of credit. 

Home Equity Loan

A home equity loan is a secured loan that uses the same house you have equity on as collateral. In most cases, lenders allow you to borrow up to 80% of the equity you have in your home. So if we use the same example above, you can borrow up to $200,000 (80% X $250,000).

A home equity loan is a new loan that places a new lien on your house. It doesn’t delete the balance you have on your original mortgage. So by taking out an equity loan, you’ll have two debt accounts and liens associated with your home.

Also, since a home equity loan uses your home as collateral, you risk losing it due to non-payment. So before applying for this loan, consider getting advice from finance lawyers first. They can help you determine if it’s your most viable option and, if not, educate you on the best alternatives. 

Home Equity Line of Credit (HELOC)

Like a credit card, A HELOC is a revolving line of credit. In most cases, the limit set on a HELOC (the maximum credit amount you can use) is 80% of your equity. You can use it up to its limit to finance your investment property purchase.

Every time you pay off your HELOC balance, you can use the paid-off portion again. For example, suppose you owe $150,000 but paid it back in full. Once your payment gets credited to your account, you can use the $150,000 again.

Since a HELOC is still a type of home equity financing, it also uses your house as collateral. So, please ensure you repay your dues on time to avoid foreclosure. 

Hard Money Loan

Also called bridge loans, hard money loans are short-term loans secured by hard assets. Real estate properties are the most common collateral used to back these loans.

As hard money loans are short-term loans, they’re best used for financing house flips. A house flip is when you buy, renovate, and sell a property for a profit instead of holding on to it. You make a one-time lump sum income from its sale instead of renting it out.

While that means you won’t earn continuously, flipping can still be an excellent way to make money. You can then use the income you generate from flipping to invest in other properties.

However, be careful when taking on hard money loans, as they usually have high rates. The upside is that they have less stringent requirements than conventional mortgages. 

Private Money Loan

Private money loans are financing contracts between two individuals. The lender is usually a family member or a close friend of the borrower.

Some private investors also offer such loans to other investors, including first-timers. They usually belong to local real estate investment clubs. They can be an ideal alternative if you don’t have a close friend or family who can loan you money.

However, do your due diligence, as some private lenders can charge predatory rates. They may also specify in the contracts how they can foreclose on a property in case of non-payment.

Choose Competitive Investment Property Financing Offers

Remember: Investment property financing programs are high-amount loans. Thus, they’re also among the most expensive, and the longer their term, the more they cost overall. So if you decide to apply, choose the one with the most reasonable rate and requirements. 

Lastly, consider lawyering up before making any real estate transaction. A lawyer can help you make sound investment decisions and even secure financing.

If you enjoyed this article, you’d love our other home-buying guides. So, check out our post on overcoming affordability challenges in today’s housing market!

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