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If you’re looking for a new income stream, investment properties can be a smart strategy. The rental market is booming. According to Abodo, the national median rent for a one-bedroom apartment is $1,025.
If you want to become a landlord, you’ll likely need to take out an investment property loan to buy your first investment property. Here’s everything you need to know about your financing options.
4 types of investment property loans
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If you’re thinking about buying a rental property, there are four main loan types:
1. Conventional loans
One financing option is to take out a conventional loan or mortgage. With this approach, you take out a mortgage that conforms to the guidelines set out by Freddie Mac and Fannie Mae — mortgage companies created by Congress.
To qualify for a conventional mortgage, you typically need to put down a significant down payment. For investment properties, you will usually need to put down 20% to 25% of the home’s value, at minimum. For a $200,000 property, that means you’ll need to save at least $40,000 to $50,000 for the down payment.
You’ll need to have good to excellent personal credit, and a low debt-to-income ratio so that the mortgage lender sees you can comfortably afford the monthly loan payments. Ideally, your debt-to-income ratio will be under 36%.
2. Government-backed loans
If you don’t have enough money saved for the down payment necessary for a conventional mortgage, consider a government backed loan. With Federal Housing Administration (FHA) loans and Veterans Affairs (VA) loans, you can get a mortgage with a down payment of 3.5% for FHA loans, and 0% for VA loans.
However, there is a catch: for investment properties, you can only qualify for VA and FHA loans if you buy a multi-unit property — such as a duplex — and live in one of the units.
3. Portfolio loans
If you plan on buying multiple investment properties, you may struggle to qualify for a traditional or government-backed mortgage. An alternative financing option is a portfolio loan. These loans don’t meet Freddie Mac or Fannie Mae guidelines, and the lender holds onto the loan, rather than selling it as a security on the stock market.
Portfolio loans have less stringent borrower requirements, but they tend to have higher interest rates and fees than other mortgage types.
4. Commercial loans
If you’re planning a commercial property, such as an office building or strip mall, you’ll need a commercial real estate loan.
Commercial loans tend to have shorter repayment terms than residential mortgages. And, you’ll have tighter loan-to-value ratio restrictions.
Because commercial loans aren’t backed by the government or private mortgage insurance, they often rely on real property as collateral.
Where to get an investment property loan
When it comes to getting an investment property loan, you have a few options:
Traditional banks
Many banks, such as Bank of America and Wells Fargo, offer investment property loans. Whether you’re buying a single-family home or a multi-family dwelling, you can get a conventional mortgage or government-backed mortgages from most major banks.
Online mortgage lenders
If you want an easy application process you can do completely online, working with an online mortgage lender can be a smart option. Lenders like Quicken Loans and Viso allow you to apply for a mortgage online and handle every step of the process from your computer, with no need to visit a bank during business hours.
Hard money lenders
If you’re having trouble finding financing help, look for a hard money lender. Hard money lenders look at what collateral you have for the loan, rather than your credit score and income.
Rates vary from lender to lender. In general, they have higher interest rates and shorter repayment terms than other loans. However, they can help you get the money you need much faster than other lenders can.
How to qualify for an investment property loan
Qualifying for an investment property loan can be more difficult than qualifying for a residential mortgage. You can increase your chances of getting approved by following these tips:
- Make a down payment: At a minimum, you’ll need to have at least 20% of the home’s value saved to serve as a down payment. However, some lenders will find you more attractive as a borrower if you have 25% to 30% saved, instead.
- Be an ideal borrower: Most lenders will expect you to have good to excellent credit. You can boost your likelihood of getting approved by increasing your credit score. Pay down any current debt, and make all of your monthly payments on time to improve your score.
- Go to a local bank: Some local banks or credit unions may be willing to work with you if you have a smaller down payment or less-than-stellar credit — especially if you are already a customer.
- Negotiate owner financing: In some cases, you may be able to secure owner financing. With this approach, you make payments directly to the homeowner. You’ll typically have a shorter repayment term and higher interest rates with this strategy, but it can be a great option if you struggle to find financing.
- Explore alternatives: If you can’t get an investment property loan, explore other options. You may be able to get enough money with a personal loan or home equity loan to finance the purchase, and get the money more quickly.
Final word
Buying an investment property can be an excellent way to grow long-term wealth. If you don’t have enough money saved to complete the transaction in cash, there are a number of investment property loans available to help you reach your goals.
This article was originally written on November 14, 2019.
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