Investing in real estate can increase your cash flow and bring you new income opportunities. If you don't have the money on hand to purchase a property with cash, then selecting the right type of loan is essential to keep a healthy financial state.
4 Types of Real Estate Investment Loans
No matter what kind of investment property financing you choose, be sure you fully comprehend all terms and conditions before signing. Beware of a balloon payment, which would require you to pay a large lump sum at the end of the loan.
Conventional Loans
You can use a traditional mortgage, much like the mortgage on the house you live in, to purchase an investment property. These conventional loans range from ten to 30 years and must be paid off when the property is sold. The shorter the term of the loan, the higher the payment will be. This type of loan typically offers the lowest interest rate, so you can pay off your investment quicker.
You will need a minimum of 20 percent of the property value to put down for a conventional investment loan, as these types of loans do not allow for lending more than 80 percent of the property value. The riskier the loan, the more money you will have to put down. Closing costs will also be associated with the loan in addition to the down payment. These costs usually range from three to six percent of the loan amount, depending on your lender.
A minimum credit score of 620 is required, and some lenders require it to be higher than that. Debt-to-income ratios must not exceed 45 percent, including the new mortgage payment.
Though market conditions dictate interest rates, the more money you put down and the better your credit history, the lower interest rate you will be awarded, as you pose a lesser risk to the bank. If you have a contract from a renter to show good faith that you've secured payment for the mortgage on the investment property, your chances of obtaining a conventional loan are higher.
Blanket Loans
If you're looking to buy multiple pieces of property, you may want to consider applying for a blanket loan, which covers multiple parcels of land under one loan with a 15 to 30 year term. These loans are popular for developers who buy a large plot of land and divide it into parcels, such as a subdivision. These loans can also be used for someone who is purchasing one home but has not yet sold another. This bridges the gap between the time it takes to sell one home before purchasing the next, allowing for some wiggle room if you haven't sold one investment home before purchasing another.
Before considering a blanket loan, remember that all of the property is tied together, so if something goes wrong with one, it goes wrong for them all. These types of loans usually require a minimum of 25 percent down payment, but lenders may be more flexible with credit scores on these loans than with a conventional mortgage, and personal debt may or may not be a factor in qualifying, depending on the bank you choose. Blanket loans are hard to come by, so speak to your preferred lender to see if they offer this type of loan or know where one might be available.
Seller Financing
Some sellers offer their own financing terms as an incentive to purchase their property. They will administer a loan to an investor on the property that they are selling, usually with the investor putting a significant amount of money down. Down payments of 50 to 60 percent with a balloon payment are not uncommon. These types of loans are attractive to investors who have good cash flow but bad credit.
Sellers can set their own terms and interest rates because they are the lender in this situation. Always have a real estate lawyer review the contract's terms before signing.
Hard Money Loans
Hard money loans, also known as bridge loans, are short-term loans, usually 12 months but ranging from six months to five years, that carry a very high interest rate. Rates usually range from 10 to 18 percent, which means the monthly payments will also be high.
These loans may be administered by an individual providing a private loan or a hard money lender company. They are typically secured by the property the investor is borrowing the money to purchase. The loan provider will take a lien out on the property until the loan is repaid. These loans are most popular for 'flips,' which are properties that are purchased, remodeled, and then put back on the market for a profit. These loans may include enough to cover the purchase of the property plus repairs. Once the property is sold, the loan is paid back.
These loans are very risky for both the lender and the borrower, and they are usually only used when an investor is not able to obtain any other type of investment property financing due to credit score, debt-to-income ratios, or a lack of down payment funds. Though most hard money lenders do consider credit history, they are less concerned with the score and more concerned with any bankruptcies or foreclosures. They look for indications of how likely an investor is to repay the loan.
The high payment makes it more likely for the borrower to fail to make payments, and the short term nature of the loan means that if you aren't able to pay the loan back because the house hasn't sold, the lender will foreclose on the property. Hard money loans should be a last resort for investors. They should only be considered when several factors indicate that a property is likely to be sold quickly at a profit. Have your real estate agent check for comps (comparable property sales in the area) to help ensure you will make money when selling the property after investing money into the loan and remodeling.
Financing Considerations
When applying for a property investment loan, the lender will take several factors into consideration. They include:
- Credit score
- Mortgage payment history
- Debt-to-income (how much you owe versus how much you make)
- Bankruptcy history
- Foreclosure history
Making a Wise Decision
Purchasing an investment property (or properties) can be a wise investment in your future. Renting a property to create additional monthly income while accepting tax and mortgage insurance deductions can be a smart way to build your bank account while also building equity in a home. Alternately, selling a property in a seller's market can be a great way to pay back a mortgage quickly while realizing financial benefits from the sale.
Before financing an investment property, make sure you have enough money in the bank to cover the payments in case you cannot find a renter or buyer. While real estate investments carry risk, they can become extremely lucrative with the right knowledge and research. With the right loan, a real estate agent with strong market knowledge, and solid finances to weather any stormy market conditions, you just might find that you're in a great position to begin investing in real estate.
