INVESTMENT PROPERTY LOANS: A COMPREHENSIVE GUIDE

investment property loans

Regardless how long you’ve been a real estate investor, at some point, you’ll be looking into taking out investment property loans.  

The great thing is there are quite a few investment property loans and other financing options available to real estate investors to help us build wealth and financial security.

My goal for this post is to really cover the topic of investment property loans & other forms of real estate financing thoroughly.  

So, with that being said, pour yourself a cup of coffee, find a comfortable chair and soak in all I’m about to cover.  You’ll walk away much more informed – I promise. Let’s get started.

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Should you finance your investment property?

Before we take a deep dive into the world of real estate financing, it may be wise to stop and ask ourselves, “Is financing your investment properties a wise move?”  

After all, financing is just a fancier way of saying the four-letter word DEBT.  Debt brings about risk, risk can bring about stress and stress is bad for your health.  

However, pursuing debt sensibly and responsibly can help you to scale your business and develop long-term (and possibly even short-term) wealth.

The alternative is to invest your own cash, and own your properties outright, but who has that kind of cash?  Not many.

If you do have a six or seven digit balance in your savings account, and you pour it all into real estate, well now you have limited or zero cash reserves which still puts you in a risky situation.

So, in real estate investing, there’s no way to avoid risk.  Whether you finance your properties or use your own cash, you’re taking a risk.  

Deciding on whether you should take out investment property loans or not will depend on your risk tolerance and your goals as a real estate investor, so this topic deserves some thoughtful consideration.

If your goal is to acquire several investment properties per year, for instance, you may not have the financial means to buy a house every six months with your own cash.  Shoot – most people wouldn’t.  In which case, some form of investment property financing would be required.

On the other hand, maybe your goal is to pay cash for a property every couple years, and you’re able to do this because you’re very good at living frugally and saving money.

How much should you finance?

If you’ve decided that financing is going to be part of your real estate investment strategy, you need to carefully consider how much to finance.  

In my opinion, as you pursue investment property loans, you should borrow no more than 80% of a property’s value.  In fact, most lenders won’t loan above 80% LTV.  LTV stands for loan-to-value.  Going above 80%, in my opinion, is just too risky.

You also need to consider your exit strategy.  

Your exit strategy is how you will abandon ship if the sky falls on your real estate business, or how you will sell your properties even if the sky doesn’t fall.  At some point you’ll want/need to exit.  

You need to have enough equity to pay off your mortgage, pay for closing costs, capital gains tax, etc. from the sale of your properties.  At the very least, you want to break even and walk away if worse comes to worst.

Pulling the maximum amount of cash out of your investment properties may seem very tempting, especially with interest rates being so low, but fight that temptation and pursue financing with a sober-mind and a clear game plan.

Ok – enough said.  Let’s dive into the different financing options available for real estate investors.

Purchase mortgages

If you want a bank or other lending institution to finance the purchase of your investment property, then this is called a “purchase mortgage.”  

There are two main types of purchase mortgages: conventional & government-backed.  

Conventional Mortgages

A conventional mortgage is not backed (insured) by the federal government.  There are 4 types of conventional mortgages, which include the following:

  • Conforming loans
  • Non-conforming loans
  • Portfolio loans
  • Subprime loans

Conforming loans

Conforming loans are conventional loans that conform to the underwriting guidelines set by Fannie Mae & Freddie Mac.  “Fannie & Freddie who?”, I hear you pondering.

Fannie Mae & Freddie Mac are government-sponsored enterprises (GSEs) that buy most of the mortgages on the secondary market.  

It’s important to know something about the underwriting requirements for these agencies because their requirements can really hinder real estate investors.  

I’ll explain more about Fannie Mae & Freddie Mac and how they affect real estate investors in the “portfolio loans” section.

Non-conforming loans

Non-conforming loans do NOT conform to different GSE underwriting guidelines (hence non-conforming).  If a loan is non-conforming because it exceeds the maximum loan amount set by a GSE, the loan is referred to as a “jumbo loan.”

Portfolio loans

Portfolio loans are handled by banks and other lending institutions that hold their loans in-house in their loan portfolio as opposed to selling them on the secondary mortgage market to entities like Fannie Mae & Freddie Mac.  Lenders who offer portfolio loans are known as “portfolio lenders.”

Since portfolio lenders don’t sell their loans, they are not concerned with abiding by the underwriting requirements imposed by Fannie Mae & Freddie Mac.  This allows portfolio lenders to be more flexible with their lending practices – making them much more investor-friendly.

Possibly one of the biggest disadvantages to working with a lender that sells their loans, is that Fannie Mae has a loan limit of 10 properties per individual.  

So, if you’re an investor who wants to build a sizable real estate portfolio, you won’t be able to get financing on more than 10 properties if you work with a lender who sells their loans.  

This limitation does not apply to portfolio lenders which makes them very appealing to many property investors.

Subprime loans

Subprime loans are designed for borrowers with poor credit.  They come with high fees and interest rates.

Government-Backed Mortgages

Unlike conventional loans, government-backed mortgages are insured by the Federal government.  

While the underwriting requirements can be more strict than other home loan options, the main appeal is the low or no down payment financing these types of mortgages provide.

There are 3 types of government-backed loan programs: FHA, VA & USDA.  Let’s quickly review the basics of each one.

FHA Loans

FHA loans are mortgages that are insured by the Federal Housing Administration which is a part of HUD (Department of Housing and Urban Development).  

As of 2018, with an FHA loan, borrowers can purchase a property with as little as 3.5% down assuming they have a credit score of at least 580.  A minimum credit score of 500 can potentially get you approved for a FHA loan, but you would have to put 10% down instead of 3.5%.

While you can’t get an FHA loan for a single-family investment property, you can acquire a multi-family dwelling (2-4 units) with a FHA loan as long as you live in one of the units.  

VA Loans

VA loans offer 100% financing for active service members or service members who have been discharged under conditions other than dishonorable.  

To be approved, applicants must meet certain credit and income standards and have a valid Certificate of Eligibility (COE).  

Like FHA loans, the property financed must serve as the borrower’s primary residence, so financing a single-family investment property with a VA loan won’t work.  

However, like FHA loans, the VA does allow financing of multi-family properties (2-4 units) as long as the borrower lives in one of the units.

USDA Loans

USDA loans are offered by the Department of Agriculture, and offer 100% financing to applicants who meet certain income and credit requirements which vary by state.  

USDA financing is typically only available for properties located in rural areas.  The USDA has an eligibility map you can use to determine if a property is eligible for USDA financing.

For single-family investment properties, a USDA loan is not an option as one of the USDA requirements is that borrowers “agree to personally occupy the dwelling as their primary residence.”  For more USDA loan requirements, click here.

However, you may be able to get a USDA loan to purchase a multi-family dwelling through the USDA’s “Multi-Family Housing Direct Loans” program.  

According the USDA’s website, this loan program is specifically designed to “…provide competitive financing for affordable multi-family rental housing for low-income, elderly, or disabled individuals and families in eligible rural areas.”

To see if a multi-family property lies within an eligible area for the Multi-Family Housing Direct Loans program, contact your state’s USDA office.

Renovation loans

If your strategy involves buying fixer-uppers, then acquiring the property is just the beginning; you’ve also got to consider how you will pay for the renovations.  

HomeStyle® Renovation Mortgage

A HomeStyle® Renovation Mortgage is a long-term (15 or 30 year) renovation mortgage that is available for property owners interested in rehabbing 1-4 unit principal residences, one-unit second homes, or one-unit investment properties, including units in condos, co-ops, and PUDs.

Hard money & Private Money

Hard money and private money can be great short-term alternatives to bank financing that can help you purchase or renovate a property…or both.  

While the terms “hard money” and “private money” are often used synonymously, there are differences. Let’s quickly discuss each of them.

Hard money lenders

Hard money lenders tend to be companies who are professional money lenders. They are not banks, but they operate in a similar fashion in that they loan out other people’s money for profit.  

For instance, a hard money lender may have $50M at their disposal that they can borrow at 10%.  Their hope is to turn around and loan that money out at 12-15% percent, on average, and make a nice spread.

Additionally, hard money lenders charge points and fees, such as origination fees, which you pay up front and on top of the interest paid throughout the life of the loan.  

The benefit to hard money is that it’s widely available, an alternative to bank-financing and you can get large amounts of capital to finance the purchase or rehab side of your investment.

The two biggest disadvantages to hard money is they are expensive and oftentimes present a number of hoops to jump through to access the money such as lengthy applications, appraisals, inspections and draw requests – similar to what you may experience getting money from a bank.

If you decide to pursue hard money, you can easily find hard money lenders by doing an internet search.

Private money lenders

As the name suggests, private money lenders are simply people lending you their private money.  The best place to find private money is family, friends, coworkers and other people who know and trust you.

The main benefit to private money is the lending terms are usually much more simple compared to hard money.  Uncle John agrees to loan you $5,000, and you agree to pay Uncle John $5,500 in three months.

Furthermore, the interest rates are typically lower than hard money (10-12%), and there are likely no appraisals, applications and other hoops to jump through.

The biggest disadvantage to private money, however, is you may not have access to the amount of capital you need to get your project off the ground.  

Owner financing

Also known as “seller financing”, owner financing is another viable way you can acquire investment properties if you lack enough cash to purchase the property or can’t qualify for bank financing or other investment property loans.  

Owner financing is essentially where the seller loans you the money to purchase the property.  Owner financing can be structured in different ways. Here are five of them:

  • All-inclusive mortgage
  • Land contract
  • Lease option
  • Lease purchase
  • Assumable mortgage

All-inclusive mortgage (wrap-around mortgage)

An all-inclusive mortgage (aka wrap-around mortgage) is where a seller extends a loan to a buyer while maintaining an existing mortgage on the property.

This is best explained by creating a simple example.

John wants to buy a house from Chris.  They agree to a price of $150,000.  Chris has an existing $50,000 mortgage on the property.  

John can’t get financing from a bank to buy the house from Chris, so Chris agrees to act as the bank for John, and John agrees to pay Chris a set amount each month based on a $150,000 loan over 20 years at 9% interest.  

The loan Chris extends to John would “wrap-around” John’s existing mortgage of $50,000.  At closing, Chris conveys the property’s title to John.

One major issue with wrap-around mortgages is what’s called a “due on sale” clause.  If the lender of the existing mortgage has a “due on sale” clause this means that, at the point title is conveyed to another party, the lender of the existing mortgage would demand the loan ($50,000 in this example) to be immediately paid in full.  

Thus, it’s important for the seller to find out from the lender of the existing mortgage whether this clause is in place or not.

Land contract

Under a land contract, the seller and buyer agree to a purchase price, loan duration and monthly payment amount, etc.  The seller maintains legal title, and the buyer receives equitable title to the property. Once the buyer has paid the seller in full, the buyer receives legal title to the property.

“What’s the difference between legal title & equitable title”, you ask.  Great question. The answer? Ownership. The party who holds legal title owns the property while the party who maintains equitable title has the right to use and possess, and in this case, the right to own at a future time (once the terms of the land contract have been met).

This can pose a real risk to the buyer because if the seller has an existing mortgage on the property and defaults on that mortgage, the house could go into foreclosure and the buyer is out the money paid to the seller.  

Lease option

A lease option is an agreement usually between a property owner (lessor) and a tenant (lessee) whereby the lessee has the option to purchase the property after a certain period of time.  However, this agreement could be between a property owner and an investor.

In a lease option the lessee would typically enter into the lease option by signing a contract and paying the lessor an option fee usually equal to 3-5% of the purchase price.  It’s important to note that this option fee is usually non-refundable.

The lease option contract would lay out the purchase price, monthly payments, payment amount applied toward the purchase price and the lease option period.  

The lease option period is usually 1-3 years.  This period gives the buyer time to arrange for permanent financing or gather the funds needed to purchase the property.

With a lease option, the lessor is obligated to sell to the lessee if the lessee is able and willing to buy, but the lessee is not obligated to exercise their option to buy.

Lease Purchase

A lease purchase is very similar to a lease option with the main difference being that unlike a lease option where the seller must sell but the buyer is not obligated to buy, a lease purchase binds both parties to a purchase agreement.  The seller must sell, and the buyer must buy.

Assumable mortgage

With assumable mortgages, the buyer is taking over (assuming) the seller’s existing mortgage on the property.  In essence, the lender behind the mortgage is transferring the mortgage along with its terms from the seller to the buyer.  

The advantage for the buyer is its cheaper and faster to close as an appraisal will likely not be required, and you will probably save on other financing-related fees.  

Additionally, the buyer could save on interest if the interest rate on the mortgage being assumed is lower than what banks are offering at that time.

With all this being said, assumable mortgages typically only apply to government-backed loans (FHA, VA, USDA) and may require sizable down payments.

Cash-out refinancing

Cash-out refinancing allows you to exchange some of the equity in your property for cash.  This is a great way to either get your money back that you put into purchasing or renovating a property, or as a means to get cash up front in order to begin renovations.  

Here’s a an example…

You buy a property cash for $50,000, and it’s ARV (After-Repair-Value) is $150,000.  A bank will give you a loan up to 80% of the property’s value.

You spend $30,000 on renovations, so your total investment is $80,000.  You take the bank’s loan based on 80% LTV (Loan-To-Value), and receive $120,000 cash (excluding bank and titles fees).

Now, there are some banks that will grant you investment property loans based on the home’s ARV (After-Repair-Value) even before you do renovations.  

In this case, the bank would order a “subject-to” appraisal informing the appraiser to provide an opinion of value of the property “subject-to” certain repairs being completed.

The lender will then extend financing to you based on the property’s future value, giving you cash to start your renovations.  

Acquiring Property With No Money Down

There are also a number of ways you can acquire investment properties with no money out of pocket.  Let’s explore a few of these options.

Seller Concessions

Regardless of how you acquire investment properties, there will be closing costs you’ll be responsible for such as title insurance, appraisal costs, inspection fees, loan processing fees, transfer taxes, etc.  

You can potentially get all these closing costs paid for by getting the seller to agree to a seller concession.  A seller concession is when the seller agrees to pay for some or all of a buyer’s closing costs.

There are often caps on seller concessions, however.  Depending on the type of financing used to purchase the property (if financing is being used), the maximum allowed seller concessions will likely be 3-6% of the sales price.

Home equity loans and lines

If you own your primary residence, you may want to look into getting a home equity loan or a home equity line of credit (HELOC).  

Unlike personal loans and lines of credit that come with high interest rates, home equity loans and lines are secured by your home’s equity, so the interest rates are usually much lower than unsecured loans and lines.

Call your lender to inquire more about what might be available.  

Personal loans and lines

Speaking of unsecured personal loans and lines of credit, there are a number of lending institutions that offer sizable personal loans and lines that you can take advantage of to help you purchase or rehab an investment property.  Here are a few companies to consider:

 

Conclusion

As a real estate investor, there are many financing options and investment property loans available to help you build a large real estate portfolio and amass wealth from investing in properties.  

Hopefully you’ll be walking away from this post feeling clearly informed as to what these options are and better equipped to building wealth as a real estate investor.

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