Ultimate Guide to Rental Real Estate Loans

How Do Rental Property Mortgages Work?

Using mortgage loans for investment rental properties, allows investors to take advantage of the power of financial-leverage through rental real estate to generate significant profits when done correctly. A mortgage typically works by using the subject property (or other assets) as collateral for a loan. If the borrower defaults on the loan, the lender can foreclose on the property/collateral and recoup their losses. These loans can be used to finance the purchase of virtually any type of rental properties such as commercial and residential properties. Loan terms for rental property mortgages can range anywhere from 1 to 30 years depending on the property type. The interest rate on a rental property mortgage is typically higher than a traditional mortgage because the lender is taking on a higher level of risk. To offset that risk, larger down payments are usually required – 20% to 40% for a rental property.

Multifamily real estate loans are designed for the purchase or refinancing of residential buildings that can range from 2 units, up to hundreds of units, such as apartment complexes or condominium buildings. These loans are a popular choice for real estate investors looking to generate consistent rental income through residential assets. Many types of lenders, including banks, private lenders, and government-backed entities, offer multifamily loans.

A CRE loan, an acronym for Commercial Real Estate, is a loan that’s used to finance the purchase of commercial real estate. The property can be anything from an office building to a retail storefront, and the loan proceeds can be used for anything from renovations to new construction. CRE loans usually have shorter-term loans, which means they are typically shorter repayment periods when compared to a traditional 30-year mortgage.

HELOC

HELOCs (Home Equity Line Of Credit) can be used in 2 different ways to fund rental property purchases. This can include using a HELOC to pull money out of your primary residence, or pulling money out of an existing investment rental property. Proceeds from a HELOC can be a great source of down payments for real estate investors to use existing idle equity for acquiring another property or even do upgrades to an existing property.

Adjustable-Rate-Mortgage (ARM)

ARM loans, an acronym for Adjustable Rate Mortgage, are a type of mortgage loan in which the interest rate is adjustable. This means that the monthly payments can go up or down over time, based on changes in the market interest rates. There are several different types of ARM loans used for investment properties, with the most common being 3/1, 5/1, 7/1, and 10/1.

Hard Money

Hard money loans are high-interest and short term loans that experienced investors use to purchase and/or rehab properties. These loans are a go-to option for experienced real estate investors who need quick access to capital, to quickly purchase or rehab an opportunistic property. Interest rates on hard money loans are generally higher than traditional loans, ranging from 10% to 15%.

Pros

1. Potential for passive income: A rental property can generate a steady stream of income, which can help cover the mortgage payments and potentially provide additional income. This can be an effective way to build wealth over time, as property values tend to appreciate.
2. Tax benefits: Rental property owners can often benefit from tax deductions, such as mortgage interest, property taxes, insurance, and depreciation. These deductions can help reduce the overall tax burden, making the investment more financially attractive.
3. Leverage and appreciation: By taking out a mortgage, you are using leverage to buy a more valuable property than you could afford outright. As the property appreciates in value, your equity increases, potentially providing significant returns on your initial investment.

Cons

1. Financial risks: Rental properties come with risks, such as vacancies, unexpected maintenance costs, or a drop in property values. These risks can make it difficult to meet your mortgage obligations, potentially leading to financial stress or even foreclosure.
2. Increased liability: As a landlord, you are responsible for maintaining the property and ensuring the safety of your tenants. This may expose you to potential lawsuits and other liabilities, which can be costly and time-consuming.
3. Reduced liquidity: When you invest in a rental property, your money is tied up in an illiquid asset. If you need access to cash quickly, selling a property can be a lengthy and potentially costly process. This reduced liquidity can make it difficult to respond to financial emergencies or take advantage of other investment opportunities.

Debt

With debt investing, you’re lending money to a borrower (usually a real estate developer) and receiving interest payments on that loan. The loan is secured by the property itself, so if the borrower defaults, you could pursue ownership of the property. Debt investing is generally a more predictable and less risky investment than equity investing, but the returns are typically lower as well.

Equity

With equity real estate investing, you’re essentially buying a piece of property and becoming a partial owner. You’ll share in the profits (or losses) generated by the property, but you’ll also have a say in how it’s managed. Equity investing can be a great way to build wealth over time, but it’s important to remember that it’s also a more volatile investment than debt investing.