Purchasing an investment rental property requires a lot of capital. With property prices in the hundreds of thousands or even millions of dollars, it is very common for investors to use financing (i.e. a mortgage loan) to acquire assets. By utilizing a mortgage, investors are also able to capitalize on the benefit of “leverage” at a reasonable interest rate, to generate more money. Below we take a deep dive into investing everything you need to know about mortgages for rental properties.
What is a Mortgage?
A mortgage is a loan that is secured by property or real estate. Investors lend the required capital for an investor to purchase the property, and in exchange receives the legal promise for the investor to pay back the original principal capital as well as interest within an agreed upon time frame. Mortgages are legally binding real estate agreements. The contract is also called a “Note”, which gives the lender the right to have legal claim against the borrower’s property should they default on the terms of the note.
How Does A Rental Property Mortgage Work?
A rental property mortgage is a specific type of mortgage used to finance a rental property purchase. These types of mortgage can be used to finance the purchase of both commercial and residential multifamily properties.
The mortgage typically works by using the subject property (or other assets) as collateral for the loan. If the borrower defaults on the loan, the lender can foreclose on the property/collateral and recoup their losses. 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. Loan terms for rental property mortgages are typically shorter than traditional mortgages, lasting anywhere from 5 to 15 years. Lenders require shorter loan terms because they want to be sure they can recoup their investment before the property is sold.
Rental property mortgage rates are typically higher than mortgage rates for primary residences. That’s because lenders see rental properties as a higher-risk investment. To offset that risk, you’ll need to make a larger down payment on your rental property. Lenders generally ask for a down payment of 25% to 30% for a rental property. You’ll also need a good credit score to qualify for the mortgage. Lenders will look at your credit history and score to determine whether you’re a good candidate for a loan.
If you’re looking for a mortgage loan to expand your budding property empire, remember that rental properties are businesses at the end of the day, and many lenders will require profit and loss statements or other financial proof that your rental property is positively cash flowing – especially if you’re planning on using that income to qualify.
Pros and Cons of a Mortgage
Mortgages can be a great way to use the power of financial leverage to your benefit. This financial scheme however also comes with risks. Since there are several different ways to finance a rental property with a mortgage loan, we take a look at each type with its own set of pros and cons:
Conventional Mortgage Pros & Cons
A conventional mortgage is the most common way to finance a rental property. This type of loan is issued by a bank and typically has a fixed interest rate and a term of 15-30 years.
|Low Interest Rates||You’ll need a good credit score to qualify|
|Flexible repayment terms||You’ll need a down payment of at least 20%|
|You can include the cost of renovations in the loan|
Portfolio Loan Pros & Cons
A portfolio loan is a loan that is issued by a private lender, rather than a bank. Because private lenders are not subject to the same regulations as banks, they can offer more flexible terms.
|You can often get a lower interest rate||The lender may require you to have experience as a landlord|
|You may be able to get a loan with a shorter term||The lender may require you to have a higher credit score|
|You may be able to get a loan with a smaller down payment||The loan may be more difficult to qualify for|
Hard Money Pros & Cons
A hard money loan is a short-term loan issued by a private lender. Hard money loans are typically used for fix-and-flip properties and come with high interest rates and short repayment terms.
|You can get the loan quickly||The interest rate is usually high|
|You don’t need a good credit score to qualify||The loan term is usually short|
|You can use the loan to finance renovations||You may have to put down a larger down payment|
Home Equity Loan Pros & Cons
If you have equity in your primary residence, you can take out a home equity loan to finance a rental property. Home equity loans, in most cases, have lower interest rates than other types of loans, but they also come with the risk of foreclosure on your primary residence.
|Low interest rates||You could lose your home if you can’t make the payments|
|You can use the equity you’ve built up in your home||You’ll need to have equity in your home to qualify|
HELOC Pros & Cons
A HELOC, or “home equity line of credit,” is similar to a home equity loan, but gives you the flexibility to borrow and repay the loan as you need. HELOCs typically have variable interest rates, which means the payments can go up or down over time.
|You can borrow and repay the loan as you need||The interest rate is variable, so your payments could go up|
|The interest rate is usually lower than a credit card||You could lose your home if you can’t make the payments|
|You’ll need to have equity in your home to qualify|
The #1 Rental Property Newsletter
Once a Month We Send Out an Exclusive Rental Property Market Update with Exclusive Content, Exciting Products, Mortgage Trends, and More. No Spam and Unsubscribe Anytime.
What is the Difference Between Debt and Equity?
In the wide world of real estate finance, financing a rental property can be broken down into two components: Debt and Equity. So, what’s the difference between the two? Debt investments, also known as mortgages, are loans that are used to finance the purchase of a property. The investor agrees to make payments on the loan over a set period of time, and once the loan is paid off, they own the property outright.
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.
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.
Rental Property Loans vs Home Loans
There are a few main differences between rental property mortgages and conventional personal home loans. The most obvious difference is that with a rental property loan, the property is being purchased with the intention of generating income from rent.
Conventional home loans are typically for owner-occupied properties, meaning that the borrower intends to live in the home. This distinction is important because it affects the types of loans available and the terms of those loans. Rental property loans are usually either short-term loans or long-term loans. Short-term loans are typically interest-only loans, meaning that the borrower only pays the interest on the loan during the term of the loan. These loans are often used to purchase properties that will be quickly flipped for a profit.
Long-term loans are typically amortizing loans, meaning that the borrower pays both interest and principal over the life of the loan. These loans are often used to purchase properties that will be held and rented for a longer period of time. The terms of rental property loans are also typically different from those of conventional home loans. Rental property loans are usually interest-only loans with shorter terms (5-10 years) than conventional loans (30 years). This is because the goal with a rental property loan is to generate income from rent, and the property will be sold once it has appreciated in value. The interest rates on rental property loans are also usually higher than those of conventional loans. This is because rental property loans are considered to be riskier than conventional loans. If you’re thinking of purchasing a rental property, it’s important to understand the difference between rental property loans and conventional home loans.
Rental Real Estate Finance News
Types of Rental Property Loans
Now that we understand how rental property mortgages work, we will take a closer look at the different types of common loan products available to investors.
A conventional loan is a type of mortgage loan that is not insured or guaranteed by the government. Conventional loans are typically used to purchase primary residences, investment properties, or second homes. They are available in a variety of terms, with the most common being 30-year and 15-year fixed-rate mortgages and also a variety of adjustable-rate mortgage (ARM) products available.
Unlike other types of loans, conventional loans for rental properties are harder to come by. Lenders are usually more conservative when it comes to lending money for an investment property, as there is more risk involved. Things to keep in mind when searching for a conventional loan:
This is the most important factor when it comes to getting approved for a loan. Lenders want to see that you have a down payment of at least 20%, as this shows that you’re serious about the investment.
Your credit score will play a big role in getting approved for a loan. The higher your score, the higher your chances of getting approved.
Lenders will want to see that you have a steady income in order to repay the loan. This is especially important if you’re self-employed.
In order to secure a loan, you’ll need to have some sort of collateral. This can be in the form of a down payment, equity in another property, or even a savings account.
A FHA loan is a loan provided by the Federal Housing Administration, and it’s a popular choice for rental property investors for a few reasons. First, the down payment requirements are lower than for other types of loans, making it a more accessible option for many people. Unlike conventional mortgages, which can require a 20% or more as a down payment, FHA loans have a very low down payment requirement – currently just 3.5%. Additionally, FHA loans have lower credit score requirements, starting at 580 on the low end.
Another advantage of an FHA loan is that it allows you to include the costs of repairs and improvements in the loan amount. This can be helpful if you’re planning on making some upgrades to the property before you start renting it out. However, there are several things to keep in mind before you apply for an FHA loan for your rental property. First, the property must be your primary residence, and you can only have one FHA loan at a time.
You do have to reside in the property itself for at least one year and can rent out the rest of the units, or you’ll be in violation of the contract you signed when you took out the FHA loan. It’s also important to remember that in order to qualify for an FHA loan, the property needs to be in good condition – so they’re often not a great option for fixer-uppers or rehab projects.
If you’re a veteran of the United States Armed Forces, then you’re probably familiar with the VA loan. But what if you’re looking to use a VA loan for a rental property?
The VA loan is a government-backed loan program available to eligible veterans, active-duty service members, and reservists. The loan is guaranteed by the Department of Veterans Affairs, which means that lenders are more willing to finance borrowers with less-than-perfect credit, with 580 as the baseline minimum to qualify. VA loans can be used to purchase a single-family home, a condo, or a multi-family home or used to refinance an existing home loan.
If you’re looking to use a VA loan for a rental property, there are a few things to keep in mind. First, the property must be for investment purposes only. You cannot use a VA loan to purchase a property that you will occupy as your primary residence. Second, the rental property must be income-producing. This means that you must charge rent that is equal to or greater than the monthly mortgage payment.
Rental income can be used to cover the mortgage payment, property taxes, and insurance. Third, you will need to make a down payment of at least 25% of the purchase price. This is higher than the typical down payment for a VA loan, which is 0%.
Private loans for rental properties are typically more challenging to obtain than traditional mortgages, but they can offer more favorable terms and rates.
There are several benefits of a private loan for rental properties. First, private loans can offer more favorable terms and rates than traditional mortgages. This is because private lenders are typically more willing to work with investors looking to purchase rental properties. Private loans can be used to finance the purchase of a property that may not qualify for a traditional mortgage because private lenders have different underwriting standards than traditional lenders. They also typically have a shorter loan process, making a private loan a great option if you want to purchase a property fast.
However, there are also some drawbacks to consider when taking out a private loan specifically for a rental property. They can be more expensive than standard mortgages. Private lenders typically charge higher interest rates and fees in exchange for the speed and reduced underwriting requirements they offer.It can also be harder to qualify for a private loan than a traditional mortgage. Private lenders typically have stricter credit and income requirements than banks and other traditional lenders. You may also have to put up collateral when taking out a private loan. If you default on the loan, the lender has the right to take possession of your property.
Still, private loans offer up a combination of reduced underwriting requirements and speed that make them very attractive to certain borrowers, particularly those who need to raise capital fast or those that might not have the best credit profile.
In seller financing, the seller of a property agrees to provide financing to the buyer. This type of financing is often used when the buyer is unable to obtain traditional financing from a bank or other lender.
In a seller financing deal, the buyer and seller agree to an interest rate and repayment schedule. The buyer has to make payments to the seller, and the seller holds the title to the property until the loan is paid back in full.
Seller financing can be an excellent option for buyers who cannot obtain traditional financing. However, there are risks associated with this type of financing. For example, if the buyer happens to default on the loan, the seller could lose the property.
There are several benefits of seller financing, including:
- The buyer may be able to purchase a property that they otherwise would not be able to afford.
- The seller can often sell the property for a higher price than if they were to sell it through traditional means.
- The seller can choose the interest rate and repayment schedule.
As with any type of financing, there are some risks associated with seller financing. These risks include:
- The buyer may default on the loan, which could result in the seller losing the property.
- The seller may not be able to sell the property for as much as they could if they were to sell it through traditional means.
If you’re pondering using a HELOC, an acronym for Home Equity Line Of Credit, to finance an investment property, there are a few things you need to know. For starters, a HELOC on an investment property differs from a HELOC on your primary residence. The latter is considered a home equity loan, while the former is considered a commercial loan. As such, the interest rates on a HELOC for an investment property are generally higher than the rates on a home equity loan. Additionally, the loan-to-value (LTV) ratios are usually lower for investment properties, meaning you’ll need to have more equity in the property to qualify. HELOCs are typically variable-rate loans, so your payments could go up or down depending on market conditions.
Assuming you can qualify for a HELOC, you can do a few things with the loan proceeds. You could use the money to finance the purchase of a new investment property. Or, if you already own an investment property, you could use the funds to cover the down payment on a refinance or to make renovations and improvements.
Before taking out a HELOC on an investment property, it’s crucial to weigh the pros and cons of this type of mortgage. On the plus side, a HELOC can provide a flexible source of funding for your real estate investments. On the downside, the interest rates are usually higher than traditional loans, and there’s always the risk that your payments could go up if market conditions change.
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 store, and the loan proceeds can be used for anything from renovations to new construction.
CRE loans are usually long-term loans, which means they have a longer repayment period than a traditional mortgage. A longer term can be helpful if you’re looking to keep your monthly payments low. But it also means you’ll need a good credit score and a solid business plan to qualify. If you’re thinking of taking out a CRE loan, here are a few things to keep in mind:
You’ll need to have a down payment. – Most CRE loans require a downpayment of 20% or more. So, if you’re looking to finance a $1 million property, you’ll need to come up with at least $200,000.
You’ll need to show that you can handle the loan. – Lenders will want to see that you have a good credit score and a solid business plan. They’ll also want to see that you have the financial resources to make the monthly payments.
You’ll need to have collateral. Collateral is something that you can use to secure the loan. It can be anything from another piece of property to equipment or inventory.
You’ll need to pay closing costs. Closing costs are the fees associated with getting the loan. These can include appraisal fees, loan origination fees, and title insurance.
You’ll need to have insurance. Most CRE loans require that you have insurance on the property. This is to protect the lender in case something happens to the property.
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. ARM loans are typically used for investment properties, such as rental properties.
Types of ARM Loans
5/1/ ARM Loan
The most common type of ARM loan is the 5/1 ARM loan. With 5/1 ARM loans, interest rates are fixed for the first 5 years, and then it can adjust every year after that. The 5/1 ARM loan is a good option for investors looking to buy a property and hold it for the long term. The initial 5-year fixed interest rate gives the investor time to stabilize the property and rent it out before the interest rate adjusts.
7/1 ARM Loan
Another popular type of ARM loan is the 7/1 ARM loan. This loan has a fixed interest rate for the first 7 years, and then it can adjust annually after that. The 7/1 ARM loan is a good option for investors looking to buy a property and flip it within a few years. The initial 7-year fixed interest rate gives the investor time to renovate the property and sell it for a profit before the interest rate starts to adjust.
A permanent loan is a long-term loan used to finance the purchase of real estate. Compared to other types of commercial loans, such as construction or bridge loans, a permanent loan is characterized by its low interest rate and long repayment term. Permanent loans are typically used to finance the purchase of stabilized income-producing properties, such as office buildings, retail centers, and apartment complexes. They can also be used to finance the construction of new properties.
For borrowers, the key advantage of a permanent loan is that it allows them to lock in a low interest rate over the life of the loan. This can save them a significant amount of money, as long as interest rates don’t decline.
For lenders, the key advantage of a permanent loan is that it is a low-risk loan. Because the loan is backed by collateral, the property in question, the lender has a strong chance of getting its money back even if the borrower defaults.
You’ll need a good credit score to qualify for a permanent loan. Lenders will also want to see that you have a history of successful property management. Additionally, you need to have a down payment of at least 20% and be prepared to make a large balloon payment at the end of the loan term. This is because most permanent loans have a term of 30 years, with the balloon payment coming due at the end.
A hard money loan is a high-interest, short term loan that experienced investors use to purchase and/or rehab properties. The loans are typically funded by private investors, not traditional lenders like banks, and are short-term for 12 months or less. Hard money loans are typically used for properties that require repair or are being sold by someone who needs to sell quickly.
Hard money loans can be a great option for rental property investors for several reasons. First, hard money loans can be approved quickly – sometimes in as little as 48 hours. This is much faster than traditional bank loans, which can take weeks or even months to get approved. These loans can be used for various purposes, including purchasing a property, rehabbing a property, or even making repairs. Hard money investment loans can be a fantastic option for those investors with bad credit or who may not qualify for a standard bank loan.
Interest rates on hard money loans are generally higher than traditional loans, ranging from 10% to 15%. The loans are also typically structured with a balloon payment, meaning that the borrower must repay the entire loan amount at the end of the loan term.
A bridge loan is a short-term loan that is used in real estate transactions. The loan is secured by the property itself and is typically used to finance the purchase of a new property before the borrower has sold their current property. Bridge loans are generally interest-only loans, meaning that the borrower only pays the interest on the loan each month. The borrower does not make any payments towards the principal of the loan.
The most prominent advantage of a bridge loan is that it allows the investor to buy a property without having to sell their current property first. This allows the investor to take advantage of opportunities that might otherwise be lost. The greatest disadvantage of a bridge loan is that the interest payments can add up quickly. If the property is not sold promptly, the investor can end up paying a significant amount of money in interest payments.
These loans are typically used by investors who are flipping properties, where the loan is used to finance the purchase and improvements of the property. But keep in mind that bridge loans are not for everyone. They are a high-risk, high-reward investment.
A blanket loan is a type of loan used to finance the purchase of multiple properties. The term “blanket” describes the fact that the loan is secured by more than one piece of collateral. Blanket loans are often used by investors who are looking to purchase multiple rental properties in a short period.
The primary advantage of a blanket loan is that it allows the borrower to save money on closing costs. When multiple properties are purchased with a single loan, the borrower only has to pay one set of closing costs. This reduction in closing costs can save the borrower a significant amount of money, especially if the properties are being purchased in different states.
Another major advantage of a blanket loan is that it allows the borrower to make a single monthly payment. A single payment can be helpful for investors who are managing an extensive portfolio of properties. Additionally, a blanket loan can give you more flexibility. With multiple loans, you have to ensure that each property generates enough income to make the payments. With a blanket loan, you have more flexibility to use the income from one property to make the payments on the loan.
Of course, blanket loans for rental or investment properties have their downsides. This includes the fact that the borrower must take on a large debt. Too much debt can be risky if the market changes and the value of the properties decreases. Additionally, if the borrower defaults on the loan, all of the properties will be foreclosed upon. Should this happen, it would likely be a significant financial loss for the borrower.
A mezzanine loan is a type of real estate financing often used in conjunction with a first mortgage loan. The mezzanine loan is subordinate (i.e. after) to the first mortgage but typically has a higher interest rate than the first mortgage. Mezzanine loans are often used to finance the purchase or renovation of a multifamily or commercial property. Mezzanine loans can be an attractive financing option for investors who cannot obtain a traditional first mortgage loan. They can also be used to finance a portion of the purchase price of a property or to finance the renovation of an existing property.
One of the main benefits of a mezzanine loan is that it can be structured as an interest-only loan. This structure means the borrower only pays interest on the loan for a certain period, typically 5-7 years. After the interest-only period, the loan is generally paid off in a lump sum. Another benefit of a mezzanine loan is that it can be used to finance a property that may not qualify for a traditional first mortgage loan. For example, a property needing significant renovation may not qualify for a first mortgage loan. However, a mezzanine loan can be used to finance the purchase or renovation of such a property. The downside of a mezzanine loan is that it is a subordinate loan, which means it is at a higher risk of default than a first mortgage loan. If the property is sold or foreclosed upon, the mezzanine loan will be paid off after the first mortgage loan is paid off.
Mezzanine loans are typically more expensive than first mortgage loans due to the higher interest rates and the subordinate position of the loan. However, mezzanine loans can be a good option for investors who are unable to obtain a traditional first mortgage loan.
An SBA 7(a) Loan is a type of loan provided by the Federal Government’s Small Business Association, or SBA. This is their primary program for providing financial assistance to small businesses. The 7(a) loan program covers a wide range of financing needs, including working capital, inventory or equipment, business acquisition- as well as commercial real estate, including rental properties.
Interest rates on 7(a) loans are generally lower than rates on traditional bank loans, and the terms can be up to 25 years. The maximum loan amount for a 7(a) loan is $5 million. SBA 7(a) loans are available through participating SBA-approved lenders, such as banks, credit unions, and non-bank lenders.
In order to be eligible for a 7(a) loan, your business must:
- Be for-profit
- Operate in the United States or its territories
- Have a good credit history
For businesses seeking financing for commercial real estate, the SBA 7(a) loan program offers several options. 7(a) loans for the purchase of an existing property can be used for owner-occupied real estate, like office buildings, retail space, or industrial facilities.
The SBA 504 loan program provides financing for major fixed assets, such as real estate or equipment, through the sale of bonds. The loan program is designed to promote economic development and job creation/retention by providing long-term, fixed-rate financing for eligible small businesses. 504 loans are available through Certified Development Companies (CDCs), federally certified and regulated non-profit organizations.
The maximum loan amount under the 504 program is $5 million, with a maximum debenture (bond) amount of $5.5 million. The Small Business Administration (SBA) guarantees 100% of the loan, making it easier for small businesses to obtain financing. Interest rates on 504 loans are typically lower than rates on other types of commercial financing, making the 504 program an attractive option for small businesses.
504 loans can be used to finance the purchase of land, buildings, and equipment and for renovations and improvements. The program can also be used to finance the construction of new facilities and the purchase of existing buildings. They are available for for-profit businesses of all sizes, including rental real estate firms.
Disclaimer: The information provided on this website does not, and is not intended to, constitute financial advice. As such, all information, content, and materials available on this site are for general informational purposes only. Please review our Editorial Standards for more info.