Investment properties come in many shapes and sizes, and so can the loans you need to obtain them. Investment loans are harder to obtain because lenders know that a borrower is more likely to default on an investment property than their primary residence. If you’re new to investment loans, you may find an entry point through a multi-unit owner occupied property which allows you to obtain an owner-occupied loan.
An owner-occupied property is the primary residence of the owner. A second home or vacation home is also considered an owner-occupied property. Typically, an investment property is one which you don’t occupy: non-owner occupied. However, if you own a four-unit multi-family property and live in one of the units, you can earn rental income on the other units and still have it listed as owner-occupied property. That’s just one option available to investors. Here are a few others.
Investment Loan Options
Hard Money Loans
These loans are sometimes called commercial real estate loans or “fix and flip” loans because house flippers and professional real estate investors use them the most. They are non-conforming loans that come from individuals and private companies. Some borrowers lean toward these loans when they want to avoid the traditional mortgage process and timeline, or they can’t get approved for another loan program.
These are short-term investment loans (1-5 years) which is why flippers or commercial real estate investors are more likely to use them. They close quickly, and it’s easier to qualify for them as long as you make a down payment of 25%-30%. The lender will look at the value of the property as part of the collateral for this loan, and they’ll look at your track record if you’re flipping homes. The downsides to hard money loans are the average interest rates which can fall between 9%-14% and the upfront fees of 2%-4% of the total loan (in the form of points).
Bottom line: These loans are riskier because you have less time to repay the loan, and the rates are significantly higher.
This traditional loan is less expensive than a hard money loan but more costly than an owner-occupied conventional loan. As you take on more mortgage debt, you become a greater risk for a lender. They will compensate with higher interest rates and more strict requirements for qualification.
- Minimum down payment of 20% (No PMI) and rate may lower if you put down more
- A credit of 720 or higher will get you better rates. Anything lower and you may not qualify, or you may pay for it with higher interest rates.
- Cash Reserves of at least six months or assets that can be liquidated
- Typically, a four-mortgage limit. There are programs that will allow 5-10 mortgages but finding a lender may be difficult.
Technically, FHA mortgages are not for investment properties, however, you can purchase a multi-family property with 2-4 units and rent the other units if you live there for a minimum of a year. This may be a good option if you’re thinking about rental property investment.
What are the requirements and basic guidelines?
- Minimum down payment of 3.5%
- Lower credit score: As low at 580
- Higher DTI limit. In some cases, as high at 55%.
- Mortgage insurance (referred to as Mortgage Insurance Premium, MIP)
- Property must be your primary for at least 12 months.
- Some of your closing costs can be rolled into your loan.
- FHA lenders will consider borrowers who have a bankruptcy or foreclosure on record.
The advantage of FHA mortgages is they have less strict requirements for borrowers. If you qualify, you can use this multi-family property as a means of increasing your income and saving for future investments. The FHA also offers FHA 203(k) rehab loans which allow you to combine the purchase of a home and the renovations into one loan. The minimum credit score for their rehab loan is 500 with 10% down.
If you qualify for a VA loan and want to purchase a multi-family unit or eventually rent out your home, you will have to make it your primary residence for at least 12 months after you close. There may be some exceptions, for example, intermittent occupancy due to employment, retiring service member, spousal occupancy, or active-duty status.
What are the basic guidelines for a VA loan?
- Down payment: Zero down – 100% financing
- Debt-to-Income (DTI) Ratio limit: 41% (May vary based on other credit factors)
- Personal Mortgage Insurance: Not required
- VA Funding Fee: Yes. Can be rolled into mortgage
- Credit score minimum: 580
- Must be your primary residence
- Property types: Single-family, Condos, Townhomes, Multi-family, Manufactured
Borrowers can use the rental income from the other units to qualify for the loan by including up to 75% of the market rents as income.
Home Equity Lines of Credit (HELOC)
A HELOC is a type of second mortgage that acts like a revolving line of credit. It’s an equity line of credit which means you secure this credit with the equity in either your own primary residence, if you don’t already own an investment property, or an investment property if you already have one. It is harder to get a HELOC on an investment property.
How a HELOC works
You receive a set amount from your lender and draw from that line credit as needed. Your access to this credit is known as the draw period, and it’s limited (ex: 10 years). During that period, you make monthly payments that may just cover the interest due. Once the draw period ends, you must begin repaying the loan. You can pay it down or off at will during the draw period.
There are pros and cons to HELOCS. They are more flexible than conventional mortgages. They also have lower monthly payments during the draw period. Because they are variable-rate loan products, the interest rates fluctuate. This could increase your monthly payments during the repayment period. Still, it could be a lower cost route than a hard money loan. There is risk involved. Defaulting on a HELOC could mean risking your primary residence.
What to expect with a HELOC
- DTI of 30% – 35%
- Higher interest rates or you may have to pay 2-3 points upfront
- Credit Score: Above 650. 700 or higher is preferred
- You need at least 15% – 20% equity
- Proof of reliable income
The Bottom Line
Unless you’re purchasing a multi-family unit in which you plan to live, you will pay higher interest rates for investment loans. Having multiple mortgages makes you a greater risk. Lenders want to mitigate that risk when they can. They’re looking for higher credit scores and lower DTI. If real estate investment is your goal, consider all your options and maintain a good credit score.