Summary: In this article, you’ll learn everything you need to know about financing a rental property. Topics include: should you finance or pay in cash, how to qualify for a rental property loan and 12 real estate financing options you can utilize today.
Should I finance a rental property instead of paying cash?
Real estate has proven to be one of the best long term investments and an extremely safe place to put your money during uncertain economic times whether paying cash or financing a rental property. The S&P Case-Shiller US national price index that was recently released further exemplifies this – From 1960-current real estate prices have continued to rise even during all of the major recessions except for the 2008 crash where real estate was the driver of the recession.
How can real estate be an even better investment? As discussed above, real estate is most certainly a great long term wealth builder. However once paired with a rental property loan the overall returns and benefits of investing in real estate are exemplified.
When financing a rental property, we have access to long term fixed rates (30 year fixed) which are a great hedge against inflation like we are currently experiencing. In addition to that, when we finance a rental property we get to take part in the overall growth of the real estate market without the need to deploy all of our capital and this is true beauty and long term wealth builder in real estate. For example: If we purchase a $300,000 home utilizing rental property financing with 20% down and the market appreciated 10% a year, as it has the past few years, you would be able to take part in the growth of the $300,000 property with just the initial investment of $60,000.
How To Qualify for a Rental Property Loan
Depending on the type of loan, conventional versus unconventional, there are different requirements… but here are some of the most common ones that apply to both.
Credit Score/Credit history
In addition to needing money for the down payment you typically need to have money left over for reserves. Depending on the loan transaction and the number of properties you already have your reserve requirement can be anywhere form 6 months of monthly payments per property up to 6 percent of your aggregate loan balances if you have over 6 financed properties.
12 Options for Financing a Rental Property Today
#1. Traditional Financing – Conventional Loans
Conventional loans remain prevalent as the primary source of financing a rental property for investor deals. Typically, conventional loans have the most stringent qualifying criteria but also the lowest overall interest rates and fees
#2. FHA Multi Family Loans
Financing a multifamily property using a Federal Housing Administration (FHA) loan is a great way to start off in real estate investing. FHA loans do require your to live in one of the units for at least one year, however you can purchase a 2-4 unit property for as low as 3.5% down!
#3. VA multi family loans
Financing a multi-family rental property using a Veteran Affairs (VA) is the best way to purchase a rental property with minimal out of pocket funds. Firstly, you do need to be a veteran and occupy one of units for at least a year however you can purchase a 2-4 unit property with this loan with 0% down and no PMI!
#4. DSCR Non QM loans
Financing a rental property using a Debt Service Coverage Ratio (DSCR) loan is growing in popularity. DSCR loans allow you to purchase a rental property with no income documentation. The qualification is based on the rental income the property generates which generally needs to cover all or most of the total mortgage payment. DSCR loans have no limit on financed properties and are a great alternative for someone that may not otherwise qualify for a loan. Generally, these loans have slightly higher interest rates and fees versus a conventional loan.
#5. Home equity lines/ Leveraging existing properties
Financing a rental property using a Home Equity Line of Credit (HELOC) can be beneficial in order to quickly close on a new rental purchase or provide quick access to down payment funds. Generally, a HELOC can be placed on a property that is paid off or has a lot of equity. Once established the HELOC funds can be accessed almost immediately which allows for very quick closings. HELOCS do typically have variable rates so its important to have a strategy in place to replace the HELOC with permanent financing once you have drawn the bulk of the available funds.
#6. Real Estate Partnerships
Sometimes saving up enough funds for a rental property purchase can be difficult or you may not be able to qualify for a rental property loan. Partnering up with another investor can be a great idea to help minimize risk and allows you take down bigger investments.
#7. 401k Loans
Financing a rental property using a 401k loan for either the full purchase price or the down payment is a very popular means to help in qualifying for a rental loan. Generally the interest you pay on a 401k loan is paid to yourself since you are technically borrowing the money from yourself. Most 401k’s allow you to borrower up to 50k from your 401k account with no penalties.
#8. Self-directed IRA
Self-Directed IRA’s are a great way to purchase a rental property and allow your investment and income to grow tax free. With a self-directed IRA you can either purchase a property in cash utilizing the IRA funds or find a lender that will loan to the IRA itself so you can use your IRA to leverage and purchase more properties.
#9. Hard Money Loan
Hard Money loans allow quick access to cash when financing a rental property. Generally hard money loans are short term and have higher rates and fees. The lender will typically analyze your proposed deal to ensure there is enough margin for them to feel comfortable offering you a hard money loan. Its important to have a 6-12 month exit strategy when utilizing this type of financing.
#10. Seller Financing
One of the more creative ways to finance a rental property is with seller financing. Often times sellers will consider carrying a mortgage on a property they are selling with a nominal borrower down payment. You as the buyer will assume title on the property and the seller will place a mortgage or lien on the property. Seller financing can be obtained at relatively reasonable terms and is a great way to obtain a rental property loan.
#11. Land Contract
A land contract is like a mortgage, but instead of using a lender, the seller finances the buyer. The seller remains on title vs. traditional seller financing with official ownership only being transferred after the seller is paid in full. Typically, these loans have higher rates and can be more risky since the property ownership is not transferred to the buyer.
#12. Renovation/Construction loans
A growing way to purchase rental properties are renovation or construction loans. With a renovation loan you can purchase a property with deferred maintenance, often at a bargain over and above retail value. The renovation costs can be financed in to the loan which reduces overall out of pocket expenses and also generally results in increased equity gain in the property.
Construction loans allow to you purchase a bare lot and utilize a loan to build the actual home from the ground up. Generally, construction loans have an initial draw period and then a permanent period after the construction of the home is complete.
As investors, in the current environment we have a higher availability of rental property loan options than ever before which still makes it a lucrative time to purchase real estate. From partnering up with other real estate investors to building your rental from the ground up take advantage of the available options, do your due diligence as always and happy investing.
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If you want some advice about ways to finance your investment property, you can reach out to me here. Just please be sure to let me know you found me by reading this article!