I’ve been in the real estate business for almost two decades now, so I’m well aware of all the financing options available that make it possible to purchase an investment property. Out of these, I’ve found there are a few rental property loans that stand out from the rest. Below, I’ll cover these, as well as a variety of other loan options that can help you make a property purchase happen. With that said, let’s begin so you can start earning rental income sooner rather than later.
Finding Rental Property Loans that Work Best for Your Situation
Most of the time, the type of financing an individual obtains will be based on their financial situation. This might include a person who has less than stellar credit and low income and would benefit from a government-backed loan or even non-recourse financing.
There are also those who are doing well financially and can, therefore, easily get approved for a traditional rental property loan and have other options at their fingertips as well. In addition to this, investment property loans for LLCs are sometimes needed. I’ll discuss all these financing options and more so you can determine which funding avenue fits your needs best.
1. Conventional Rental Property Loans For Real Estate Investors
There are government-backed loans that help those who may need a boost in the approval process, but what about investors who don’t fall into that particular loan applicant category? They simply seek out a conventional-type loan. I’ll go over traditional loans, as well as a few that are not so traditional and even known as a “best kept secret” funding option.
Traditional Bank Loan
A traditional home loan, also known as a conventional loan, is a mortgage not backed by a government agency. They are loans offered by private lenders like banks, credit unions, and mortgage companies. Traditional loans require a down payment, sometimes 20%, and will come with fixed or adjustable interest rates.
Borrowers will need to be in a certain credit score range, as well as meet debt-to-income (DTI) ratio standards. Credit score requirements normally start at 620. However, those with higher scores, such as 740-850, will receive more favorable interest rates.
The loan terms are often 15 to 30 years and can be used for a primary residence, second home, or investment properties. A loan such as this is the most difficult to qualify for, and the reason why investors sometimes take a different path to financing a rental.
Home Equity Loan
A home equity loan is one that’s taken out against the equity that sits within a property. Generally, around 80% of the value is allowed to be tapped into, and is typically set to be paid back within a 30-year time-frame. A home equity loan will normally have a fixed interest rate and a higher rate than a traditional mortgage loan. To qualify, the property owner must have at least 15-20% of equity built up, have a credit score that’s somewhere in the 600 range, as well as a debt-to-income ratio of around 43% to 50%. If you’d like to read more about this type of loan, you’ll find information on it in my post – Harnessing the Power of Home Equity to Buy a Rental Property.
If approved, the investor will be provided with a lump sum, and then the timer starts ticking in regard to interest and paying back the loan. It’s worth mentioning that when you take out rental property loans such as this, you’ll then have two loans to repay – the original mortgage and the new loan.
Consider a Home Equity Line of Credit Instead
A home equity loan is a popular funding source if you have equity built up, but in my opinion, utilizing a home equity line of credit instead is the better option. It’s similar because you’re still tapping into your property’s equity, but it’s a line of credit similar to using a credit card. This means that you begin with a zero balance, as opposed to receiving a large loan amount where interest starts accruing from day one, as it does with a home equity loan. You can read more about HELOCs and how they work by heading over to my article, Exploring a HELOC for Purchasing Investment Properties. You can watch my video on the topic of HELOCs as well:
Non-Recourse Loan – Top Pick for Funding a Rental Property Purchase
I’d like to place this option in a “specialty loans for investors category” because it’s one of my favorite rental property funding options. When utilizing a traditional recourse loan, the approval is based on the borrower’s credit, income, and debt-to-income ratio. In contrast, a non-recourse loan doesn’t rely on the borrower’s credit and financial specs, but instead, bases qualification on the property itself.
With a non-recourse loan, lenders evaluate the property, its location, demand, area vacancy rate, whether a tenant and property manager are in place, and more. Bookmark the following article if you’d like to become well-versed on the topic – Non-Recourse Financing for Real Estate Investing.
I also wanted to highlight that property investors often create a limited liability company (LLC) to hold their properties. They do this for added liability protection and tax benefits. As a result, many individuals specifically look for investment property loans for LLCs. When this is the case, a non-recourse loan is a good funding choice since the LLC will own the property, and the bank will want to focus on the property and the LLC, not you. If you’re interested in forming an entity, I suggest reaching out to Corporate Direct; they’re highly recommended.
Morris Invest Offers Non-Recourse Financing on New Construction Rental Properties
Our properties at Morris Invest often have built-in non-recourse financing. This is possible because we have fantastic relationships with area lenders who are familiar with the great locations we build in – the cash flow potential, the quality of the properties, and so on. Because of this, these lenders are comfortable providing rental property loans based on the rental itself. This setup makes it simple for investors who come to us for a new construction property.
I put together a video that covers non-recourse loans that I think will help you grasp the subject even more:
Don’t hesitate to reach out to Morris Invest if you have questions about non-recourse loans or LLCs.
401(k) Loan – Client Favorite for Investment Property Down Payments
Although not referred to as a home loan, your money that sits in a 401(k) can be borrowed to cover the down payment of a rental property. Over the years, I’ve noticed that this option is favored by my clients who are looking for ways to come up with $40,000 to $50,000 for a down payment. Not everyone feels the same, though. Many people refuse to touch their 401(k) funds. However, some, after becoming informed, realize their money is not only at risk sitting in a 401(k), but also doesn’t stand a chance at producing enough money to retire on.
Owning performing assets such as a rental property is a safe and lucrative way to save for retirement. That said, borrowing money from your retirement account to purchase a rental is a wise strategy. You can read the fine details of this topic in my article, Borrow From Your 401(k) to Invest in Rental Real Estate – Secret Wealth-Building Strategy.
The max amount you can borrow is around $50,000, and the funds are paid back through deductions taken from your paychecks, normally over a five-year time frame. Also, you’ll be happy to know that you won’t be charged a penalty for tapping into your retirement funds early when you opt to borrow because it’s not labeled as a withdrawal. You’ll be charged interest, though, but guess what? You’re paying that interest back to your 401(k) account, so you’re actually growing your funds in the process. Now, keep in mind that this would just cover the down payment, and you’ll need to consider an additional loan option to cover the rest of the purchase price.
How Do You Borrow From Your 401(k)?
This option is great for those who have a 401(k) attached to a current employer. That said, how do investors take out rental property loans from their 401(k)s? You can easily do this through your retirement account web portal. Look for a section labeled “loan,” or “borrow,” or something similar, and from there, it should be pretty self-explanatory. Each provider will have its own unique process, so be sure to give yours a call if you have questions about how to move forward.
More Ways to Utilize a 401(k) or Other Retirement Account to Fund an Investment Purchase
For those who are not currently employed with the company your 401(k) is attached to, you’re in luck because you have more options. You won’t have to borrow from your account; you can simply move those funds into a self-directed IRA (SDIRA) – this applies to a 401(k) and various IRA accounts. With that in mind, you’ll want to look over the following post I put together – How To Use a Self-Directed IRA To Invest in Real Estate.
Traditional IRAs and 401(k) retirement accounts deal in stocks, as well as bonds and mutual funds. Hard assets such as gold and real estate are not allowed to be held in these types of accounts. So, what this means is that you’re basically stuck with paper assets that are subjected to the volatile stock market. The bottom line is that when the economy tanks and Wall Street crumbles, so does your retirement account balance. Here’s a post I wrote that you can save for future reading; it will open your eyes to just how risky keeping your money in a 401(k) really is – Why a 401(k) is a Bad Investment Vehicle to Retire On.
Using Your Retirement Funds the Smart Way
A way around this risk is to roll over your funds from your traditional IRA to an SDIRA, or transfer funds from a 401(k). It’s simple to do, and once completed, you can use those funds to buy a rental property. Morris Invest can get you set up with a self-directed IRA in minutes, which will place you on the path to investing in performing assets that are not tied to the economy or the government.
Depending on how much you have in your retirement account, the funds can be used to cover the down payment on a property purchase, or it may be enough to cover the down payment on a few properties. If you’d like to determine how many properties you would need to retire, download my Freedom Number Cheat Sheet that I put together when I was calculating the number of properties I would personally need to be able to leave my day job.
Retirement Funds and Investment Property Loans for LLCs
Earlier, I touched on investment property loans for LLCs, and here’s another scenario where an LLC and a non-recourse loan can come into play. When you transfer or roll over your 401(k) or other retirement funds to an SDIRA, you’ll want to ensure you set up an entity, such as an LLC, that will hold the SDIRA and your property. Remember, retirement funds generally are only enough to cover the down payment, and a non-recourse loan can be used to fund the rest of the property purchase. I know this all can seem a bit tricky, so feel free to contact Morris Invest to clear up any confusion you may have on this subject; we’d be happy to explain the process to you.
Before you move on to the next section, if you have a 401(k), take a moment to watch the following video, your financial future might depend on it:
2. Government-Backed Loans that Allow for a Rental Property Purchase
If you’re not in a good place financially, using a government-supported loan as an investor can provide an easier entry point into the housing market. The reason for this is that these loans feature favorable terms or advantages for those who might not qualify for traditional rental property loans.
Government-backed mortgages offer lower interest rates, lower down payments, and lower credit score requirements. However, there are rules you won’t find with conventional loans, with the most notable being that to qualify, the investor will need to reside in the property for a minimum of one year.
The most common government-backed loans include FHA and VA loans, which I’ll breakdown below:
Federal Housing Administration (FHA) Loan
The FHA is part of HUD, which you may be familiar with. How it works is that a home loan is obtained through a lender and the FHA backs the loan. This government backing makes the loan less risky for the lender and provides the buyer with an easier entry point. An FHA loan will typically require a down payment that may be as low as 3.5%. In contrast, some conventional loans ask for as much as 20%. As for the buyer’s credit score, it can be in the low to mid 500s.
Most FHA applicants apply for a loan to purchase a house they intend to live in, so the requirement of residing in the property wouldn’t be an issue. When it comes to applying for rental property loans, the only way to get around this requirement is to buy a multi-unit property such as a duplex or fourplex, or even rent a room out in a single-family home that the investor resides in as well.
Keep in mind that FHA loans generally require an annual mortgage insurance premium, which will increase monthly costs. Also, this government-backed funding strategy may not work for those looking to buy in higher-cost locations because there may be lower loan limits.
Veterans Affairs (VA) Loan
VA loans are similar to FHA government-backed loans, where the entry requirements are not as rigid. Obtaining an investment property loan that’s backed by the U.S. Department of Veterans Affairs can be a good option for veterans and active-duty service members.
This loan type provides a few great advantages, such as lower interest rates and not requiring a down payment or private mortgage insurance. It’s important to note, though, that just like FHA loans, VA loans are intended for primary residences, so you’ll have to find a way to reside in the property for a year. You can see additional requirements by heading over to the VA home loan program’s page. It’s also worth noting that VA loans may have certain restrictions or limitations, such as loan limits and funding fees.
These government-backed loans are perfect for those with lower incomes and not-so-great credit scores, but don’t forget that you can easily qualify for a non-recourse loan because qualification is based on the property, not your financial situation.
How Do You Qualify for Rental Property Loans?
Although I touched on some of this previously, I thought I’d go over a summary of typical qualifications. Keep in mind that each loan type will have different requirements, but everyone who applies for a loan would benefit from the following:
One main element is to ensure your credit score is in good standing, preferably 620 or higher, although government-backed loans accept lower scores. Also, take an inventory of your debt-to-income ratio; lenders prefer a DTI below 43, in some cases 50; this shows the lender you’re able to handle more debt.
For those utilizing a non-recourse loan, be ready to provide property details, like expected rental income and location specs. This increases the chances of getting approved for rental property loans that base approval on the property itself. You’ll also need a stable income, verified through W2s or tax returns if you’re self-employed.
Leveraging Fund & Grow for the Down Payment Requirement
Unless you’re applying for certain VA loans, a down payment is expected, or the loan won’t be approved. If you’re not in a place where you’re able to drum up the full down payment, you can look into using Fund & Grow.
They’re a company that helps investors secure funding for rental properties by helping them get approved for unsecured business credit cards with introductory 0% interest rates. The cards are used to cover the down payment on a rental property. The investor then pays down the balance during the interest-free period, and then refinances the property through a bank loan after around 6-8 months of ownership, avoiding higher credit card interest rates in the process. You can read our full Fund & Grow Review if you’re interested.
About Investment Property Loan Terms & Rates
These days, shopping for the best mortgage rate can be a little depressing, seeing how high rates have been over the past few years. Even so, you should always search for the lowest rate so you can save as much of your hard-earned money as possible.
You can start by comparing rates with recommended lenders, making sure to look into points, fees, and the annual percentage rate (APR), which reflects the real cost of the loan. You can also put online comparison tools to good use, or check in with local banks, as well as credit unions and mortgage brokers. In addition to this, dive into the fine print in the loan agreements; be on the lookout for phrases such as prepayment penalties and escrow requirements, since these affect the loan’s cost over the years. When reading over offers, consider the loan term length, whether fixed or variable rates are offered, and that all the details line up with your investment goals.
Shooting for Lower-Than-Industry-Standard Rates
For those investing in a new construction property with Morris Invest, you’re offered lower-than-industry-standard rates. This is possible because we work with over 200 banks and have close relationships with a large number of lenders. With rates at record highs, being able to secure a lower rate can save an investor thousands of dollars, so it’s worth looking into.
You can also save money by paying your loan off sooner than the typical 30-year timeframe. I know this sounds impossible, but it’s totally realistic. Read the article I put together where I discuss the topic in detail – How to Pay Off Your Mortgage in 5-7 Years. Or, dive into my personal book on the subject that you can pick up from Amazon.
Additional Morris Invest Articles
- Streamlining Rental Property Inspections with Effective Checklists
- Landlord Insurance: What Does It Cover?
- Rental Property Metrics: Rentometer, Rent Estimates, Rent Roll, and NOI
- The Ultimate Guide to Residential Property Management
- Understanding Tenant Background Checks and Security Deposits
Maximize Your Investment Opportunities with the Right Rental Property Loans
Whether you’re looking for investment property loans for LLCs, traditional loans, or even government-backed funding, there are a lot of options available that can help you achieve your goal of investing in rental real estate.
And remember, if you currently have bad credit and you’ve been turned away from conventional lenders because of it, a non-recourse loan won’t need to take your personal financial situation into consideration. That said, there should be nothing holding you back financially from beginning your investment journey. Along those same lines, you’ll want to dive into the following power resources that were created to empower investors:
If you’re new to the game, I know the financial side of things can be a lot to take in. With that in mind, our door is always open for your questions at no charge – we’re happy to clear things up for you. Schedule a call with the team at Morris Invest to get the ball rolling so you’ll be one step ahead. In the meantime, grab a cup of coffee and dive into the following video I created that covers strategies for funding a down payment:
