Whether through luck or better-than-average timing, you’ve found the perfect property for your real estate portfolio. The foundations are there and the place is located in a great neighborhood. And, perhaps most importantly, the seller is letting the property go at a huge discount.
How do you finance this purchase?
Unless you’re in the same tax bracket as Jeff Bezos or Elon Musk, you’re more than likely relying on investment loans to purchase your next property. But, as all real estate investors eventually find out, these loans come in a variety of shapes and sizes.
What are your options? Which investment loan type should you choose? Read on to learn more about how you can finance your next property investment.
Should You Take Out a Property Investment Loan?
Some people would rather get a root canal than take out a loan. They don’t like to spend too much on credit. And they definitely don’t like taking unnecessary risks with the cash they do have.
But even if you’re a frugal sort of person in practice, there are a few really good reasons to consider financing your real estate purchases:
1. You Can Scale Quickly
Imagine you’re buying a new pair of running shoes. You’re hoping to run the Boston Marathon and you can’t afford to miss a single day of training. Which, ironically, puts you in an awkward financial position because you can’t afford to buy the new shoes until next payday.
So your choices boil down to:
- Buying the shoes on credit
- Waiting until you get paid
All things being equal, you’ll likely opt for the credit card because that’s the option that will help you get those shoes sooner.
Real estate investment loans are like the ultimate credit card purchase.
In the second quarter of 2021 alone, the median price for American homes was $374,900. If your plan is to purchase your second, third, or fourth investment home with cash, you could be saving money for a long time.
Loans make it possible for real estate investors to scale their portfolios faster.
2. Real Estate is a Low-Risk Investment
A lot of people like to talk about the importance of generating returns on the stock market. And while the GameStop saga made it possible for some people to become millionaires, the investment was so speculative that brokers were actively warning people about the high risks involved.
Taking out a loan to purchase shares near the tail end of the GameStop craze would have been a disaster in the making. But with real estate investments, loans aren’t nearly as risky.
Whether you’re the president or a nurse, everyone needs a place to stay and a roof over their heads. Real estate investments are such dependable income earners that you don’t have to worry about losing money on your investment — in fact, you may be able to cover base payments and interests with your rent payments alone.
3. You Get Equity and Ownership
The stock market does make certain returns possible. But there is a catch:
It doesn’t matter how many shares you own. You still don’t fully own that company. And to make matters worse, you have no say in what happens or what the company does on a day-to-day basis.
Mutual funds, index funds, and stocks all have the same general weakness.
With a real estate investment loan, you get a little more equity with each payment you make. And when the loan is paid off and you own the property free and clear, you can do whatever you want with it. In many ways, your investment loan will help you increase your portfolio value in record time.
4. You Can Have Long-Term Income
Why are rental properties considered good investment options? Because, if you’re inclined to buy and hold, they can give you long-term rental income for the rest of your life.
After all the expenses have been deducted and you’ve covered your tax-related costs, a single property might give you $500 a month. If you purchase two properties, now you’re getting $1,000 a month. And if you multiply those numbers by five or ten, suddenly you can kiss your day job goodbye.
This is the basis of the BRRRR strategy. And for most people who are looking to build wealth through real estate, investment loans make it possible to invest indefinitely.
What Are the Different Types of Property Investment Loans?
Whether you’re a real estate investing veteran or you’re trying to close your first deal, there’s one simple truth that property investors learn quickly:
Not all loans are created equal.
Here’s a breakdown of the financing options that you’ll likely run into:
1. Conventional Loans
When most people hear the word “Loan.”, they probably picture some version of this type of loan. That’s right. This is the standard mortgage or personal loan application that you would be making at a bank or credit union.
Typically, you would start this off by booking a meeting with a loan officer or a mortgage specialist. Depending on the financial institution, you might have even been filled out a loan application before arriving.
To get approved for this type of loan, you’ll need a few items like:
- Proof of your income
- A solid credit score
- Reasonable amounts of debt
- A substantial down payment
In most cases, conventional lenders want to see a down payment that adds up to anywhere from 5 to over 20 percent of the mortgage value. The good thing about going through this process is that if you can qualify, you’ll likely enjoy both a longer repayment period and a lower interest rate. But if you already own a house or two, securing another mortgage might not be easy.
2. Hard Money Loans
What if you could secure funds from high net-worth individuals and private investors instead of relying on the bank for financing? As made-for-TV as that whole scenario might sound, that’s the entire premise of a hard money loan.
Even when you’re able to qualify for a loan, banks and other conventional lenders might be reluctant to finance your purchase if it’s for a house that needs major repairs and massive amounts of TLC. And because banks have a number of regulations and rules that they have to follow when making loans, it often takes time to get a risky real estate investment purchase approved.
With hard money loans, you can get the money you need quickly. In addition, because the loan depends on the worth of your property, this is a solid financing option for real estate investors who might not have enough income or credit to satisfy a conventional lender.
Although these loans are typically associated with fast turnaround times, they can be quite costly. But because the loans are riskier in general for lenders, interest rates can be quite steep.
If this loan option looks like an attractive option, we have a more in-depth post on hard money loans that you can read. The important thing to note here is that hard money loans can be approved for individuals who would more than likely be rejected by the bank.
3. Blanket Loans
Let’s say that you’ve purchased land and you’re planning to build multiple houses that you’ll eventually sell. Would you need to take out a new mortgage for every planned unit? Would you even be able to sell the property to individual families and individuals?
Blanket loans make it possible for you to receive funds for the total purchase of the land while also allowing you to sell off smaller portions of the property. If you’ve got large-scale ambitions and you want to build multiple houses and units, blanket loans may be a more sensible financial option.
4. Portfolio Loans
Let’s say that your credit rating just isn’t as high as it needs to be for a conventional loan. Or maybe that’s not your problem. Maybe the bank just doesn’t want to purchase a rundown house.
Whatever the case may be, you want to get a standard mortgage loan but you know that you’re unlikely to qualify for a standard loan. Are you stuck with a hard money loan in these circumstances?
With these types of loans, the mortgage goes into the lender’s portfolio. Although these loans aren’t subject to all the rules and regulations around standard mortgages, however, it’s not unusual to see lenders looking to offset risk by charging higher interest rates.
If you could see yourself being classified as a hard money loan borrower in a parallel universe, portfolio loans are another option that’s well worth looking into.
How to Find the Best Property Investment Loan for You
We’ve gone over the basics of your financing options. How do you choose the best one for your situation? By our count, there are at least three things that need to be considered as you explore the possibility of taking out a property investment loan.
1. How Soon Do You Need the Funds?
In 2021, the housing market was red hot.
Buyers were routinely paying five figures above the standard asking price and getting outbid. People were competing with other buyers. For a time there, real estate professionals and home buyers alike were all claiming that there weren’t enough houses for buyers to choose from.
If your local real estate market is scorching hot, you might not have time to wait around for a loan approval. Why? Because even if you’re only looking at a one or two-day delay, those discount properties will more than likely be snapped up by other buyers.
Hard money loans and portfolio loans are known for having faster approval times. However, if you’re able to get your mortgage pre-approved, the underwriting-related delays are unlikely to be a factor. Regardless of which financing option you choose, you’ll want to have the estimated timelines in mind.
2. How’s Your Credit?
We’re about to let you in on an open secret in the financial world:
People with high credit scores are often able to land much lower interest rates. And while a percentage or two might not sound like a huge deal at first, those figures could cost you a solid four or five figures over the course of a 20 or 30-year mortgage.
If you’ve got a bit of time on your hands, you may want to spend some time shoring up your financial situation. Pay down your credit cards, lower your debts, and make sure that the information on your credit report is accurate.
Your bank will be more likely to see you as a strong borrower candidate. And you’ll have an easier time securing the financing you need because lenders won’t see you as a risk.
But even if you’re not able to secure conventional financing at this time, you still have other options at your disposal. Portfolio loans and hard money loans in particular are designed to give people with less-than-stellar credit a chance at securing the investment financing they need.
3. What’s Your Business Model?
Are you planning to build your next investment home from scratch? Is your plan to purchase fixer-uppers and then sell them within the year or are you planning to hold on to the properties you purchase?
If your real estate investment model involves buying and selling a bunch of short-term purchases, the lower interest rates associated with conventional loans might not matter nearly as much to you as making sure that you’re able to secure funding fast.
However, even if the initial part of your process happens to involve making renovations, you don’t want to be paying higher interest rates on a multi-decade mortgage if you can help it. So even if the state of the property makes it so that you need to secure funding through a hard money loan to start, you’ll want to have a financial plan that will allow you to transition towards a lower-interest option over time.
Things to Watch Out for When Taking Out a Property Investment Loan
Let’s say that you’ve picked a financing option. You’ve got your eye on a particular lender, but you’re not entirely sure if that company is the right one to partner with.
Here’s a shortlist of things to consider as you prepare to make your loan application:
1. Problems With the Property
They say that real estate investing is as close to a sure thing as it gets. But in reality, there’s buying an investment property. And then there’s buying an investment property that has the potential to be profitable.
If you’re taking out a loan, you’ll want to do your due diligence on the property you’re investing in.
Is this house or apartment building located in an area that’s going downhill fast? Has there been a crime wave or a change in public transit routes that will make it harder for you to attract the tenants you’re looking for?
And then there are the ongoing maintenance costs and expenses. If the building is very old or if the original builder was taking shortcuts, basic things like plumbing and electrical wiring might need to be done on a larger scale.
Underwater mortgages are a nightmare for regular homeowners. But the financial consequences of choosing the wrong property are often worse for real estate investors.
2. Interest Rates
As a general rule of thumb, you can expect the interest rates attached to conventional loans to be lower than what you’ll get with a hard money or portfolio loan. But even within these broader categories, you’ll still want to make sure that you’re not being fleeced.
Take multiple quotes from different lenders. Call a few brokers and ask them about their lowest offered rates. Once you’ve done this, you should have a ballpark figure when it comes to reasonable interest rates.
If you feel that the deal you’re being offered is unreasonable based on general market prices, don’t hesitate to walk away.
3. Tenant-Related Concerns
Although it’s certainly true that a rental property can generate income for years to come, there’s no guarantee that you’ll have a 100-percent occupancy rate the entire time that you own the property. And if you go through a period of extended vacancies or limited demand, it’s important that you’re able to weather the uncertainty with relative ease.
Maybe you’ll need to rent at a slightly higher price so that you can put aside funds for property taxes and other maintenance costs. Or perhaps you’ll need to establish a separate fund that’ll tide you over during periods of low occupancy. Regardless, you’ll want to refine your business model and your prices before you take on the commitment of a loan.
How to Prepare for Your Loan Application
Okay. So at this stage, you’ve found the property, you’ve picked your preferred loan format, and now you’re in the process of submitting your official application.
We’ve already provided real estate investment borrowing tips elsewhere. But here are a few key pieces of advice that can make the application process go smoothly:
1. Have Your Down Payment Saved
Remember what we said before about how conventional lenders will often want to see a substantial down payment for a mortgage? Well, there are two reasons why this part is so important:
For one, it allows you to take out a larger amount if necessary. If you’re looking at properties in the $300,000 and you’ve got 20 percent saved up, you’re in good shape. But if you happen to fall in love with a property that’s in the $350,000 or $400,000 range, you may still be able to qualify for it even if the rest of your application package stays the same.
And secondly, a larger down payment can give lenders more confidence in your ability to handle a second, third, or fourth mortgage.
2. Have Your Paperwork Together
There’s nothing worse than booking an appointment for Thursday while hoping that your boss is able to verify your income before Friday. And if your bank statements are somewhere else while you’re also waiting for your down payment, it could take a while for you to get through the loan approval process.
When all of your paperwork is in order, however, it becomes a lot easier for loan and mortgage specialists to let you know what, if anything, they still need from you. And in a real estate market where time is of the essence, being prepared can speed up your funding in more ways than one.
3. Be Prepared to Get Funding Through Unconventional Sources
Even the most seasoned real estate investors have to start somewhere. So if you don’t think that you’re conventional loan material, it may be worth your while to start thinking about where you can qualify.
FHA loans, for example, are well-known for having lower closing costs and lower down payment requirements than conventional loans. And if you’ve served in the military or you’re a member of a faith-based organization, you might have access to more financing opportunities than you think.
Investment Loans, Real Estate, and Your Wealth-Building Portfolio
For many people, real estate investing is a catch-22. On the one hand, you can build wealth while acquiring property and income. But to get into a position where rental income is on the table, you need to secure financing before you can purchase the property.
If any of this is starting to sound a little too familiar, investment loans could be the solution that you’ve been looking for. These financing options will allow you to purchase what you need while increasing your investment income. See your investment loan options today!