You hear all the time about cryptocurrencies, stocks, bonds, and other investments. No matter what new trends arise, investors still agree that real estate is the best investment around today, and why wouldn’t it be?
Real estate is versatile, profitable, tangible, and always in demand. Everybody needs somewhere to live, so as long as you know what you’re doing, it can be easy to profit from real estate.
However, without the right property and the right loans, your investment could easily turn sour. So, what kind of loan do I need for an investment property? We’re glad you asked!
Different Types of Investment Properties
Before we discuss the different types of loans, let’s briefly review some of the most popular types of real estate investments, why they are popular, and some of their challenges. Once we understand these, we’ll see why certain loans are better for these types of investments.
Multi-family homes and commercial properties may not be the same when it comes to taxes, but they are the same as an investment strategy. Either way, you buy a building (or several buildings) and rent out individual units to tenants for monthly income. When people think of investment properties, this is likely where their minds go, as it’s one of the most popular types.
If all goes well, you generate monthly income that exceeds your mortgage payment, property taxes, insurance, maintenance, and other expenses. You can use a rental property calculator for more specific information. This income is steady and predictable when things go well, and you’ll always have the building to resell if you choose.
Other investments may offer a lump sum on the backend, which is very appealing to many investors. However, if you want to secure extra income during retirement, supplement your existing income, or have someone else pay your mortgage, then this is one of your best options.
However, there are many challenges that come with rental properties. For example, when you purchase a home and something goes wrong. Even a broken water heater could seriously harm your investment, especially right after making a down payment.
Also, if you don’t choose the right tenants, they could ruin your profits for a substantial period or leave you with major repairs that you will be responsible for. Lastly, if you’re holding the building for a long time, it’s hard to predict where the market will go or what will happen to the property in that time. As long as you choose the right tenants and the right building, these shouldn’t pose any issues.
Flipping houses is a very popular investment method that can earn you a large profit on the backend. Let’s say you buy a “fixer-upper” for $100,000 in a town with an average home sale value of $300,000. In that case, you may put in $80,000 in repairs and earn a $120,000 profit.
For that reason, it’s easy to see why this is such an appealing strategy. Who wouldn’t want to earn a paycheck like that? However, as we’re sure you can guess, this strategy comes with risks.
First, there’s no guaranteed profit. Even if you have a quote of $80,000 for all of the repairs, more issues could arise, and there’s no guarantee that anybody will be willing to pay for the house.
Second, renovation costs, for both materials and labor, are high. The more DIY home improvements, the more you’ll save, but this can be a very involved job. If you don’t have the time to put in some of the work yourself, it will cut your profits.
While this is a limited risk, the market could change dramatically during your “flipping period”. If you’re reselling within a year, this won’t be much of a concern, but the longer you hold, the riskier it is.
Lastly, a mortgage may charge serious fees if you pay it off too early, which could leave you with a large bill at the end or you could find yourself stuck making payments after selling. Also, you may have to make payments on it while doing the renovations, but there are ways around this. More on that later.
BRRRR is the most specific strategy on this list, but we’re adding it because of its increasing popularity. It’s essentially a combination between flipping and rental properties. You buy a property, fix it up, and rent it out.
So, that’s “buy”, “rehab”, “rent”. The last two, which give this strategy its unique viability, are to do a cash-out refinance with your newly renovated property and then use that lump sum for a down payment on another property. These are “refinance” and “repeat”.
On paper, this is the best strategy for building a real estate portfolio from scratch. With only 15% to 20% down on a discounted home, you could potentially build a serious real estate business in the shortest possible time with this strategy. However, there are also plenty of risks.
For the BRRRR method, you can essentially apply any of the risks listed above for both rental properties and home flips. On top of that, you have to consider the terms of the investment property loan to pull off this strategy successfully. More on that later.
Selling condos can be very lucrative on the backend, much like flipping properties. However, in this strategy, you will have to buy a large enough building that is unoccupied, which isn’t as easy as it sounds. For that reason, most condo investors will choose to develop from scratch.
Once construction is complete, you can sell each individual unit. The business model here is the same logic as buying wholesale and selling retail. Selling unit by unit will almost certainly secure a profit, but only if you can find buyers!
Of course, the other glaring downside is the upfront costs. Few investors have the money to develop such a building, so they’ll need to secure the funding through other investments or find the right construction loans.
Also, you may not generate long-term income from condos unless you can charge maintenance fees or take control of the homeowner’s association. There are ways to build an ongoing income from condos, but they’re often not as profitable or consistent as rental properties.
Different Types of Investment Loans
Regardless of what type of real estate investing you want to pursue, now is the time. The Fed is signaling that interest rates will continue to rise, and the housing market is still shooting up. For some investors, it’s now or never.
While there are many different investments for many niches, most real estate loans will fall under two umbrellas. Real estate tends to be the most expensive type of loan, so they’re often different from car payments. However, these are the two most common types of short-term and long-term investing.
Mortgages are long-term loans with a fixed rate that you pay down over the course of 15 to 30 years. Generally speaking, you’ll have a set monthly payment that you’ll need to pay down over this designated period, with your investment property or house acting as collateral.
In this case, if you fail to pay back the loan, the lender may take the building for compensation. However, if you have tenants occupying the building and making monthly payments, then you won’t have to worry, as this should cover your mortgage payments entirely.
The only downside of mortgages and similar loans is that they are a large, long-term commitment. Also, paying them off too early could result in large fees. However, they are an excellent way for people to afford real estate without the ability to pay in full.
Bridge loans are short-term loans designed to be paid off in full. Typically, they will last around 18 months, and you can pay off the loan entirely. While these may sound strange to new investors, they are perfect in certain scenarios. Let’s talk about that.
What Kind of Loan Do I Need for an Investment Property?
Depending on the type of investment you plan to pursue, there are different types of loans that will fit your needs better than others. Here are the best options to choose from for each type of investment!
For House Flipping
There is no better option for a house flip than a bridge loan. Instead of having to make payments while fronting the bills for expensive renovations, you can put in the work and sell the house before having to pay back a dime. From there, you can keep the remaining profits!
These terms last anywhere from 12 to 24 months, offering ample time for you to fix the property, market it, and close. There won’t be any surprise fees on these interest-only loans that you can pay back in full without any penalties.
Also, these loans won’t just cover the cost of the house. They’ll also front up to 100% of the cost of renovations, allowing anybody to get into this lucrative side hustle!
For Rental Properties
You’re probably assuming that we’re going to say that a traditional mortgage will be the best option for a rental property investor. Well, think again. Like others on this list, there are loans specifically designed for these types of investments.
Choosing a multifamily loan is far better than a traditional mortgage, especially if it is not owner-occupied. These are perfect for buildings with more than 5 units. Otherwise, a traditional mortgage will work great for an owner-occupied two-unit or four-unit building.
Keep in mind that this is for a turnkey investment property with existing tenants. If you need to do major renovations before renting it out, then we suggest avoiding a mortgage or multifamily loan. Here’s what to do instead.
For the BRRRR Method
As we mentioned, the BRRRR investment strategy is a very specific niche within the real estate industry, and finding the right loans for it can be challenging. Most investors won’t want to take out a mortgage and have to make payments during repairs, and they won’t have the money from rent to pay off a bridge loan in full.
Fortunately, there are loans designed specifically for the BRRRR method, and they’re called multifamily bridge loans. Essentially, they allow you to hold off on payments until after the repairs are complete, and then you can begin paying off the loan once you have a stable income from rent. These are perfect for newer investors who don’t have the money upfront for these repairs and loan payments!
If you plan on developing condos, remember that the more capital you raise from loans than investors, the better it will be for your profits. Otherwise, you’ll need to share the profit with other investors. With a construction loan, you’ll only need to pay off the amount you owe, and then the rest is yours!
Construction loans are essentially the same as bridge loans, although you may be able to negotiate the term. However, interest rates will be similar and you won’t be penalized for paying off the loan in full. After that, you’ll be left with the remaining profit!
Get the Most Out of Your Investment
Now that we’ve answered the question “what kind of loan do I need for an investment property?”, you can make an informed decision that’s right for your needs. Choosing the right loan could save you thousands of dollars on your investment and eliminate plenty of headaches, so make sure you choose the right one for your investment.
If you still have questions about investing in real estate, stay up to date with our latest investment tips, and feel free to contact us at any time for more information!