Rental Property Loans – 8 Loan Types You Should Know
Part of real estate investing is finding the best property loans for optimal cash flow and low interest rates. Have you found the perfect property you know would be ideal for a rental? Whether this is your first investment property or you're building up your portfolio, you'll most likely need funding to make it happen.
To help you maximize your return on investment (ROI), you'll want to find the most favorable loan terms and competitive rates. Fortunately, you have several options to consider when taking out rental property loans. Each has its pros and cons, depending on your unique situation.
Here, we'll explore which loan might be right for you. But first, let's look at a few of the differences you can expect to find between home loans and rental property loans.
Getting residential rental property loans
Lenders consider rental property loans risker than home loans. That's because it's much easier to walk away from an investment property than your home. For this reason, you'll find the following differences from a home loan:
- Slightly higher interest rates and fees
- Larger down payments (typically 20%-25% or more)
- Minimum credit score of 620
- Debt-to-income ratio of 36% or less (DTI ratio is your percentage of gross monthly income used to pay for any debt.)
- Cash reserves that will cover six months of your mortgage payments
- The property must be a condo, townhome, small multifamily or single-family home to qualify
Options in rental property loans
There are lots of options to consider when getting rental property loans. The following represent the eight most common approaches.
1. Conventional loans
One of the most common rental property loans is a conventional loan. You usually obtain these loans from traditional lenders like banks, credit unions and mortgage brokers. Also known as conforming loans, they must conform to guidelines set by Fannie Mae or Freddie Mac.
- With a good credit score, lower interest rates than other options
- Down payment requirement is typically 20% or more (Based on the DTI ratio and credit score)
- Up to 10 mortgages by the same borrower (Lenders usually set lower limits of around four)
2. Federal Housing Administration (FHA) loans
The FHA backs these loans, which are designed to help low- and moderate-income buyers. You must use the property as your primary residence for at least one year. Because of this restriction, investors use these loans for multi-unit dwellings of up to four units, living in one and renting out the others. You also get these loans from traditional lenders and mortgage brokers.
- Lower interest rates than conventional loans
- Lower qualifying credit score
- Lower down payment (3.5% if credit score 580 or higher / 10% if credit score between 500 and 579)
3. Veterans Affairs (VA) multifamily loans
The VA designed these loans to help military members, veterans and eligible spouses with housing. The homes must also be owner-occupied. Like FHA loans, you can buy a multi-unit house, live in one unit and rent out the rest. Traditional lenders and mortgage brokers offer this loan.
- Lower interest rates
- No minimum credit score requirement (VA requires lenders to review the complete loan profile)
- No down payment
4. Portfolio loans
Portfolio lenders originate and keep loans in-house, retaining them in their portfolio. This approach differs from conventional lenders that sell loans on the secondary market. Because they're keeping them, these lenders decide the qualifying terms and conditions. Because they're assuming the risk, they may also impose higher loan rates and fees. Private lenders and mortgage brokers offer these loans.
- Interest rates, credit score, down payment and loan terms customized for each borrower
- Generally, carry higher interest rates and fees
- Easier to qualify
- May impose prepayment penalties
- More investor-friendly than traditional loans
- No restrictions on the number of properties
- Unfavorable repayment schedule, such as interest-only payments followed by a large balloon payment
5. Blanket mortgage loans
A blanket loan is ideal if you want to buy several properties and finance them using a single loan. These rental properties are usually used as cross-collateralization. This means each of your properties acts as collateral for the other ones. A release clause may let you sell one or more properties without needing to refinance. Private lenders and mortgage brokers offer these loans.
- Interest rates, credit score, down payment and loan terms vary
- Tend to have higher interest rates and down payments
- More likely to approve seasoned investors with an existing real estate portfolio
6. Private loans
Private companies, individuals and experienced real estate investors issue private loans. Some lenders may accept a small equity position in exchange for lower interest rates and fees. If the investment performs well, these lenders can be a good source for future rental property loans.
- Interest rates, loan terms and fees customized for each borrower
- Easier to qualify
- Shorter approval process
7. Owner-financed loans
Sellers who own a property free and clear may offer seller financing. These property owners generate interest income. They can also spread out capital gains tax payments, an alternative to conducting a 1031 tax-deferred exchange.
- The seller sets the loan terms
- Interest rates typically higher
- Possible balloon payment due after 5-10 years
- A good option for a property that's hard to qualify for
- Quicker and easier loan process
8. Home equity line of credit (HELOC) & home equity loans
HELOCs and home equity loans are options for investors with equity in an existing property. Your equity equals the market value of the property minus what you owe.
A HELOC is like a credit card. It lets you use the money as needed, make monthly payments and reuse it. A home equity loan offers one lump sum.
- Interest rates are typically higher than a conventional cash-out refinancing loan
- Borrowing limits are usually between 75%-80% percent of the available equity
- Because property acts as collateral, you risk losing it if you can't make payments
- Good alternative source of funding to have on hand
Finding the right rental property loan for you
Successfully investing in real estate requires securing loans that offer the best ROI. To accomplish this, it's critical to find a lending partner that will work with you throughout the process.
Talk with investor-friendly lenders and mortgage brokers who know your market. The goal is to develop a relationship with a dependable lender you can trust. Make sure to shop around for the best terms. Then, when you're ready to apply, have your loan application documents in order to show you're a serious investor.