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Investing in real estate comes with many benefits, including tax advantages, a regular cash flow, passive income and the potential for value appreciation.
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Borrowers have numerous lending options for investment properties. The right loan for you depends on your unique goals.
In our complete guide to investment property loans, we’ll dig into the various loan options borrowers have and the considerations you should make prior to your purchase.
What is an investment property loan?
An investment property loan is used to purchase a property that will earn the borrower income, whether it be through rental units or renovating the property and selling it for a profit.
Seasoned investors may have enough cash to purchase their next property, but newer investors likely will need to take out a loan.
There are numerous ways to invest in real estate, so the “right loan” for you depends on your ultimate investment goals and what you intend to do with the property.
Common types of real estate investments include:
- One-to-four-unit residential rental properties
- Vacation rentals
- Fix-and-flip properties
Investors sometimes use a conforming conventional loan to purchase an investment property. Investors may also use the equity from an existing property to fund the purchase.
Let’s take a look at the types of investment property loans available to borrowers.
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Types of investment property loans
Investment property loan options are similar to the options you had to purchase your primary residence. These loans will, however, have different qualifications and requirements since investments are considered more of a risk to lenders.
Conventional mortgages are the most popular type of loan used to purchase an investment property.
Conforming conventional loans follow the lending guidelines established by government-sponsored entities Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation).
Conventional loans offer a wide range of loan options and include varying term lengths and rate structures. In exchange for these benefits, borrowers must meet specific requirements including:
- 15%-20% down payment
- Credit scores in the high 600s to 700s
- Loan limits
- Maximum debt-to-income ratio (DTI)
- Cash reserves
- Income and employment documentation
The requirements will vary by lender, but generally, you can expect to make a significant down payment and should have a high credit score to access the greatest flexibility and benefits.
FHA loans are backed by the Federal Housing Administration, offering lenders more protection and borrowers more flexibility.
FHA loans and other government-backed loans aren’t the most common option for investment properties because they require borrowers to purchase a primary residence.
This means that to use this loan type for a rental property, you would have to live in one of the units.
However for some borrowers, this may be an ideal option, especially for duplexes, triplexes or fourplexes.
General requirements for FHA loans include:
- Credit scores as low as 580
- Minimum down payment of 3.5%
- Owner occupancy of one of the units
- Obligatory upfront and annual mortgage insurance premiums (MIP)
FHA loans have lower loan limits than conventional loans which could limit your range of property options depending on location.
On the other hand, an FHA loan may have lower interest rates than conventional loans, possibly helping you secure a lower monthly payment while maximizing your profit.
As is the case with FHA loans, VA loans are backed by the government and require your investment property to be your primary residence.
VA loans are only available to active-duty service members, veterans and qualifying surviving spouses and offer several advantages to those who qualify.
VA loan benefits include:
- Potential for no down payment
- Lower minimum credit scores
- Lower interest rates
- No requirement for mortgage insurance
Eligible borrowers interested in purchasing an investment property with a VA loan can access these benefits as long as they are willing to reside in one of the units of the property.
Some investors choose to use their equity from an existing property — such as their primary residence — to purchase an investment property.
One way to access your home equity is with a home equity line of credit (often called a “HELOC.”)
Depending on what you owe on your current mortgage, you may be able to borrow up to 95% of your home’s value with a HELOC.
HELOCs act as a revolving line of credit, allowing you to continuously withdraw and repay the funds during a set period of time.
The major consideration for financing your new property with a HELOC is that your home is being used as collateral for the loan.
Things to consider before purchasing an investment property
Before purchasing an investment property, there are several considerations to keep in mind, including:
- Investment strategy: Determine your goals and strategy, including whether you’re looking for a long-term or short-term investment
- Location: Look into the lifestyle of the area, especially if you need to reside in the property as your primary residence
- Property type: Single-family homes and multi-unit properties are among the most common options
- Risks: Is the investment financially viable? Consider the purchase price, potential income and ongoing expenses
- Financing options: Make sure you understand the requirements of each loan type, including down payment, interest rates and eligibility criteria
- Management options: Consider whether you’re managing the property yourself or hiring a property management company
- Exit strategy: Lay out how long you intend to hold the property and whether you eventually may sell it for a profit, refinance to access equity or convert it for a different use in the future
Consult with a trusted real estate agent and mortgage loan officer to help you navigate the process.
Apply for your investment property loan with Compass Mortgage
At Compass Mortgage, we promise to be your partner and advocate throughout every step of the lending process.
If you’re ready to move forward with your investment property purchase, the first step is to apply for pre-approval.
Compass Mortgage offers a unique program known as Get Committed® which puts you in the best possible position to win the property you truly want. Get Committed® provides a fully underwritten loan commitment and locks in your interest rate before you even find the property you want to buy.
A loan commitment essentially has the power of a cash offer, proving to the seller that you’re fully approved financially and that your deal isn’t likely to fall through.
With standard pre-approvals, you haven’t secured a loan yet. Get Committed® allows you to go through most of the steps in the loan process to secure a loan commitment, even before you make an offer on a home.
We can’t wait to help you purchase your perfect investment property.