Investing in real estate has the potential for long-term earnings, and while some people have the capital to pay cash for a property, many need to get a loan to purchase an investment property.
Choosing the type of loan can be important when you are seeking a profit from your investment.
The type of loan to consider varies depending on several factors, including:
- What type of property is the investment?
- Does the investor have cash for a down payment?
- The credit score, financial history, and income of the investor.
- Does the investor plan to live in the property?
- Will the property need renovations?
- Does the investor currently own a residence?
These are just a few of the things that can impact what type of loan might be best suited for an investment property. However, they are just a general guideline when evaluating one of the three main types of loans used for real estate investments.
Conventional Loans
A conventional loan is what most people think of as a “bank” loan. This is the type of financing generally used for primary and secondary residences. There are more stringent requirements when using this type of loan for a property used purely as an investment, but it is still one of the most used types of financing.
The main determining factors for obtaining a bank loan for an investment property is personal credit score and credit history. The bank will also require a down payment, usually of 20% of the purchase price, but can run as high as 30% for an investment loan that isn’t for a primary residence.
Additional factors the bank will look at include any existing mortgages, income, and cash reserves. A pro for bank loans is that they are accessible to most investors, although it can be a lengthy process and take longer to secure a loan than with other financing options.
A conventional bank loan is not federally backed, and is regulated by Fannie Mae or Freddie Mac. The process can vary from state to state and between vendors, and so it is important to research the specifics pertaining to each investment situation.
Hard Money Loans
A hard money loan comes from an individual or company that specializes in real estate investment financing. The lender is not affiliated with a bank and has their own requirements for loan approvals.
The benefit of working with a hard money lender is that the process is faster than a bank loan. In addition, the lender usually looks at the income potential of the investment rather than the investor’s credit history.
The drawback to a hard money loan is that while they might be easier to secure, they also tend to have higher interest rates and have shorter terms for repayment.
Because of the higher interest rates and payment terms, this type of loan might be useful for investors with a fix and flip project that will be completed in a short amount of time. This type of loan is generally not best suited for an investment property seeking long-term passive income.
Home Equity Loans
If the investor has a current mortgage on a property with equity, they can use a Home Equity Line of Credit (HELOC) to finance a real estate investment. Like a bank loan, the lender will likely run a credit report. They will also get an appraisal on the property to estimate the current value to determine equity.
In addition to the three loan types discussed above, there are many other loan options for investment properties. An investor might consider these alternatives depending on their specific circumstances.
- Private Money Loan
- Federal Housing Authority Loan (FHA)
- Commercial Investment Property Loan
- 401(k) loan
Ultimately, deciding on the type of loan for an investment property will depend on the borrower’s financial background, how quickly they need the loan, access to a down payment, and the overall goal for the investment.
