5 Investment Property Loans: Pros and Cons

Are you looking to make a real estate investment but are worried that you have little or no money to invest? Then investment property loans are your best option.

While real estate investing requires a lot of money, it doesn’t have to be your own. There are several investment property loans that you can take out for your next purchase. However, not all of them are ideal for you. Finding the best possible investment property financing option requires some research on your part. Here are 5 investment property loans to consider together with their pros and cons.

1. Conventional Loans

These are the most commonly used investment property loans. They are usually issued by traditional lenders such as banks and credit unions, as well as mortgage brokers. These loans are guaranteed by Fannie Mae or Freddie Mac.

Pros

• If you have a good credit score, investment property mortgage rates and fees are usually lower than those of other investment property loans.

Cons

• You’ll typically be required to make a down payment of at least 20% of the property’s purchase price. Many first-time real estate investors may find it hard to raise this amount of money, depending on the price of the property.
• A good credit score is required for you to qualify for these investment property loans.

2. Federal Housing Authority (FHA) Loans

These are multifamily investment property loans offered by traditional lenders and mortgage brokers that are backed by the Federal Housing Authority (FHA). Investors can use FHA loans to buy a multifamily property (such as a duplex or fourplex), live in one unit, and rent out the rest of the unit. In order to qualify for these loans, you are required to live in the property for a least one year.

Pros

• Unlike conventional mortgages, FHA loans require a very low down payment (3.5%).
• FHA loans have lower credit score requirements than conventional loans. This makes them easier to qualify for.
• Since you will be renting out the rest of the units, your rental income can cover your expenses and enable you to live for free.

Cons

• You are required to live in one of the units for at least a year. This may not be convenient for some real estate investors.
• To get approved for these investment property loans, the property has to be in good condition. Therefore, they may not work for a fixer-upper.

Related: Can You Use FHA Loan for Investment Property financing?

3. Hard Money Loans

Hard money lenders are private investors or companies that issue short-term loans with your property as collateral.

Pros

• Hard money loans are easier to qualify for relative to other investment loans. If you are thinking of how to invest in real estate with no money and poor credit, you should consider this option.
• Unlike a conventional investment property mortgage, hard money loans tend to be approved very quickly.

Cons

• Hard money loans can be very costly because the lenders tend to charge high investment property loan rates and fees.  Generally speaking, these loans are more suited for short-term fix-and-flip projects rather than buying investment property.

4. Private Money Loans

You can also buy rental property with no money of your own using private money loans. These are short-term loans from friends and relatives.
For this investment property financing method to work, there needs to be a high level of trust between the two parties.

Pros

• Fewer financial documents are needed for you to get approved.
• You can negotiate the loan terms and fees.
• Quicker approval. Some private money lenders can approve your loan application in just one day.

Cons

• Short repayment period.
• Higher interest rate than traditional loans.

Related: A Guide to Private Money Lenders for Real Estate

5. Home Equity Lines of Credit (HELOC) and Home Equity Loan

Home equity is the difference between the fair market value of your property and the remaining amount you owe on the property. For existing homeowners, home equity builds as they pay down their primary mortgage or when the home increases in value. They can then use the equity as collateral for a second investment property loan. Keep in mind that you can borrow up to 80% of your home equity.

When it comes to borrowing against your equity, there are normally two options. You can either take out a one-time lump sum loan at a fixed interest rate or use a home equity line of credit (HELOC). With a HELOC on investment property, the investor can tap into the equity in their home whenever they want up to a particular pre-set loan limit. Basically, it works like a credit card.

Pros

• Lower interest rates than other investment property loans
• In most cases, your loan is tax-deductible. This lowers your total tax expense liability

Cons

• You risk losing the property if you fail to repay the loan

Related: Can I Get a HELOC on Investment Property? How?

How to Reduce Investment Property Loan Costs

Generally, investment property loans have more stringent terms and higher interest rates than primary residence mortgages. This is due to the fact that banks see investment property loans as inherently riskier. With that being said, it is important to note that there are several strategies that investors can use to keep investment property loan rates and fees low and obtain the best possible terms. Below is an overview of some of them.

1. Maintain a Good Credit Score

For most investment property loans, your credit score will be taken into account to determine your eligibility, down payment, and interest rate. Keep in mind that a small change in interest rate can save you a lot of money. This is why you need to make sure your credit is healthy before applying for a loan. Shoot for a credit score of 740 or higher.

2. Lower Your Debt to Income (DTI) Ratio

Paying down your debt will boost your qualification for investment property loans, especially conventional mortgages. A lower DTI ratio will also help you get better loan terms.

3. Find Investment Property That Will Generate Good Cash Flow

When borrowing asset-based investment property loans, the property needs to justify the loan. This means that the property’s rental income should be sufficient enough to cover your mortgage payments and other recurring expenses.

4. Shop Around

Before you settle for a particular loan type or lender, be sure to shop around for the best interest rates and loan terms. A lower interest rate or origination fee can make a huge difference in the profitability of your investment property.

5. Make a Bigger Down Payment

If your resources allow it, consider making a large down payment. By paying more upfront, your loan will be smaller. This means that your total interest costs over the life of the loan will be lower.

The Bottom Line

Buying investment property can be tricky if you don’t have a clear idea of how to secure financing. Real estate investors looking for a good return on investment should look at the pros and cons of different investment property loans before making a decision.

When investing in real estate, always carry out an in-depth analysis to ensure your rental property investment is profitable. Mashvisor’s real estate investment will help you tackle this task with ease. Try out our calculator now!