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A rental property gives you the chance to increase your cash flow through lease payments while also potentially profiting from long-term equity growth. If you are considering this type of investment, you should know that rental property loans are different from standard home mortgages.
Even if you have already borrowed to pay for your primary residence, you might still wonder how to get a loan for a rental property. While some financing programs, such as FHA loans, are available for purchasing a rental property, there are different options, including hard money loans, that you need to understand if you want to invest in real estate.
Here is a closer look at getting a loan for a rental property and what details you should be aware of during the application and closing process.
- What Is a Rental Property Loan?
- Rental Property Loans vs. Conventional Loans
- How to Get a Loan for a Rental Property
- Types of Rental Property Loans
- Wrapping Up: How to Get a Loan for a Rental Property
What Is a Rental Property Loan?
A rental property loan is a mortgage to purchase a residential property. However, unlike standard home mortgages, rental property loans are for buildings that will be occupied by long-term tenants or short-term guests.
Rental Property Loans vs. Conventional Loans
Some aspects of rental property and conventional home mortgage loans are similar, but there are also a few important distinctions.
Here are some of the major similarities:
- Both types of mortgages have a similar application process. The lender will run a credit history check and ask to see financial documents related to your income, assets, and current debts.
- Rental and conventional loans come with similar terms. Both are typically amortized over 30 years, although 15-year loans are also available.
- Both loan types have down payment requirements.
There are some essential differences between conventional and rental loans that you need to understand before applying for the latter.
- Lenders assign a higher level of risk to rental property loans. This means that the interest rate could be higher, and you will have to make a larger down payment of between 10% and 20%. The stricter terms allow the lender to make up for the higher risk.
- Rental property loans have a stricter underwriting process. For example, the lender may ask for cash flow data from investments or other properties in addition to your income and bank statements.
- Lenders may require you to have additional funds to cover six or more months of mortgage payments, insurance, and taxes, in reserve.
How to Get a Loan for a Rental Property
Can you get a loan for a rental property? There are four main factors that you need to consider before you decide to follow your real estate investing ambitions:
- Credit Score: Lenders will always look at your FICO credit score at the start of the application process. For most lenders, the absolute minimum score is 620, which is typically regarded as a “fair” score on the FICO scale. A score above 670 will put you in the “good” range and qualify you for better interest rates. The best rates are for those who have a “very good” rating of 740 or higher. Since interest rates are higher on rental properties, increasing your score to the “very good” range can help make the loan more affordable.
- Down Payment: The down payment requirement for a residential mortgage can be as low as 3% of the total purchase price. However, because of the higher risk associated with rental properties, lenders often ask for a down payment of 20%. You may be able to lower the amount of the down payment if you are willing to purchase mortgage insurance.
- Savings: Lenders may require you to have savings to cover six months of your mortgage, insurance, and tax payments on the property. This amount can help cover the mortgage costs if you do not find tenants right away. Savings requirements can vary by lender and could depend on other factors.
- Debt-to-Income Ratio: The debt-to-income ratio (DTI) is the amount of income you have versus the amount of debt you carry. It gets expressed as a percentage. You can think of it as the amount of income that goes toward paying your debts each month. The ideal mortgage applicant has a DTI of between 28% and 36%. This shows that you can manage loans but that your finances are not too strained. Since real estate investors may already have a conventional mortgage for their primary residence, a DTI of up to 43% to 45% is acceptable for some lenders.
Types of Rental Property Loans
The first step in getting a loan for a rental property is choosing which type best fits your needs and financial situation. Factors for making this decision may include how long you plan to hold the property, your current credit score, your level of experience as a real estate investor, and your down payment amount.
Traditional lenders, such as banks or credit unions, offer conventional mortgages. These institutions may be more consumer-friendly and willing to work with people who have a lower credit score or less money for a down payment. They may offer solutions such as mortgage insurance or a second, separate loan to cover a larger down payment.
However, if you are wondering how to get a real estate loan with bad credit, a regular bank or credit union may You will still likely need a fair or good credit score to get a loan from these financial institutions.
Hard Money Loan
Hard money loans are different than conventional loans because they do not come from a bank or credit union. Instead, private investors lend the money for real estate purchases. These are meant to be short-term loans for flipping a property or purchasing a rental property with a plan to refinance once it is up and running.
Hard money loans allow you to use the property as collateral. If you default, the lender takes over the property. This puts more focus on the value of the property and less on your credit score and other factors that are essential during the conventional loan application process. This means you can apply for a hard money loan and get an answer very quickly.
residential hard money loans. Because they require less documentation than standard loans, the application process is faster, and you may be able to qualify with a lower credit score.
The Federal Housing Administration (FHA) does not give rental property loans. Instead, they insure mortgages Thanks to this extra insurance, the lender can offer better terms, such as a lower down payment (as little as 3.5 percent). You can also qualify for a loan with an FHA loan with a lower credit score.
A Veterans Affairs (VA) loan is for veterans, active military members, and qualifying surviving family members. The VA guarantees these loans, allowing lenders to offer more favorable terms. For example, some loans do not require a down payment, and they have favorable interest rates. Also, since the VA guarantees the loan, the VA loans are only for properties that you occupy, so they only work if you plan to purchase a multi-unit rental property and live in one of the units.
Home Equity Line of Credit (HELOC)
A home equity line of credit (HELOC) allows you to borrow against existing equity in your property. If you would like to make expansions or improvements on a rental property, for example, you can use a HELOC. Because it is secured by the property, a HELOC comes with favorable terms, including a low interest rate. Also, you can access the money when you need it, much like a credit card.
Wrapping Up: How to Get a Loan for a Rental Property
The best type of rental property loan depends on your needs and your credit score, debt-to-income ratio, down payment amount, and savings. While it is possible to get a conventional loan for an investment property, you can also use a hard-money lender like Source Capital. With a simple and rapid application process that focuses on the property’s value rather than your financial information, you can use Source Capital loans to purchase a rental property.
Visit Source Capital to find a reliable guide to hard money loans for your rental property.