Are you entertaining dreams of becoming a real estate mogul and you figure rental property investment is the way to go? It’s not quite as simple as buy low, sell high. There are a few key things to know about rental property loans before you take the leap into real estate investment.
While your well-intentioned Uncle Bob might be trying to dole out advice on your new rental property investment, he may not realize it’s not quite the same as obtaining a conventional mortgage for your primary residence. One, because rental property financing works differently than a primary residence mortgage. And two, because lending rules for single-family investment properties shifted back in 2019.
Instead, prepare to assemble a team well-versed in the ways of rental real estate. This might include: a realty expert, a reliable source of funding, an experienced inspector and a lender that understands your financing objectives.
Types of Rental Property Loans
Hard Money Loans
One source of funding is referred to as a hard money loan. These rental-focused loans are streamlined for property investors looking to make, you guessed it, “hard money,” by flipping homes. Or alternatively, to make passive income as landlords. These rental loans aim to remove some of the hurdles set by banks, for example, with less-agile terms.
And if you’re not new to real estate, then you know how important timing can be. Targeted hard money loans can make the financing happen in time to score that ideal rental property you’ve been eyeing. But they can come at the cost of high interest rates.
Do you know your Fannie Mae from your Freddie Mac? Let’s explain further: The Federal National Mortgage Association (FNMA) A.K.A. Fannie Mae and the Federal Home Loan Mortgage Corporation (FHLMC) A.K.A. Freddie Mac are both government-backed enterprises. And while they’re “lovingly” referenced by their shortened names they stopped offering loans to single-family rental investments back in 2019.
Additionally, with conventional home loans your ability to get approved becomes harder with each property you purchase. Banks and mortgage companies will apply stricter credit requirements for each new home loan you apply for.
So, why mention conventional loans at all? If you live at the property for a specified amount of time you can still qualify for a Fannie Mae or Freddie Mac. You will also have to either pay primary mortgage insurance (PMI) or plan to make a down payment of over 20%. Finally, you will likely need a credit score closer to 800 to be offered low enough interest rates to make your rental property profitable. While the minimum may be 620, that will simply get you the first sit-down and it comes with a less desirable rate.
Other loan options:
- Home Equity Lines of Credit (HELOC)
- Slower process to be approved
- Variable rates
- Federal Housing Administration (FHA) Loans
- Cannot be used for investment properties unless it’s multi-unit property
- Stricter appraisal process
- VA Loans for Rental Investments
- Needs to be owner-occupied so must be a multi-unit property
With the higher rates of hard money loans, and the stricter requirements of conventional home loans, some aspiring real estate investors might be wondering where to turn? Here’s where Debt Service Coverage Ratio (DSCR) loans come in to save the day. Essentially, you qualify for a loan based on the property’s cash flow, not your income. The DSCR formula is simple: as long as the rental income covers your debt service, you’ll qualify. You can get 30-year fixed-rate loans from $100,000 to $3,000,000. No personal income or tax returns needed. Finally, if the rental income doesn’t cover the cost of debt service you can also contact Truss to learn more about a No Ratio Loan.
A Quick Guide to Rental Property Loans
Hard money loans:
- For non-owner occupied homes
- Less financial documents required
- Faster time to funding
- Higher interest rates
- Required to be primary residence
- Financial documents required
- Hard credit pull
- Higher down payment to avoid paying primary mortgage insurance (PMI)
- Fluctuating interest rates
- For investment property mortgages
- No income or tax returns needed
- Fixed-rate loans
Use this quick guide to determine which loan makes sense for you (and your mogul dreams). But don’t take too long, or that gem on Birch Boulevard might get scooped up before you’ve said yes to the credit check.