Investment Property Loans: How to Choose the Best Option
Investing in real estate can be a great way to generate extra income, but only if you make the right decision when it comes to financing your properties. Investment property loans come in several flavors, each designed for slightly different investors and with unique pros and cons.
If you’re considering an investment property loan, stick around to learn how you can improve your application and get a loan that helps you invest — whether it’s for a rental home or flipping a fixer-upper.
What is an investment property loan?
Loans for an investment property are mortgages used to purchase an income-generating property. That includes properties you plan to rent, or a house you want to fix up and sell for a profit (also known as “house flipping”).
Strictly speaking, investment property loans are mortgages designed to finance these types of properties. But you also have other options that give you access to a lump sum of cash and aren’t specifically for real estate investing. We’ll cover both types of options below.
Most investment property loans have tougher qualifying requirements, heftier down payments and higher interest rates than a typical mortgage.
What is an investment property?
An investment property is real estate you buy to earn income rather than live in. For the purposes of this article, we’re focused on residential real estate loans, which typically only allow financing on properties between one and four units. Residential investment home types include:
- Condominiums
- Duplexes
- Manufactured homes
- Multifamily homes
- Cooperatives
Why do I need a special loan to buy an investment property?
You can’t use a standard home loan to buy a property unless you plan to occupy it as your primary residence. In most cases, this just isn’t viable for real estate investors. But there’s one big exception: It’s fairly common to use a standard home loan to buy a property with multiple units and live in one of them while renting out the rest (this is known as “house hacking”).
Types of loans for an investment property
Investment property loan options
| Loan program | Description | Number of units allowed |
|---|---|---|
| Conventional loans | This is the standard way to buy an investment property with no occupancy requirement. |
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| Federal Housing Administration (FHA) loans | You can buy a home and collect rent on the other units. In most cases, you’ll use a traditional FHA loan, which requires that you live in one of the units for at least 12 months. |
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| U.S. Department of Veterans Affairs (VA) loans | This VA multifamily loan program is exclusively for eligible military borrowers. It allows them to buy a property with up to seven units, as long as they live in one of the units. |
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| Nonqualified (non-QM) loans | Non-QM loans can allow you to qualify for financing when you aren’t able to provide either the income or documentation needed to qualify for other loans. These “no-doc” investment property loans are usually more expensive and require larger down payments than regular loan programs. |
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| Owner financing | Sometimes sellers are willing to act as your lender. Owner financing arrangements often include a balloon payment, which means you're required to pay off the entire loan balance within a short period, usually five to 10 years. |
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Other ways to finance an investment property
| Loan program | What it is | How it works |
|---|---|---|
| Home equity loan or home equity line of credit (HELOC) | If you currently own a home, you can borrow against a portion of your equity and leave your current mortgage loan in place. A home equity loan is paid out in a lump sum with a fixed rate, while a HELOC works more like a credit card that you can use and pay off for a set time. | Using home equity to buy an investment property usually means converting some home equity into cash and using that cash to make a large down payment toward an investment property purchase. |
| Cash-out refinance | A cash-out refinance allows you to take out a mortgage for more than you owe and pocket the difference in cash. | As with home equity loans and HELOCs, you’ll typically borrow against your home equity to come up with a down payment on the investment property. |
| Hard money loan | Hard money investors are private parties or businesses (not banks) willing to lend you money as long as you agree to pay it off quickly — typically in one to five years. The loan is secured by a physical asset (usually the investment property), and therefore little-to-no emphasis is placed on your credit history. | House flippers who need to bridge a short gap — usually between a property’s purchase and refinance or sale — often use hard money loans. This type of financing is typically the most expensive and most short-term option available. |
What type of loan is best for your investment property?
| Loan type | When it’s the best choice |
|---|---|
| Conventional loan |
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| FHA loan (owner-occupied) |
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| FHA loan (multifamily) |
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| VA loan |
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| VA “joint” loan |
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| Non-QM loan |
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| Owner-financed loan |
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| Home equity loan or HELOC |
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| Cash-out refinance |
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| Hard money loan |
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Minimum requirements for investment property loans
Down payment
You can purchase a multifamily home using an FHA loan with only 3.5% down — or a VA loan with 0% down — if you intend to live in one of the units. But although conventional guidelines permit down payments as low as 15% for rental homes, most lenders require at least 20%.
→ How to boost your down payment: Down payments can be partially composed of gift funds if you’re purchasing with an FHA or VA loan. Family members, your employer, a union or charitable organization are all approved sources. However, you don’t have that luxury when using a conventional loan to buy a rental home — the money must be all yours.
Read more about the down payment requirements for investment properties.Cash reserves
More commonly called “mortgage reserves,” this is cash the lender wants you to have in the bank. It’s usually one to six months’ worth of mortgage payments, depending on the loan program.
→ How to boost your reserve funds: Conventional and FHA loan guidelines allow you to count gift funds as part of your mortgage reserves, although FHA borrowers must put the gifted funds toward closing costs first. VA loans, however, don’t allow gift funds to count toward your reserves.
Learn more about how to save for a house.Income
As with all mortgages, you’ll need to show that you have enough income to afford your monthly payments. Conventional lenders typically cap you at a 45% debt-to-income (DTI) ratio.
→ How to boost your qualifying income: Lenders may allow you to add the actual or estimated rental income from the home you’re buying to qualify. Conventional, FHA and VA loans allow you to count rent payments received from the units you’re not living in toward your qualifying income. The lender may require copies of current leases, a rental history or tax returns showing rental income.
Credit score
You’ll need a minimum 620 credit score for a conventional loan, although the bar is a bit higher if you can’t make at least a 25% down payment — in those cases, you’ll need a 700 credit score.
FHA loans are a little more forgiving: You can qualify with a 500 credit score if you put down 10%, or with a 580 if you make at least a 3.5% down payment. And while there’s no hard-and-fast minimum if you’re eligible for a VA loan, it’s common for VA lenders to require a 620 credit score.
→ How to boost your credit score: There are many strategies for improving your credit score quickly, from requesting credit line increases to paying off outstanding debts.
History of property management
Some loan programs may require you to document or explain your experience renting properties.
→ How to boost your approval chances: A track record of successfully managed rentals will work in your favor.
How to get an investment property loan
The mortgage process for getting an investment loan requires a few extra steps.
- Shop around for an investment property mortgage lender. Most lenders offer some type of investment property loan option, but the rates may vary significantly between companies. Not all lenders offer non-QM loans, so you may have to make some extra calls if you need one. Hard money lenders are often private individuals or partnerships — ask your real estate agent or other real estate investors for recommendations.
- Fill out a loan application. If you’re applying for a standard loan program (like a conventional, FHA or VA loan), the process is similar to any other loan type. However, non-QM lenders and hard money lenders may have their own process or application system.
- Provide extra asset documentation. You may need to show bank statements and current leases or rental information on the property you’re purchasing. Lenders typically permit you to use a percentage of your retirement or 401(k) vesting toward your reserve requirement, so have a current statement handy.
- Pay for an appraisal. The home appraisal process requires an extra report detailing the average rent collected on similar homes in the area. In some cases, the rental income from this report can be used to help you qualify for the loan.
- Review your closing disclosure. The lender will issue a closing disclosure three business days before closing. Review it to make sure all the figures are what you expected. If you’re taking out a hard money loan, make sure you understand any prepayment penalties or “guaranteed interest” language. Hard money lenders typically want to make a set amount of interest, regardless of how quickly you pay back the loan.
- Gather your funds and close. You’ll send a wire or bring a cashier’s check for your closing funds. Once the mortgage closing paperwork is signed, your loan funds are sent and the property is recorded in your name.
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How much do investment property appraisals cost?
Appraisal fees are more expensive due to the extra work involved to estimate both the property value and average rent value. If you need a multifamily home appraisal, expect to pay an extra $100 to $300 above the standard $300 to $400 it costs for a regular appraisal, since each unit must be inspected and valued.
Investment property mortgage rates
Lenders must mark up investment property mortgage rates to cover the extra risk that the loan defaults. In general, rates for an investment property will be 0.25 to 0.75 percentage points higher than for a primary residence.
Your credit score and down payment also substantially impact the rate you’re offered. In fact, lower-credit-score borrowers may end up having to purchase mortgage points to get an investment property loan.
Read our tips on how to improve your credit score.Frequently asked questions
A document called an occupancy affidavit certifies whether a borrower intends to use the property as a primary residence or rental property.
Take time to improve your credit score and make the largest down payment you can. These factors will help give you the best chance of a low investment property rate.
You can own as many properties as you can afford. However, you’re capped at 10 properties through conventional mortgage lending.
You’re usually required to report all forms of rental income to the IRS, but they may be treated differently depending on whether — or how frequently — you use the rented property for your own personal use. If you’re unsure about how your rental activities should be dealt with, consult a tax professional.