Financing an Investment Property

As an aspiring landlord, securing financing is crucial for your investment property journey. However, coming up with the money to buy an investment property can be a big hurdle to clear. 

The median single-family home price in 2023 is anticipated to hit $385,800, according to estimates from the National Association of Realtors (NAR). That’s a lot of money to save up for. There’s a silver lining for investment property owners, though: The NAR expects rent prices to increase by 5 percent in 2023. Bear in mind, the average rental price for a single-family home in 2022 was already $2,495.

If you don’t have the savings on hand, don’t fret. Financing your investment property purchase is an incredibly common way to get into the rental market.

Here’s a look at how to get the job done — from considering your loan options to preparing your personal finances to score a great mortgage deal — so you can start collecting rental income.

Investment Property Loans

To purchase an income-producing property, you’ll need to use an investment property loan. With this type of loan, you can apply for a mortgage to buy a new or existing property for the purpose of generating a rental income.

Investment property loans typically apply only to property purchases in which you won’t be residing, but financing options are available if you do plan to live in one of the units or rooms of the property.

You can use investment property loans for a wide range of residential real estate, including single-family homes, condominiums, manufactured homes, and multifamily homes.

Investment Property Financing Options

When it comes to investment property loan programs, you have a number of financing options to choose from. Here’s a look at the more common routes to take:

Conventional Loans

If you’re already a homeowner, you may be familiar with conventional loans if you sought this type of financing for the purchase of your primary residence. Conventional loans are conforming loans that meet the standards set by Fannie Mae and Freddie Mac; however, you’ll find distinct requirements based on state and location. 

Unlike with government-backed loans like those through the Federal Housing Administration (FHA), lenders will expect you to come up with a down payment of at least 20 percent of your home’s purchase price.

Investment properties come with higher risk to lenders, too, so some may bump the down payment threshold to as high as 30 percent.

A great perk? You do not have to live in the investment property with conventional loans, unlike government-backed ones.

Government-Backed Loans

If you meet the criteria to qualify for a government-backed loan, they’re certainly worth checking out as an option for financing your investment property purchase.

Government-backed loans are nonconforming and come in many different shapes and sizes. FHA loans, which often have a lower down payment threshold, are the most applicable for investment property homebuyers. For example, qualifying applicants can purchase a two- to four-unit home with an FHA-backed mortgage to use as an investment property as long as they live in one of the units for at least 12 consecutive months.

VA home loans, mortgages backed by the Department of Veterans Affairs, offer a prime opportunity for veterans and military homebuyers looking to acquire investment property. 

Under the VA’s multifamily loan program, you can buy a property with up to seven units if you as the mortgage applicant occupy one of the units. Because the VA acts as the guarantor on these loans, 90 percent are typically granted without a down payment along with better terms and lower interest rates.

Home Equity Loans and HELOCs

Homeowners aiming to expand their property portfolio can tap into the home equity they’ve built up to help them purchase an investment property.

If you have accumulated about 15 to 20 percent equity in your home, you can trade in the value for a home equity loan or a home equity line of credit (HELOC) that can be applied as a down payment. You can typically borrow up to 85 percent of your home’s value, minus the outstanding mortgage balance.

These tools are convenient for dealing with a down payment, repairs, and even furnishing an investment property: A home equity loan provides you with a single lump sum amount of cash you can access once you’re approved for your loan while a HELOC involves opening a revolving line of credit you can draw from whenever you need to. 

Home equity loans typically come with a fixed term of five, 10, 20, or even 30 years — all sufficient time frames to repay your loan with the rental income that’s to come. HELOCs usually have a draw period of about a decade.

Be sure you have the flexibility in your budget to manage the mortgage payments for your primary residence and investment property as well as the home equity loan.

Hard Money Loans

Hard money loans are short-term loans of about 36 months — or just enough time to help you buy your property, set it up for renting, and accumulate rental income to pay off the loan.

Usually, these loans are geared toward flipping an investment property by making repairs and selling it; however, because they’re easier to get approved for, they’re a viable tool to help you in your homebuying process. Some investment property owners pay off their hard money loan with a conventional loan or home equity loan once they’ve got their bearings in the rental market and have established some home equity.

You’ll need about 25 percent down to qualify for these loans.

Private Loans

Some property investors go into the game with the help of friends, family members, or business partners who are willing to help finance the purchase. They may decide to do so to gain some interest on their savings or to test the waters with investment properties too.

Private loans don’t have concrete terms, interest rates, and minimum requirements — these factors are all up to you and the person you’re working with. But tread carefully with these loans to make sure you’re in a favorable position and ensure your loan’s details are documented by a legal contract.

Minimum Requirements for Investment Property Loans

The minimum requirements for investment property loans will vary depending on the type of loan you’re applying for. VA loans, for example, will have much more lenient requirements compared to a conventional loan.

On a whole, here are the requirements you’ll most likely be expected to meet:

Down Payment of at Least 20 Percent

Anticipate coming up with a down payment of 20 percent to 30 percent if you’re applying for a conventional loan for your investment property financing. (The cash must come from your savings as gifts can’t be used for buying a rental home, according to conventional loan guidelines.) 

Essentially, lenders need to know you’ve got some significant skin in the game to lower the risk of you defaulting on your loan. The investment property may not be your primary residence after all, so you may be more willing to default on your mortgage. 

Meanwhile, if you meet the criteria, you can purchase a home with an FHA with as little as 3.5 percent down or a VA multifamily loan with zero down, as long as you’re using the home as your primary residence.

Mortgage Reserves for About Six Months

Beyond your down payment, lenders also need to see savings of about three to six months of mortgage payments in your bank account. Once again, this alleviates their concern that you may default on your mortgage payments.

Strong Credit Score and Good Credit History

A baseline credit score of 620 is traditionally required to secure a conventional loan, but you may need a higher score because you’re applying for an investment property loan instead a mortgage for your primary residence. It’s crucial to show lenders that you have a solid credit history and have managed debts well over the years with payments made on time, especially for an investment property loan where your primary residence isn’t on the line as collateral.

Home Equity

If you’re applying for a HELOC, home equity loan, or cash-out refinance, most lenders want you to have at least 20 percent equity established. The more equity you have, the more likely you’ll qualify.

Good Monthly Debt-to-Income Ratio

Lenders will want to see that you have the adequate income to service your investment property loan along with any other debts you’re responsible for. Debt-to-income (DTI) ratio is the percentage of your gross monthly income that goes toward paying your existing debts. It should be at 43 percent at the highest, but your goal is to aim for far lower than that. To figure out your DTI ratio, add up your existing debts to see how much of your income is spent on debt repayments and how this additional loan may work into the calculations.

Proof of Employment and Steady Income

Lenders underwriting your loan application will zero in on your employment and whether you’re earning enough to feasibly take on this debt. In some cases, you may be able to use your estimated rental income to boost your earnings and help you qualify. For example, you may be able to take potential rent payments into account for FHA and VA loans, but you’ll need to check with various lenders for their policies on this.

If you’re already a landlord, your lender may ask for copies of current leases, tax returns showing rental income, and property appraisals showcasing what similar properties charge for rent in the community. Make sure you’re keeping up to date with this paperwork.

How to Qualify for an Investment Property Loan

You’ve saved for a down payment or successfully tapped into your home equity, and you’re ready to take the plunge on an investment property purchase. Here are the steps to get the job done. 

1. Comparison shop between investment property lenders

From government-backed loans to conventional and private loans, your financing options are quite varied, especially if you have a strong credit score and savings.

Shop around to see what loan options are available to you, and focus on their interest rates, terms, and conditions. You can ask your real estate agent or your current lender for their suggestions too.

2. Fill out an application

Narrow your shortlist to two or three options that would provide you with the financing you need and have competitive interest rates and terms.

Before you fill out loan applications, make sure you’re in a position to put your best foot forward with your personal finances. This means checking your credit score, bulking up your savings, and building up your down payment. Remember, you may need a down payment of as much as 30 percent and mortgage payments of up to six months.

3. Provide documentation

From bank statements and letters of employment to property appraisals and tax returns showing current rental income, the lender underwriting your loan will zero in on your financial details before approving you for a loan.

Look at their checklist of requirements to ensure you have everything they need for a seamless application process.

4. Review your closing disclosure

Once you’ve cleared the hurdles of financial checks and a property appraisal, you should receive a closing disclosure document outlining the terms and conditions of your mortgage. Review it to make sure the details line up with what you requested in your application. 

This is also the step where you should triple check that your loan payments are manageable and won’t land you in the red each month.

5. Receive your funds and close on your property purchase

After signing on your contract, you should be able to receive your funds and close on your property. 

Congratulations! You’ve secured the financing you need to buy your new investment property.