8 Types of Rental Property Loans for Real Estate Investors

Read this guest post from our partner Kiavi to learn some of the popular financing options available to rental property owners.

As a real estate investor, it’s exciting to find “the one” — that property that checks all the right boxes and is just begging to become a rental. You can see the cash flow opportunities clearly and are ready to move further down the path toward financial freedom.

But, finding that perfect property is just the first step. There can't be a great rental property deal without reliable funding. That means your attention needs to turn toward finding a dependable lender to help you get into the deal.

You want to find the most competitive loan rates and favorable terms to maximize your return on investment (ROI), and several options are available for financing a rental property. Plus, each loan type offers its own advantages and disadvantages.

What is the best option for you? Read on as we look at 8 types of rental property loans and discuss their advantages and disadvantages for real estate investors.

Rental property loans: An overview

• Debt Service Coverage Ratio (DSCR) loan
• Conventional loan
• Veterans Affairs (VA) home loan
• Federal Housing Administration (FHA) loan
• Blanket mortgage loan
• Portfolio loan
• Private loan
• Owner-financed loan

Debt Service Coverage Ratio (DSCR) loan

The debt service coverage ratio – or DSCR – measures your ability to service or repay the annual debt service compared to the amount of net operating income (NOI) the property generates. The larger the DSCR ratio is, the more net operating income is available to service the debt. Lenders use the debt service coverage ratio to determine the maximum loan amount when a borrower is applying for a new loan or refinancing an existing one.

A typical non-qualified (non-QM) DSCR loan allows a real estate investor to qualify for a mortgage based on the cash flow generated from a rental investment property instead of their personal income. This is also known as a rental investment loan or rental loan. 

In the world of real estate investing, timing is everything. Today's hot seller's market requires quick approvals. Many restrictions that come with traditional funding avenues are erased from the slate when targeted, goal-focused rental investment DSCR loans are used, making them a popular option for eager investors.

Because the lender is not looking at personal income, they can offer an easy documentation process (no tax returns or employment verification) and no cash reserve requirements. It's a more streamlined way to obtain funding than traditional banks that don't provide this added agility. In fact, many investors who do multiple deals in a year will only do those deals using DSCR loans because they don't have time for conventional mortgages.

Conventional loan

If you have owned a home as your primary residence, you're most likely familiar with conventional financing. A conventional — or conforming — mortgage must conform to guidelines set by Fannie Mae or Freddie Mac and is not backed by the federal government.

The minimum down payment required for a conventional mortgage is 3% of the purchase price. However, the lender may require a more significant percentage as a down payment, typically 20% or more, based on your credit score or debt-to-income ratio (DTI).

With a conventional loan, the borrower's personal information like credit score and credit history will determine whether or not they're approved and what kind of interest rate they'll receive. Conventional lenders also review borrowers' income and assets, which requires a lot of paperwork and time from the borrower.

Using a conventional loan for an investment property differs from a residential one. Compared to a residential property, an investment property loan may have higher interest rates, higher down payments, prepayment penalties and higher credit score requirements. Additionally, the DTI requirements are often more strict, and there may be higher reserve requirements.

Another thing to remember about conventional home loans is that your ability to get approved shrinks as you purchase more properties. That's because banks and mortgage companies apply stricter credit requirements each time you apply for a new loan. Larger down payments and cash reserves are also often required when several mortgages are in play, which can be a detracting factor for investors who are scaling their rental portfolios.

Veterans Affairs (VA) home loan

A VA loan is designed to provide military members and veterans with housing during and after service. This loan type offers terms like no required down payment, lower interest rates, low closing costs and no property insurance required. Depending on state eligibility, the borrower may also qualify for property tax reductions.

The Department of Veterans Affairs restricts VA loans from being used to purchase properties solely for investment purposes. Thus, only owner-occupied properties qualify for VA loans.

The owner-occupied stipulation also leaves room for investors to purchase and live in a property with more than one unit. So, you can buy a multi-unit house and rent out the other units, so long as you occupy at least one unit.

You can also refinance an existing loan with VA Streamline Refinance loan. The VA loan option doesn't require you to live in the residence after refinancing it if it was already your primary residence before applying.

Federal Housing Administration (FHA) loan

Many people are drawn to FHA loans because this financing option offers low interest rates for lower-income buyers. The terms and benefits of this loan type include a lower required down payment, lower qualifying credit score, more flexible DTI requirements and lower monthly insurance rates.

An FHA loan does not allow for single-family rentals. Like a VA loan, the FHA loan has residency requirements. You can still rent a multi-unit home if you live in one of the units. But at least one person on the loan must use it as their primary (not second) home.

For an FHA loan, this residency requirement is only one year. Owners can then use it as an investment property after that time, sometimes referred to as “house hacking.” If you want to refinance for better investment property loan rates, you can use an FHA Streamline Loan.

An FHA loan also requires a stricter appraisal process. Unfortunately, an investment property you're trying to scoop up “for nothing” might not pass the test.

Blanket mortgage loan

A blanket mortgage loan is used to purchase multiple properties under the same investment loan terms. When investing in multiple assets, real estate investors and developers use them to save time and money.

With a blanket loan, each of the multiple investment properties is cross-collateral for the loan. But investors can sell off individual properties without closing the entire loan. These loans usually have comparably higher investment property loan rates and down payments than conventional loans.

Blanket mortgages are not meant for primary residences, vacation homes or brand-new landlords who are just getting started. Large commercial lenders are more likely to approve established real estate companies and seasoned investors buying properties in bulk. Typically you must already have a real estate portfolio and sizable assets, including a good portion of cash on hand, to be approved.

Portfolio loan

A portfolio loan is similar to a blanket loan in that multiple properties are held by the same lender. The lender originates and retains the loans and doesn't sell them to the secondary market — the loans stay within the lender's portfolio.

Because the lender holds onto the loan, they decide the qualifying standards and terms. Additionally, the lender can offer more flexible terms than a conventional or blanket loan, like easier qualification, customized loan terms, optional mortgage insurance and less-strict property condition requirements.

And, since the lender assumes more risk by holding onto the loan, they may take steps to modify that risk by imposing higher investment property loan rates or higher fees and penalties.

Private loan

A private loan is issued by a private company or an individual lender instead of a bank, credit union, or federal institution. Lenders generate profits from the interest and often offer private loans to family, friends, or someone with whom they have a personal relationship.

Some investors consider this option if they may not qualify with a traditional lender or they want to close a deal quickly with less red tape. Private loans make it easier to qualify, have a shorter approval process, and offer flexibility.

While private loans are less regulated than bank or federal loans, they still need to follow certain federal and state laws. With a private loan, the lender maintains a lien on the property. Failure to make payments or defaulting on the loan could result in legal action or seizure of the home — and damage a personal relationship in the process.

Owner-financed loan

Owner financing is another alternative to a traditional mortgage in which the homeowner who's selling the property finances the purchase for the buyer. The seller sets the loan terms, allowing you to skip a lengthy mortgage process.

The loan process of owner financing is quicker and easier than applying for a loan through a financial institution. Unlike a traditional mortgage, the seller doesn't give money to the buyer. The seller extends credit to the borrower that covers the price of the home, and the buyer makes payments until the amount is paid in full.

There are risks involved with owner financing, however. The interest is typically higher on these loans, and there's often a balloon payment at the end of 5 or 10 years. Also, if you don't obtain title insurance, the property title could have mortgages, outstanding taxes, and liens that end up being your responsibility as the buyer to repay. There could also be property line disputes and erroneous square footage listings that affect the home's value as an investment property.

Final thoughts on rental property loans

To have a successful real estate journey, you must have the proper financing in place. While there are many types of loans for rental investment properties, it's essential to understand what options are available because choosing the wrong kind of loan can potentially derail you from closing the deal. That's why it's vital to find a reliable lending partner you can trust to help you navigate your options and secure the funding you need to grow your rental business.

Ready to access reliable, fast, and easy financing? Get started with Kiavi today.

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