September 11, 2023

8 Types of Rental Property Loans for Real Estate Investors

Get an overview of some of the most popular financing options available to rental property owners.

8 Types of Rental Property Loans for Real Estate Investors

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 eight types of rental property loans and discuss their advantages and disadvantages for real estate investors.

Rental property loans: An overview

1. 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.

Pros of DSCR loans:

  • Income flexibility: Focuses on rental cash flow, not the investor's personal income.
  • Faster approvals: Quicker than traditional loans, aiding in seizing timely opportunities.
  • Less documentation: Simplified application with fewer personal financial details.
  • Emphasis on property potential: Approval based on the property's earning potential.

Cons of DSCR loans:

  • Higher interest rates: Often higher due to perceived risk.
  • Stricter property analysis: Emphasis on the property's cash flow can be a double-edged sword.
  • Varied lender requirements: Different lenders might have inconsistent DSCR criteria.
  • Risk of over-leveraging: Ease of qualification might tempt over-borrowing.
  • Market vulnerability: If rental income drops, debt obligations might be challenging.

2. 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 varies by lender but is typically 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 mortgage lenders will 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 minimum 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.

Pros of conventional loans:

  • Well-known: Familiar process for many investors.
  • Wider acceptance: Accepted by most sellers and real estate agents.
  • Potentially lower interest rates: Especially with good credit.
  • Flexibility: Can be used for primary residences, second homes, or investment properties.

Cons of conventional loans:

  1. Stricter qualifications: Higher credit scores and lower debt-to-income ratios are often required.
  2. Higher down payments: Especially for investment properties, often 20% or more.
  3. Property limitations: Lenders may have limits on the number of properties you can have loans on.
  4. More paperwork: Compared to some alternative loan types.
  5. Private mortgage insurance (PMI): Required if down payment is less than 20%, increasing monthly payments.

3. 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.

Pros of VA home loans:

  • No down payment: Enables 100% financing.
  • Competitive interest rates: Often lower than conventional loans.
  • No PMI: No need for private mortgage insurance.
  • Reusable: Can be used multiple times under certain conditions.
  • Foreclosure protection: Assistance provided by the VA.

Cons of VA Home Loans:

  • Primary residence only: Can't be used for pure investment properties.
  • Funding fee: This can be rolled into the loan but is a cost to consider.
  • Size limit: Depending on location, there may be a cap on loan size.
  • Potential VA inspection: Some properties may not meet VA criteria.
  • Limited scope: Only available to veterans, active-duty service members, and certain members of the National Guard and Reserves.

4. 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.

Pros of FHA Loans:

  • Lower down payment: As low as 3.5% with qualifying credit scores.
  • Flexible credit requirements: More forgiving of lower credit scores.
  • Potentially lower interest rates: Especially for those with less-than-perfect credit.
  • Upfront MIP can be financed: Upfront mortgage insurance premium can be rolled into the loan.

Cons of FHA Loans:

  • Primary residence stipulation: Can't be used for standalone investment properties.
  • Mortgage insurance: Both upfront and annual premiums are required.
  • Property standards: Must meet specific FHA property guidelines and standards.
  • Loan limits: Maximum loan amounts based on the location of the property.
  • Longer approval process: Due to the government involvement and additional criteria.

5. 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.

Pros of blanket mortgage loans:

  1. Consolidation: Finance multiple properties under one mortgage.
  2. Flexibility: Sell individual properties without refinancing the entire mortgage.
  3. Time and cost efficiency: Fewer closing costs and paperwork compared to multiple separate loans.
  4. Cash flow management: Simplify payments with one monthly mortgage instead of multiple.

Cons of blanket mortgage loans:

  • Higher rates: Typically comes with higher interest rates compared to traditional loans.
  • Cross-collateralization: If one property faces issues, it might impact the entire portfolio under the loan.
  • Stricter lender requirements: Often requires a proven track record and sizable assets.
  • Limited availability: Not all lenders offer blanket mortgages.
  • Higher down payment: Typically, a larger down payment is required compared to individual property loans.

6. Portfolio loan

A portfolio loan is similar to hard money loan or 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.

Pros of Portfolio Loans:

  • Flexibility: Since the loans are held by the lender (and not sold on the secondary market), they might offer more flexible terms and criteria.
  • Customization: Lenders can often tailor the loan to the borrower's specific needs or situation.
  • Alternative qualification: It might be easier to qualify for a portfolio loan if you don't meet conventional lending standards.
  • Diverse portfolio: Suitable for investors looking to finance multiple types of properties.

Cons of Portfolio Loans:

  • Higher rates: Interest rates may be higher than traditional financing options.
  • Lender's risk management: Because the lender retains the risk, they might impose stricter requirements or more considerable penalties.
  • Limited availability: Not all banks or lenders offer portfolio loans.
  • Balloon payments: Some portfolio loans may have short terms with a balloon payment at the end.

7. 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.

Pros of Private Loans:

  • Speed: Often faster approval and funding process than traditional banks.
  • Flexibility: Terms can be negotiated based on personal relationships or specific deals.
  • Easier qualification: Less stringent credit and income requirements.
  • Short-term solutions: Ideal for bridge financing or quick-turnaround investments.

Cons of Private Loans:

  • Higher interest rates: Typically come with higher rates than traditional financing.
  • Shorter terms: Often structured as short-term loans which might require refinancing or paying off quickly.
  • Personal relationships: Borrowing from personal connections can strain relationships if issues arise.
  • Potential for less regulation: Could result in less protection for the borrower compared to institutional loans.

8. 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 the monthly payments until the amount is paid in full.

There are risks involved with owner financing, however. The interest is typically higher on these types of loans for investment property, 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.

Pros of owner-financed loans:

  1. Speed: Often faster to close than traditional mortgages.
  2. Flexibility: Terms can be mutually negotiated between buyer and seller.
  3. Less red tape: Typically fewer administrative hurdles and credit requirements.
  4. Potential cost savings: May avoid some bank fees or lender charges.

Cons of owner-financed loans:

  • Higher interest rates: May have a higher rate than bank-financed loans.
  • Balloon payments: Some owner-financed contracts require large lump-sum payments after a few years.
  • Dependence on seller's terms: Unlike banks, individual sellers might be less flexible if financial hardships arise.
  • Potential for unclear terms: Without proper due diligence, terms might be less clear or potentially unfavorable.

Loan calculators and comparison tools

Azibo offers a range of online calculators that can help investors who are considering real estate investment loans. Here are a few that may be particularly useful:

  1. Cap Rate Calculator: This calculator helps investors determine the capitalization rate, which is the ratio of the property's net operating income to its purchase price. This can be useful for comparing the profitability of different investment properties and for understanding the potential return on investment.
  2. Cash Flow Calculator: A cash flow calculator estimates the monthly cash flow generated by a rental property after accounting for expenses like mortgage payments, property taxes, insurance, and maintenance costs. This can help investors assess the viability of a rental property investment.
  3. Loan Amortization Calculator: This calculator provides a detailed breakdown of the repayment schedule for a loan, including principal and interest payments. It helps investors understand how much they will pay over the loan term and how the balance will decrease over time.
  4. Loan-to-Value (LTV) Calculator: LTV is a crucial metric that lenders use to assess the risk of a loan. A lower LTV generally means lower risk, which can result in better loan terms for the investor. This calculator helps investors determine the LTV of their loans.
  5. Rental Property ROI Calculator: This calculator helps investors estimate the return on investment for a rental property by taking into account factors such as property appreciation, rental income, and operating expenses. This can be beneficial for comparing the potential ROI of different properties and loan options.
  6. Debt to Income (DTI) Ratio Calculator: The DTI ratio is often used by lenders to evaluate a borrower's ability to manage their debt obligations. A lower DTI can result in better loan terms and a higher chance of approval. This calculator helps investors determine their DTI ratio based on their monthly income and debt payments.
  7. Closing Costs Calculator: This calculator estimates the closing costs associated with purchasing a rental property, which can be an essential consideration for investors when evaluating different loan options.

By using these calculators, investors can gain a better understanding of the financial implications of various  loans and make informed decisions about which option is best suited for their needs.

Final thoughts on rental property loans

A successful real estate journey hinges on having the right financing in place. With a myriad of loan options available for rental investment properties, it's essential to fully understand your choices, as selecting the wrong type of loan could jeopardize your ability to close the deal.

This is why it's crucial to find a trustworthy lending partner who can help you navigate the various loan options and secure the funding necessary to grow your rental business. Azibo, although not a direct lender, provides valuable information and resources, including an array of calculators and comparison tools, to support investors in making informed decisions about where to obtain their loans.

By carefully assessing your financial situation, investment goals, and the unique features of each loan type, you can position yourself for success in the competitive world of rental property investment.

Investment property loans FAQs

What is a loan for an investment property called?

A loan specifically designed for purchasing an investment property is commonly referred to as an investment property loan or rental property loan. These loans cater to real estate investors looking to buy residential or commercial properties with the intention of generating rental income or capital appreciation.

Investment property loans often come with slightly higher interest rates and stricter qualification criteria compared to loans for primary residences. This is because most lenders perceive investment properties as higher risk due to the potential for vacancies, tenant issues, or fluctuating market conditions.

What is the 2% rule for investment property?

The 2% rule is a popular guideline used by real estate investors to evaluate the potential profitability of an investment property. According to this rule, a property is considered a good investment if the monthly rental income is equal to or greater than 2% of the property's purchase price. For example, if a property is purchased for $100,000, it would need to generate at least $2,000 in monthly rental income to meet the 2% rule.

It's important to note that the 2% rule is a rough guideline rather than a strict rule, and it doesn't take into account various factors like property appreciation, taxes, maintenance costs, or vacancy rates. Investors should consider it as one of many tools in their toolbox to assess potential investments and should also perform more comprehensive financial analysis before making a final decision.

Is it harder to get a mortgage for an investment property?

Obtaining a mortgage for an investment property can indeed be more challenging than securing one for a primary residence. Lenders typically perceive investment properties as carrying a higher risk, given that the borrower may prioritize their primary residence's mortgage in case of financial hardship.

Consequently, lenders often impose stricter requirements for a rental property mortgage, such as demanding higher credit scores, larger down payments, and more substantial cash reserves. Additionally, interest rates on investment property mortgages are generally higher, making it essential for investors to carefully assess their financial situation and plan accordingly before proceeding.

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