Simple Ways to Finance a Rental Property

Diving right into real estate investing may seem like an easy and profitable venture with endless opportunities — if you have the right financing. There are homes to flip and sell, properties to rent out, real estate to appreciate and passive income to be made. While a real estate investor’s ideas and plans may be warranted, financing those investments is worth a detailed look. Financing a rental property may be done in several different ways, with potentially the same outcome — you borrow money, you pay it back, you walk away with a profit.

How to Finance a Rental Property

Real estate financing takes time, opportunity and money. First you have to find the rental property you wish to purchase as your rental investment — a home to fix up and rent out, an already done property, a multifamily property or another property. The type of investment property that you are looking to purchase and what you are bringing to the table in terms of financing will change what kind of loan you can use and how much money you can borrow.

All loans are not created equal when it comes to investing. The criteria to make you eligible are different; requirements can be lengthy and strict; the duration and terms of the loan vary; and your down payment money varies depending on which loan you use for the investment property — and if you are planning to repeat the process.

Remember, your financing option should offer monthly payments you can afford. You want to know that the closing costs are affordable and that you can get the mortgage rates you want. The portfolio loan should offer you value over time. At the same time, loan programs for investment properties require you to make larger down payments. Keep this in mind as you search for homes and plan to get pre-approved before a real estate agent takes you out to search.

Best Ways to Finance a Rental Property

Below are the four most common types of real estate financing that investors use to purchase a rental property. It depends not just on what you want out of the investment, but what you may be eligible for and what opportunities are available to you.

Conventional Loans

Generally, if you are looking for a straightforward approach to real estate financing and the investment property is a one- to four-unit home or building in decent shape, a conventional loan should be considered. Conventional loans may offer the lowest rates and fees. Your credit score and credit history, as well as your income and assets, play major roles in your approval and interest rate. The more of a risk you are, the higher your interest rate will be.

Many borrowers are familiar with a conventional loan and use one for their primary residence. As an investor, you’ll need to show that you can fully cover your primary loan and the new investment loan payments as well. Unlike other loans, unfortunately, conventional loans will not factor future rental income into your qualifications for your investment loan. You will need to be able to show the lender that you can cover it wholly on your own.

In addition, you will need a hefty downpayment of 25% to 30% of the purchase price of the investment property. This type of loan carries high up-front costs for some investors just starting out and may be tough to get approved for. Meeting the bank’s criteria is the most difficult part of a conventional loan when borrowing for real estate financing.

Hard Money Loans

Unlike conventional loans, hard money loans are private loans that specialize in a property’s profitability. A hard money loan is used more commonly with an investment property that is in distress and will be flipped and sold. If you fix up the property and lease it, you may have an extra step later of paying off the loan with another loan type.

Hard money loans may be easier to get approved for, but you will be paying for that convenience in much higher interest rates, high origination fees and other unfavorable loan terms such as short-term repayment periods. So, it may be helpful to get approved for a hard money loan and pay it off quickly with another loan that has lower interest and a longer repayment period if you are planning to use the investment as a long-term rental property instead of selling.

While income and credit scores are still important in this type of financing, the lender is more flexible. Since it is a private loan, hard money loans can consider lower credit scores and focus on the after return value (ARV) of the investment for approval purposes. Money may also be available within days, so you can get started working on the property quickly instead of waiting on a prolonged closing process.

Private Money Loans

A private money loan is another possibility where money is basically loaned from one person to another. If you are an investor with wealthy friends and family willing to work with you, this option could be a great choice. Together you decide on the interest rate and terms and sign an agreement. This agreement is a legal contract that also details what happens if you as the borrower fail to make payments. Generally, your lender will be able to foreclose on your property as with any loan.

If you are interested in this type of loan but do not have any close relationships to hold a private money loan, attending networking events with other real estate investors is a great place to start. Clubs and networks exist that are open to handling private money loans and entering into a contract, but you face risks depending on your relationship with your lender, whether personal or professional.

Home Equity

Borrowing against the equity in your own home is another option for financing a rental property. You are using money that is basically already there. Lenders may allow you to borrow up to 80% of the equity you have to purchase or renovate an investment property.

A Home Equity Line of Credit (HELOC) allows you to have a line of credit available to you as needed, with interest-only payment plans. Here, you are using the equity in your primary home essentially like a credit card.

Additionally, a cash-out refinance would allow you to have access to cash directly from the equity in your home by replacing your previously existing mortgage with a new, larger one.

The BRRRR method (Buy, Renovate, Rent, Refinance, Repeat) is also included in this type of financing. Every time you repeat the process, you have the ability to buy the next property with the equity derived from the previous investment.

Rental Property Financing Requirements

Any real estate financing company or lender will need to see proof that you are a good candidate for an investment loan. It may ask to see your financial statements that prove your income, your credit score, loan history, the ARV of the rental property and equity in your home. These documents may be reviewed by the lender depending on the type of loan you are going for and used to decide on your approval, rates and terms. A private money lender may just need to know your plan or trust your relationship to get started.

However, the sooner you get the lender what they are looking for and the more upfront you are about your finances, the better chance you have of locking in your loan quickly and with the fewest complications.

How Many Rental Properties Can You Finance?

You can finance as many rental properties as you want as an investor. The key is to know what you can handle without falling behind. Lenders only let you borrow so much money, but if you’re doing great you may end up starting more investment properties and rental properties than you can really handle at one time. Spreading yourself too thin isn’t a good look for your investments or your credibility with lenders.

Strategic Financing for Rentals

Financing is a crucial aspect of real estate investing that can determine success. Various strategies are available for securing funds, including conventional loans, hard money loans, private money loans and tapping into home equity. Each option has its own requirements, risks and benefits. It is important to carefully consider these factors and communicate with lenders to make informed decisions and build a sustainable rental property portfolio.

Compare Investment Lenders

Getting started in rental property investing is exciting. It’s worth shopping around for the best rates and terms, especially if you plan to keep investing. Benzinga can offer insight and reviews on the top investment lenders out there. Check them out here.

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