So you’re considering buying an investment property but aren’t sure what your loan options are?
An investment property is real estate purchased to generate revenue, either through renting it out or reselling it for a profit. Investment properties are typically residential properties with four units or less, and can be a great way to generate income and increase your equity at the same time.
Investment Property Loans
Be forewarned: getting a loan for an investment property is harder than getting one for a home you plan to live in. Most lenders will want high credit scores, good debt-to-income ratios, solid documentation showing you’ve held the same job for at least two years, and six months of cash reserves. And many will want at least a 20% down payment.
Luckily, these aren’t your only options — you don’t need a mountain of cash to buy an investment property. There are a number of loan options available for 10% down — or even less!
FHA loans are generally a great way to finance a rental property, with a caveat: you have to live in one of the units in the building. FHA loans offer good interest rates and low down payments, but mandate the home be owner-occupied. You can satisfy that condition by living in one of several units on the property.
The down payment required for FHA loans is extremely low — just 3.5% for up to a four-unit property. By contrast, a traditional lender could require up to 25% down for multi-unit properties.
Like FHA loans, VA loans come with stipulations: you have to live in one of the units and you must be a veteran or active service member to qualify. But if you do qualify, VA loans are among the best options out there.
Qualified buyers can use VA loans to buy properties with up to four units with 0% down. That’s right: 0%. VA loans also offer some of the best interest rates available. If you qualify for a VA loan and can live in one of the units, this may be the program for you.
Freddie Mac Home Possible Loans
While many other private lenders require at least a 15% down payment, Freddie Mac’s Home Possible Loan Program does not. With the Home Possible Loan Program, investment property buyers many qualify for a loan with only 5% down to purchase a property with up to four units.
There are many benefits to the Home Possible program. It’s open to buyers with no credit history, offering an option to people who are still working on establishing their credit. Additionally, Freddie Mac is flexible on where the down payment comes from, and allows family member and employer contributions. And once the loan balance is under 80% of the property value, you can have the mortgage insurance removed for additional savings.
Home Equity Lines of Credit (HELOCs)
If you already own a home, you may qualify for a Home Equity Line of Credit (HELOC). A HELOC is a revolving credit line that will usually come with a variable rate. Essentially, a HELOC is similar to a credit card: you can withdraw any amount, at any time, up to your limit. Your monthly payment depends on your balance.
With a HELOC, there are two phases: the draw period and repayment. During the draw period, you can use as much of the line of credit as you want, and your minimum payment will be low. But when the draw period ends (usually after 10 years), your loan enters the repayment phase. During the repayment phase, you can no longer draw funds and the loan is fully amortized for the rest of its existence.
HELOCs offer many advantages but also come with more risk. HELOCs offer more flexibility and lower payments during the draw period. But HELOCs have a variable interest rate, which means your monthly payments could be unexpectedly high when the repayment period hits. And because you secure a HELOC with your primary residence, if you default, the lender will foreclose on your home, not the rental property.
Seller financing is 100% financing, meaning 0% down. But it isn’t easy to come by.
With seller financing, the property seller finances the purchase, rather than a bank or traditional lender. You are able to come to your own terms with the seller, reflecting both of your needs.
Seller financing can be hard to find. Additionally, many owner-financed contracts are structured on a 5-year balloon mortgage, requiring payment in full after only five years, regardless of how much or little you have paid off in that time.
Purchasing an investment property can be much more complicated than purchasing a home to live in, especially if you can’t afford a large down payment. Novice investors should consider working with an experienced real estate agent, who can walk you through all of the steps and help you figure out what financing option may be right for you.