Types of Financing for Investment Properties
A well-maintained rental property can be a lucrative long-term investment that provides you with a steady source of income—so long as it’s financed the right way. Here’s what you need to know about the financing options for a buy and hold rental investment.
- Conventional mortgage loans. Applying for financing at a bank, credit union, or mortgage broker will follow a process that’s similar to applying for a regular mortgage. The lender will take your credit history and credit score into account, as well as your ability to both cover your current mortgage (if you have one) and the new mortgage. In some cases, you’ll be required to have sufficient cash to cover both mortgage payments for half a year. Note that any projected income from rent won’t be factored into your creditworthiness. In addition, most lenders require a 30 percent down payment for a rental investment property.
- Borrowing against home equity. There are three ways to do this: through a home equity loan, a home equity line of credit (HELOC), or a cash-out refinance. A home equity loan usually allows you to borrow up to 80 percent of your equity in the home at its current market value. You’ll have to make monthly payments that include both interest and principal. A HELOC provides you with a line of credit against your current equity and usually requires interest-only monthly payments. A cash-out refinance is more complicated. It uses the equity you’ve built as a foundation to pay off your current mortgage on your primary property and reapply for a new mortgage. The difference between the two is paid in cash.
- Hard money. Hard money is typically used for short-term loans—not for buy and hold investments. However, there can be situations where you can use hard money to bridge the gap to a long-term loan. While these types of loans consider the value of the property rather than your personal income and credit, they come at high interest rates, so you need to consider all your options carefully before using hard money for a long-term investment.
- Private money. Private money is generally more relationship-based than other forms of financing. Basically, if you can make a strong business case for your investment, a private lender could lend you cash at a predetermined interest rate and for a fixed term. A mortgage and promissory note secure the investment for the lender.
- Owner financing. In some cases, the property’s owner will finance the sale of the investment property. This is only possible for properties that are owned outright and aren’t still partially owned by a bank or other lender. With owner financing, you typically agree on a price and make your payments to the property’s owner instead of a bank or other type of lender.
How you finance your rental property plays an important role in how profitable your investment is. If you take the time to carefully consider your options, you’ll stand the best chance of choosing a financing option that will deliver the funds you need to make your investment a success—without binding you to unrealistic financial obligations.
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