A Guide to Investment Property Financing: 3 Types of Loans

Real estate investment is when a person (or people) buys a property for the sake of generating cash flow. Active real estate investment involves purchasing and sometimes managing an investment property or investment properties. These properties can include fix-and-flip single-family homes, multiple-family dwellings, or commercial real estate. Passive real estate investment involves investing money in real estate partnerships or trusts to generate cash flow without managing the development, renovation, or operations of the properties.

Real estate investment involves the transactional sale or acquisition of real property to generate income through rent, tax benefits, or a profitable resale. Investment properties do not serve as primary residences or second homes for the owner. Much like the process for buying a residential property, you’ll likely need a loan from a mortgage lender or a bank to finance the purchase of an investment property.

Real estate is a high-risk, volatile market, and investment property financing loans often have stricter terms, higher interest rates, or require a larger down payment percentage than residential mortgages. Different lenders will also have varying terms for their loan programs depending on the borrower’s income or credit score, so proper research is essential when securing a financing option for yourself.

The type of loan that you choose to finance your investment can influence your interest rates, down payment, and timeframe of your loan, all of which affect your bottom line as a real estate investor. Some different investment options for financing properties include the following.

1. 1. Conventional loans: Conventional loans work similarly to traditional mortgage loans. This is a traditional financing option often issued by private money lenders such as banks or credit unions. They require an average-to-good credit rating and have flexible down payment percentages and fixed interest rates. Private lenders will assess your assets, debt, cash reserves, tax returns, and other qualifying factors to calculate your debt-to-income ratio to ensure that you have enough money to pay back the loan. You will be either approved or rejected after the lender assesses your finances. Interest rates for investment properties are often much higher than they are for residential properties. You can also apply for financing through government-sponsored mortgage companies like Fannie Mae and Freddie Mac but they have much stricter guidelines than private lenders in place in regards to investment property financing.
2. 2. Hard money loans: These types of loans have lower qualifying factors than conventional loans. They use the potential profitability of the property to guarantee the loan rather than a person’s personal income or credit history. Hard money lenders will provide a large percentage of the funding for the house up-front to cover the estimated market value of the home. These loans are short-term loans—often with a time frame of a year or less—that have high interest rates. They are sometimes used as fix-and-flip loans for flipping properties, rather than for long-term investing.
3. 3. Home equity loans and cash-out refinancing: A home equity line of credit (HELOC) is when the borrower uses their own home as collateral for the loan. This loan is similar to a typical line of credit, in which you can borrow against your home equity and make monthly payments based on interest, though the rates are subject to change with the prime rate. A home equity loan can also involve a cash-out refinance, in which you refinance the balance of your home loan rather than obtaining a second mortgage. A cash-out refinance lets you put around 80 percent of the loan-to-value amount (the borrowed amount divided by the appraisal amount) toward a new property loan, with the payments subject to fixed-rate interest. This can ensure you maintain a consistent, lower interest rate than with other financing options. However, it can also extend the life of your current mortgage payments.

All investments, including real estate investments, come with inherent risks which may involve the depreciation of assets, financial losses, or legal ramifications. The information presented in this article is for educational, informational, and referential purposes only. Consult a licensed real estate or financial professional before making any legal or financial commitments.

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