The Short Answer
Real estate investing can lead to wealth and financial independence, but the right financing is essential. Traditional loans like conventional loans aren’t always suitable for investment properties, but these investment property loan alternatives are:
DSCR Loans: Focus on the property’s income rather than the borrower’s financial situation, offering flexible criteria and typically lower interest rates.
HELOCs & Home Equity Loans: Leverage existing property equity with lower interest rates, providing either a revolving credit line (HELOC) or a lump sum (Home Equity Loan).
Owner Financing: The seller acts as the lender, allowing quick transactions and flexible terms, ideal for buyers with poor credit or limited down payment funds.
Private Money Loans: Offered by individuals or private companies, these loans are flexible, tailored to specific deals, and secured by the property, suitable for investors needing quick financing.
Crowdfunding: Allows multiple investors to pool funds online for real estate projects, with low minimum investments and funds typically held in a REIT.
These alternatives are designed specifically for investment properties, each offering unique benefits to cater to different investor needs.
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The 5 Main Types of Investment Property Loans
Real estate investing offers many people the chance to build wealth and achieve financial independence. However, the journey to success begins with choosing the right type of financing, to make sure your investing plans become a reality using the best financial vehicle to maximize your returns. It’s important to note that conventional loans can’t necessarily be used for investment property purchases, but there are other loans specifically designed for this purpose.
5 of the main types of investment property loans are DSCR Loans, HELOCs & Home Equity Loans, Owner Financing, Private Money Loans, and Crowdfunding. Each of these options offers unique benefits and caters to different investor profiles and strategies. Let’s take a look…
DSCR Loans
DSCR loans are often used by rental property investors. They are an attractive option thanks to their focus on the income generation capabilities of the property, instead of the borrower’s financial situation.
The Debt Service Coverage Ratio (DSCR) is a metric that is used by lenders to evaluate a property’s annual net operating income (NOI) relative to its annual mortgage debt obligations, which include principal, interest, taxes, insurance, and HOA fees (if applicable). Lenders use DSCR to assess the extent to which the property’s income can support a loan. This helps them determine the income coverage for a given loan amount.
DSCR loans are often by real estate investors because they’re flexible, and allow investors to operate the property however they see fit and make their own decisions. DSCR loans have higher Loan-To-Value ratios, with flexible underwriting criteria, and typically a faster loan process with lower interest rates. Which makes DSCR loans a great fit for those looking for an investment property loan.
HELOCs and Home Equity Loans
Home Equity Lines of Credit (HELOCs) and Home Equity Loans allow investors to tap into the equity of their existing properties to finance new projects, using investment property loans.
Home equity loans provide a lump sum amount to borrowers, and this is the difference between their old loan, and the new loan, with the amount of equity they have built up in their existing property. This lump sum is often useful for investors who need a large sum of money upfront, for a large down payment or for property upgrades, for example. Home equity loans typically offer lower interest rates which makes them an attractive option to use for investment property loans.
A HELOC functions like a credit card, where there is a revolving line of credit from the home equity, that is provided to borrowers when they need it. Getting access to funds on demand can be very useful for certain real estate projects, like ground up construction. HELOC’s have variable interest rates, and are divided into a Draw phase and a Repayment period. During the Draw phase, borrowers can withdraw funds whenever they need to, up to the agreed upon limit. During this phase a borrower will only need to make mortgage payments on the interest of the loan. This period can last several years. In the Repayment phase, the principal amount of the loan, as well as the interest rate, need to be repaid in the monthly mortgage payments.
Owner Financing
Owner financing is also referred to as seller financing, and in this case the seller essentially acts as the lender by providing the funds for the buyer. Without the need for bank approval, owner financing transactions can provide a quick solution for those who need an investment property loan fast. Sellers could also receive higher returns on their investments, and buyers can access properties that they may not have had access to before.
Owner financing can be a good solution for buyers who have poor credit, can’t qualify for loans, have limited down payment funds (cash reserves) and want to get the sale done as fast as possible. Owner financing gives borrowers more flexibility, so these are useful for an investment property loan that doesn’t fall within specific regular loan requirements.
Private Money Loans
A private money lender can be any individual or company with available funds willing to lend to a borrower. This category includes individuals, wealthy investors, family members, friends, or private lending firms with access to capital. These lenders typically prioritize the yield on their investment rather than the borrower’s creditworthiness or other factors that traditional lenders emphasize.
Private money lenders often have flexible lending criteria and tailor their terms to fit each borrower’s specific needs and real estate deal. Borrowers and lenders must negotiate the loan terms, interest rate, repayment schedule, and other conditions. These loans are asset-based, meaning they are secured by the property itself as collateral.
Private money loans are ideal for real estate investors who don’t qualify for traditional loans or those who have identified a lucrative real estate opportunity but have poor credit and limited cash reserves. These loans can be used for various real estate projects, as long as the investor can offer the lender attractive yields and returns from the deal.
Crowdfunding
Real estate crowdfunding operates differently from most other lending options, allowing investors to pool their funds on a crowdfunding platform to finance real estate projects. This investment property loan options allows borrowers to create a project listing on the platform, and investors can contribute if they view it as a viable opportunity.
Minimum investments often start at just a few hundred dollars. The funds are typically held in a Real Estate Investment Trust (REIT) or a similar entity, serving as a holding company where the capital can accumulate. Crowdfunding can be used for various real estate purposes, allowing individuals to pitch their ideas to a group of investors on a crowdfunding website.
This approach provides real estate entrepreneurs a platform to showcase their projects to a wide audience and raise funds. It is suitable for investors who need to purchase investment properties, renovate or upgrade properties, finance development projects, or passively invest in real estate projects, and more.
Loans That Aren't Suited To Buying Investment Properties
Real estate investors who come across certain loans might get their hopes up, as websites list these as investment property loans, however the following loans are not suited to rental property purchases.
Conventional Loans
Conventional loans are popular choice for home purchases but as an investment property loan option, they’re not at the top of the list. In fact, conventional loans aren’t generally used for rental property purchases and here’s why:
Stricter requirements: Conventional loans have stricter requirements than many other investment property loan options. They often require a higher credit score, and income verification. These loans are based heavily on the individual’s financial standing, which makes them challenging for real estate investors to use, as investment property loans should ideally be based on the property deal itself.
Higher down payments: Typically, conventional loans require higher down payments for investment properties (often 20-25%), which can tie up significant capital or cash reserves that could be used for other investments.
Interest rates: Conventional loans have higher interest rates for properties that aren’t going to be used as a primary residence. Which means that for the likes of rental properties and other investment properties, the overall cost of financing through a conventional loan is too high.
FHA Loans
Federal Housing Administration (FHA) loans are designed to help low-to-moderate income borrowers purchase homes, but they have limitations when it comes to rental properties and other investment properties.
- FHA loans are meant for primary residences, which means that rental properties cannot be purchase with FHA loans, unless the borrower is living in one of the units.
- FHA loans have low limits, and these are typically not suited to investment property purchases.
- These loans require both an upfront mortgage insurance premium (MIP) and monthly mortgage insurance payments, which can reduce the cash flow from rental income.
VA Home Loans
Veterans Affairs (VA) home loans have great benefits for eligible veterans and active-duty service members, however this doesn’t extend to rental properties because they’re meant for primary residences. This means that borrowers must occupy the home that they are purchasing with the VA loan, and cannot use the loan to build a rental property portfolio.
Portfolio Loans
Portfolio loans are issued by a lender who keeps loans within their portfolio, instead of selling them on the secondary market. These loans have flexible options, but are generally not well suited to be used as investment property loans. Portfolio loans aren’t well suited to rental property investing because:
- They have higher interest rates which increase the cost of borrowing.
- They aren’t commonly used and not all lenders offer them, so they have stringent lending criteria typically.
- Their loan terms can vary, depending on each lender, and they usually don’t provide good terms for investment purposes. For example, high fees and short repayment periods are common terms on portfolio loans and these don’t suit rental property purchases.
