Loans for investment properties: Your comprehensive guide

Investing in real estate is an excellent way to build wealth and generate monthly income. There are many types of investment properties, including apartment buildings, commercial properties, storage facilities, and single-family residences. 

Loans for investment property purchases vary based on the type of property, amount needed, credit score, and other factors. Learn more about investment property loans, the 2% rule, and how much you need to put down.

Types of loans for investment property purchases

There are many types of loans for investment property purchases. The best option for you depends on how the money will be used, how much you have to put down, and what your financial situation is like.

Conventional loans

Conventional loans are available through banks and credit unions for commercial buildings, apartments, residential real estate, and more. These loans typically have the highest underwriting standards because they follow guidelines set by Fannie Mae and Freddie Mac.

Getting a conventional loan typically requires a down payment of 15% or more for commercial properties and 3% for residential mortgages. Repayment periods range from 10 to 30 years, depending on the loan type you’re using. Borrowers should have good to excellent credit and verifiable income to show they can meet the loan’s debt-to-income ratio (DTI) requirements.

Bridge loans

Bridge loans are temporary loans that provide short-term funding until long-term financing can be put in place. Homebuyers often use these loans to buy their new home while waiting for their existing home to sell. Real estate investors also use these loans to bridge the gap between loans or while waiting for investors to provide more capital.

An investor may use bridge loans for many reasons. A common use is when an investor builds a property for their own use. Bridge loans provide funding during construction, which is then replaced with permanent financing upon project completion.

DSCR loans

Debt-service coverage ratio (DSCR) loans focus on the details of the property rather than your personal finances. These loans compare the potential rental income versus the payment amount to determine eligibility. DSCR loans are ideal for investors with lower credit scores, hard-to-verify income, or numerous investment properties.

The relationship between income and loan payment is known as the DSCR. To calculate DSCR, divide the property's monthly rental income by the mortgage payment. Lenders typically require a DSCR of at least 1.1x, which means that the income is 10% greater than the mortgage payments – as well as a down payment of 20% to 25%. However, the minimum DSCR may vary based on down payment size and higher credit scores.

Home equity loans

Real estate investors often tap their home equity to fund their investments. A home equity loan is based on the value of your primary residence and your current mortgage loan balance. Lenders usually allow homeowners to borrow up to 80% to 90% of their home’s appraised value, minus the balance on their first mortgage.

A home equity loan provides a lump sum of cash upon approval. It features a fixed interest rate and a consistent monthly payment. Repayment terms generally run from 5 to 20 years, so you can adjust the loan term to make monthly payments more affordable. Home equity loans are a popular choice over a cash-out refinance when borrowers have a low rate on their first mortgage.

Home equity line of credit

Home equity lines of credit (HELOCs) are similar to home equity loans. However, instead of a lump sum of cash, you have a maximum credit limit that you can borrow against. You can withdraw any amount up to your credit limit. As you repay your balance, your available credit increases, allowing you to use it again in the future.

HELOCs generally have a variable interest rate based on the Prime Rate. Payment requirements for HELOCs are interest-only during the draw period, so you’ll need to pay extra to reduce your balance. When the draw period ends (typically 10 years), your remaining balance converts into a 20-year term loan with a fixed interest rate and monthly payment.

Home equity investment

Another way to tap your home equity to invest in real estate is with a home equity investment (HEI). An HEI provides a lump sum of cash with no monthly payments. Instead, you repay the investment plus a share of the future appreciation when you decide to buy back your equity. This can be done anytime during a flexible 30-year term when you sell the property, refinance, or use another source of funds.

With an HEI, you don't need perfect credit. Additionally, you don't have to prove your income, so even people without steady or traditional incomes can qualify. 

Private loans

An alternative funding source is private loans from other investors. Private loans, otherwise known as hard money loans, usually carry higher interest rates and origination fees (also known as points). While they may charge more, private lenders can fund loan requests quickly. The higher cost can be a worthwhile trade-off if it means you don't miss out on a deal while waiting for traditional lenders to do their underwriting and due diligence.

Private lenders are generally more lenient on credit score and income requirements. They set their own underwriting standards, which means they are usually more willing to provide financing when other lenders won't. Due to the higher risk profile, hard money loans typically carry higher interest rates with origination fees ranging from 1% to 5% or more.

Investors looking to fix-and-flip real estate often turn to hard money loans. These loans for investment property purchases are short-term financing rather than permanent loans. Loan terms usually range from 6 to 12 months, but they may be renewed for an additional fee.

Government-backed loans

The government backs several types of loans when buying residential real estate. These loans include financing from the Veterans Administration (VA), U.S. Department of Housing and Urban Development (HUD), and Federal Housing Administration (FHA). Each loan type has different qualifications and requirements, like down payment size, location, and type of property. For example, VA loans are limited to active duty military, veterans, or eligible family members.

While these are not specifically loans for investment property purchases, they can be used creatively. Many homeowners use government-backed loans for house hacking their way into rental property investing. They’ll take on roommates to help cover the mortgage, or they’ll live in the home for a few years before moving out and turning the whole property into a rental.

SBA loans

Loans from the Small Business Administration (SBA) help entrepreneurs buy buildings for their businesses. These loans are not intended for the purchase of standalone rental properties or other speculative real estate. However, business owners can buy a larger building than they need, and then rent out the rest of the space.

The SBA loans for investment property purchases are called 504 loans. With a 504 loan, you can borrow up to $5.5 million. The business must occupy at least 51% of an existing building (or 60% for new construction) for it to qualify. Depending on the size of your building, the extra space could generate significant rental income.

Frequently asked questions

Is it hard to get a loan for an investment property?

The difficulty in securing loans for investment property purchases varies based on the property type, investment income, repayment period, amount needed, and loan type. There are loans for every type of borrower, even if you have poor credit or cannot document your income.

What is the 2% rule for investment property?

The 2% rule helps investors find profitable rental properties by comparing the monthly rents to the value of the property. When the monthly rents are at least 2% of the property value, the rental should generate enough income to cover its expenses and deliver profits to the investor.

Can I put less than 20% down on an investment property?

Most lenders require at least 15% down on investment properties. However, creative borrowers can get loans for investment property purchases with down payments as low as 0%. These loans typically involve “house hacking” your primary residence to rent rooms in your house or convert the entire house into a rental after a few years.

Final thoughts

Getting loans for investment property purchases is an excellent way to build your real estate portfolio. Whether you need the money to fix-and-flip, invest in rentals, or buy a building for your business, there is a loan available for you. While many people turn to conventional loans or the SBA when buying real estate, other loan options are available for people with less-than-perfect credit or hard-to-prove income.

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