One of the first things you’ll need to do when investing in a rental property is figure out how to pay for the investment. Most investors take out a loan to invest in their first property. You have a few loan options available, and this guide covers a few of the top. We’ll also review some pros and cons of each loan type.
What Is a Rental Loan?
A rental loan is a type of mortgage issued to real estate investors who want to acquire a rental property in their portfolios. Rental properties may include any real estate asset that provides tenants with housing or commercial spaces.
Rental Loans To Consider
You have a few options available when it comes to choosing a rental property loan, including:
Debt Service Coverage Ratio Loan
A debt-service coverage ratio (DSCR) loan is one of the best rental loan options because rather than considering your current debt-to-income ratio, lenders factor in the potential returns of the rental property. A DSCR loan may be an excellent funding option for investors who don’t have full-time income or already have a lot of debt from other investment properties.
DSCR loans offer lending flexibility with quicker approvals, and they prioritize the asset rather than income from other sources. A few downsides of DSCR loans are that they may come with higher interest rates than some other loan types, and lending eligibility largely depends on the chosen property. This means you’ll need to thoroughly research the market to ensure the asset you choose will be profitable.
Conventional Loan
A conventional loan is what many of today’s homeowners use to purchase their residential properties. Conventional loans have varying loan and down payment requirements. Many conventional lenders may require higher down payments when purchasing an investment or rental property rather than a personal residence.
Conventional lenders also factor in things like credit score, current debt, and property price when determining loan eligibility. If you already have a lot of debt or don’t have a steady income, you may not be approved for a conventional mortgage. A conventional loan may also not be suitable for investors with many properties because multiple applications over a short period may affect your credit score, and your debt-to-income ratio will increase.
Blanket Mortgage Loan
A blanket mortgage loan may be an option for investors who want to purchase more than one rental property under a single loan. Blanket mortgages can make it easier to keep your loan payments and fees organized. One of the biggest downsides of a blanket mortgage is that each rental included under the same loan is considered cross-collateral. This means that a failure to pay on one underperforming property could subject you to the foreclosure of all of them. Getting approved for a blanket mortgage loan can also be more difficult because of the combined value of multiple assets.
Hard Money or Portfolio Loans
Hard money loans are short-term loans designed specifically for investment properties. Because hard money loans don’t come from a traditional lender, the lending requirements depend on the specific organization. A portfolio loan is a type of hard money loan that the lender designs specifically for an investor. The lender then holds on to the loan rather than selling it to a third-party provider. Being approved for a hard money loan may require a previous relationship. You can also expect higher interest rates since hard money loans are typically meant for shorter borrowing periods.
Private Lending
A private loan is any funding source that comes from a lender other than a banking institution or credit union. Private lenders don’t follow the same state or federal regulations, which can make them a riskier choice. Additionally, private lenders set the terms of their loans, which often means higher interest rates and shorter repayment periods.
Loans Not Available for Rental Properties
You may have heard of other loan types, but many of them aren’t designed to help investors acquire rental properties. For example, a Veterans Administration (VA) loan is reserved for veterans and their families who want to purchase a personal residential property. Federal Housing Administration (FHA) loans are another lending option that doesn’t allow for rental property investments. Instead, an FHA loan is intended for first-time home buyers with less strict lending requirements and lower down payments.
Investing in a rental property is possible with any of these lending options. Whether you’re hoping to start your real estate investment career with a single property or you’re ready to expand your portfolio, you have many options. Compare each loan type to find the one that works best for your financial goals.