There are residential properties and commercial properties. There are long-term investments and short-term investments. Each investment option has pros and cons that you need to consider before you decide to take the leap and purchase an investment property.
For example, you could buy a condo and rent it out to tenants for a monthly payment. This rental property would then earn you rental income.
Can You Finance an Investment Property?
Contrary to popular belief, you don’t necessarily have to pay for an investment property in cash. Instead, you can finance it through real estate loans just as you would with a primary residence or even a second home.
How Does Investment Property Financing Differ From Primary Home Financing?
That being said, there are some key differences involved in financing an investment property instead of a primary residence. This is because investment financing is substantially riskier than primary residence financing.
Lenders know that if times get tough and you have to make sacrifices, you aren’t going to stop paying the mortgage on your primary home. Instead, you’re more likely to stop making mortgage payments on your investment property.
How To Qualify for Investment Property Financing
As a result of these increased risks, lenders have stricter qualification requirements for investment property financing. The exact qualifications vary by lender and loan type, but generally speaking, you need a minimum credit score of 640.
There could be down payment requirements of at least 20% and enough cash reserves to cover about six months of expenses left over after purchasing the property.
Here’s what you need to know about each of these different financing options so that you can make the right decision for your financial situation and goals:
Conventional Bank Loans
If you own your home, you likely purchased it using a conventional bank loan. Conventional bank loans can also be used to purchase investment properties. Conventional loans meet specific government standards. As a result, they can be guaranteed and sold to government-sponsored entities like Fannie Mae, Freddie Mac, and VA loans.
For this reason, conventional bank loans are much less risky. As a result, they often come with more favorable terms in the form of lower interest rates. One downside of conventional bank loans is that they tend to come with strict qualification requirements that can be difficult for borrowers to meet.
Generally speaking, you can expect the interest rate on a conventional loan for an investment property to be about 0.5% to 1% higher than the rate on a conventional loan for a primary residence.
So right now, with rates averaging around 4% for a primary residence 30-year fixed-rate conventional loan, the rate for your investment property would range between 4.5% and 5%. You can also expect to pay more in interest for larger investment properties that are larger than four units than you would for a single-unit property.
Hard Money Loans
If you’re looking for quick, easy money and don’t mind paying more for it in terms of interest, then you may want to consider a hard money loan. Hard money loans are provided by private lenders as opposed to conventional lenders.
So while they don’t come with the same strict qualification requirements, they do come with higher interest rates that can range from 11% to 13%. As a result, hard money loans are really only ideal for short-term financing.
Another short-term financing option is a bridge loan. This short-term loan is designed to bridge the gap between closing on an investment property and securing more permanent financing.
Bridge loans typically come with one-year terms, during which you only make payments on the accrued interest. Once you secure permanent financing, you can pay off the remainder of the loan.
Bridge loans are also typically offered by private lenders and come with more flexible qualification requirements. Note that they tend to come with lower interest rates compared to hard money loans that can range between 6% and 10%.
Home Equity Loans
If you own a home with a lot of equity, you may want to consider a home equity loan. With a home equity loan, you’re able to access some of the equity that you’ve built up in your home and use it to purchase an investment property, or at the very least, cover the down payment for an investment property.
Home equity loans tend to come with lower interest rates compared to other types of loans since you’re using your own equity, with rates for a 15-year fixed-rate loan around 6%.
But since you’re using your home equity, you’re effectively putting your home up as collateral for the loan. So if you’re unable to make payments on your home equity loan, the lender could come after your home.
Home Equity Lines of Credit
Another financing option similar to a home equity loan is a home equity line of credit or a HELOC. A home equity line of credit also allows you to access your home’s equity, but you don’t have to take out the entire amount all at once. Instead, you can spend money as you need it so that you can limit the interest you accrue.
Rates vary substantially for HELOCs depending on the loan amount and the loan term, but you may be able to secure a rate as low as 3%.
Alternatively, you could finance the purchase of an investment property using a cash-out refinance. In a cash-out refinance, you pay off your current mortgage, replace it with a new mortgage, and pocket up to 80% of the equity you’ve made so far. You can even take out a new loan that’s higher than your original loan to get some extra cash.
Since cash-out refinances are based on your current home as collateral, they tend to come with lower interest rates that are currently averaging at about 3%.
Are Investment Property Mortgage Rates Expected To Increase?
Investment property mortgage rates are expected to increase throughout the rest of the year. In fact, they have already risen substantially so far this year. So if you’re looking to get into real estate investing before mortgage rates increase even more and potentially price you out of the market, now is the time to act.
Why Are Investment Property Mortgage Rates Expected to Increase?
So we’ve established that mortgage rates are rising, but why? The Federal Reserve has kept rates close to 0% for the past couple of years as the country struggled with the COVID-19 pandemic and resulting economic downturn.
However, as things start to get back to normal and the economy recovers, the Federal Reserve is planning to make several rate hikes this year to combat rising inflation rates.
While it remains to be seen just how many rate hikes the Fed is going to enact throughout the rest of the year, most experts are predicting anywhere between five to seven increases.
This means that by the end of the year, the federal funds rate will have gone from 0% to 0.25% to at least 1.5%. The first hike is expected in March, and the Fed may also enact additional rate hikes into 2023 as well.
How To Get the Best Investment Property Mortgage Rate
Even though mortgage interest rates have already started to rise doesn’t mean that you can’t still get a great rate. Here are some tips to help you secure the best investment property mortgage rate before rates rise even further throughout the course of this year:
1. Choose the Right Loan Type
For starters, you need to choose the right loan type. As you now know, some loans come with higher interest rates than others. At the same time, it’s essential to consider all the pros and cons of the different loan options before making your final decision.
2. Work on Your Application
Next, you need to start working on your loan application. This means checking your credit score to make sure that you qualify for investment property financing and taking action to improve your score if needed.
Because although you may be able to receive a loan for an investment property with a credit score as low as 640, you will likely pay higher interest rates due to a low credit score. Instead, you should work on achieving a credit score that’s at least 760 to qualify for the lowest rates.
Another critical component of your loan application is your cash reserves. Not only do you need enough money to cover a 20% down payment, but you also need money to cover 2% to 5% in closing costs while still having six months left over in cash reserves.
Once you’ve checked those boxes, you can start gathering the necessary documentation for your loan application. Lenders usually want to see bank statements, investment account statements, income tax returns, W-2s and/or 1099s, and recent pay stubs/invoices. Gathering these documents ahead of time will help you expedite the application process.
3. Approach Different Lenders
Now that you’re ready to apply for an investment property loan, you need to approach a number of different lenders. This is because different lenders often have different requirements and will offer you different rates as a result. Most experts recommend that you speak with at least three lenders to get the best possible interest rate for your investment property.
4. Lock in a Low Rate
Once you’ve chosen the best lender that offers the lowest rate, you need to lock that rate in so that it doesn’t increase by the time you actually close on the property. Some lenders allow you to pay for rate locks in advance or pay for longer rate locks, so be sure to ask your lender about your options.
Resources for Real Estate Investors
There’s no time to waste if you’re going to lock in a low mortgage rate on an investment property. So whether you’re looking to invest in multi-family properties, single-family homes, or commercial properties, Vaster is here to help.