The Hidden Truths About Real Estate Investment Loans

Just like a residential loan, investment property loans have minimum qualification requirements including credit scores, debt-to-income ratios and down payment amounts. But unlike a traditional mortgage, these loans are more focused on the property itself than the borrower.

Understanding how these loans are underwritten will help you avoid surprises during the application process.

Buying a Single-Family Home

Whether you’re in the market for your first investment property or are considering refinancing your current mortgage, single-family homes are a popular choice for buyers. Also known as detached single-family dwellings, these structures offer buyers privacy and space and don’t require shared facilities like elevators and laundry rooms. They can be found in suburban neighborhoods, urban centers and even rural areas.

Single-family homes are distinct from multifamily residences, which have five or more units and are considered commercial construction by lenders like Fannie Mae and Freddie Mac. While it may seem like a technicality, the distinction matters for investors because a loan requires more documentation and often a higher down payment to secure a loan for a multifamily home than a single-family one. If in the state, one can also apply for Texas real estate property loans.

When shopping for single-family homes, pay attention to the zoning designation listed in real estate listings. A home with a zoning letter rating of “R” indicates that it’s eligible for a single-family residential loan. The zoning ratings are determined by local government officials and indicate how each parcel of land can be used, says Papoutsakis.

If a neighborhood is zoned R1, for example, you can build a house with three bedrooms and two bathrooms without the need to obtain special permits or approvals. This flexibility makes single-family homes more appealing to potential investors, especially first-time investors who may find it difficult to qualify for loans for multifamily properties.

Unlike condos, which are typically associated with homeowners associations that govern exterior features and amenities, single-family homes are not subject to these rules, says Klosterman. That means you’re solely responsible for maintaining the inside and outside of the property, as well as keeping up with the lawn mowing, shoveling and other general maintenance tasks that come with ownership.

Another benefit of single-family homes is that they usually feature extra storage space, including basements, attics and garages. These areas are ideal for storing equipment, tools and personal belongings that aren’t easily fit in smaller spaces like closets or cabinets in condos. Moreover, single-family homes are great for those who want to expand their family in the future and need more living space.

Buying a Multi-Family Home

Multi-family homes, which are properties that contain two to four units, can be a smart investment for new real estate investors looking to generate passive income. These properties typically provide a steady stream of rental income and can also increase in value over time. However, purchasing and financing a multi-family home comes with additional costs that aren’t associated with single-family homes.

For example, a home inspector will typically inspect the entire property for any problems that could affect tenant satisfaction or damage your reputation as a landlord. And, since these properties are older rather than newly built, it may be necessary to undertake renovations to attract tenants and improve resale value.

In addition, because you’ll be financing an investment property with a mortgage, lenders will generally require that you have a higher debt-to-income ratio than they would for your primary residence. This is because the lender will consider the projected rental income from your multi-family property as part of your overall financial picture. You’ll also be required to make a larger down payment and have to prove that you have the funds available to cover your mortgage payments in case of a vacancy or unforeseen expenses.

While you’ll need to meet higher qualification requirements for financing a multi-family property, there are options for those with less-than-perfect credit who want to get into real estate investing. For instance, FHA loans offer more lenient underwriting and allow you to buy a multifamily home with as little as 3.5% down payment. Conventional financing from Fannie Mae and Freddie Mac requires a down payment of 15% for a two-unit building and 25% for three or more units.

Whether you’re interested in buying a multi-family home or a single-family property, it’s important to determine your financial goals and establish a budget before starting the search. This will help you ensure that you can afford the upfront expenses as well as ongoing carrying costs like mortgage payments, property taxes and insurance. It’s also wise to overestimate your expenses and create a contingency fund in case there are unexpected expenses that you need to cover.

Buying a Rental Property

Purchasing and financing a rental property offers several benefits. These include a potential for a high return on investment, tax deductions related to mortgage interest and real estate taxes and depreciation, and a steady source of income. However, you will need to consider all the upfront and ongoing costs associated with renting out a property. These costs can include rent, maintenance, repairs, property management fees, insurance and property taxes. To ensure that you are able to cover these expenses and still make money from the property, you should perform an annual cash flow analysis. This can help you determine how much you will need to invest in the property and estimate your ROI.

Getting a loan for an investment property may be more challenging than it is for the purchase of a home you will occupy as your primary residence. This is because lenders consider investment properties a higher risk than homes used as primary residences.

Lenders may require a higher credit score for investment property loans and often will require more documentation than they would for a residential mortgage on a personal residence. This includes verification of rental income, a debt service coverage ratio that shows the amount of net operating income available to cover the monthly mortgage payment and property expenses, and an appraisal of the property to determine its market value.

One of the main challenges with investing in a rental property is finding reliable tenants who will pay the rent on time. This is especially important if you live far away from the property and can’t personally oversee the day-to-day operations of the rental. You will also need to budget for professional property management and make sure that you can fill vacancies quickly if necessary.

If you’re not quite ready to make the leap to investor status, consider becoming a co-borrower with someone else who wants to buy a rental property. This collaboration can simplify the process and lower the up-front costs. It is important to review the legal and tax ramifications of co-borrowing before you begin the process.

Buying a Fix and Flip

If you want to get into real estate investing with the goal of renovating properties and selling them for a profit, you’ll need to have some cash on hand to fund your first few deals. However, experienced real estate investors often use other methods to finance their flips. These may include partnering with other investors, obtaining a business line of credit or finding private money lenders.

Real estate investing isn’t for everyone, and a fix and flip project can be a significant undertaking with a lot of moving parts. You’ll need to have the time and resources to work with contractors and oversee construction, as well as an eye for identifying properties that are underpriced and can be improved at a reasonable cost. It’s also important to consider the local real estate market and how long it will take for your renovated property to sell once you’re ready to list.

Traditional lenders tend to shy away from mortgages for properties that will be fixed and sold quickly, since these investments pose a higher risk than primary residences. As a result, many fix and flip investors turn to private money lenders for financing, which are a type of loan that is specifically tailored to investment properties. Private money lenders often offer more flexible terms and faster approval processes than a traditional lender.

When looking for a private money lender to fund your next fix and flip, be sure to shop around. You can find a variety of lenders online that connect investors with potential borrowers, and some even offer peer-to-peer lending. Some of these lenders have built-in systems that make it easier to compare terms and fees among competing private money lenders.

It’s worth noting that a hard money lender typically lends between 50-65% of a home’s expected after-repair value, which is enough to cover the purchase price and rehab costs in most cases. This makes it a great option for new investors who don’t have the time or resources to save up for a down payment on their own. However, you should remember that a hard money loan will have much higher interest rates than a traditional mortgage.