Financing an Investment Property: A Complete Guide

Irina Tsymbaliuk
Financing an Investment Property

Investing in real estate has long been a lucrative avenue for income generation, attracting all types of investors. With a wide range of properties fit for investments, there are solutions to match the interests, cravings, and aspirations of both corporations, with an eye on large-scale commercial assets and individual investors seeking more affordable properties to earn passive income.

Once you pinpoint the real estate unit you want to invest in, you need to secure financing for investment property. While promising lucrative gains, investment properties entail high start-up costs. So, you might not have the required amount in cash to purchase the desired asset. Or even if you have money, you might not be eager to lock a hefty sum in a single investment. This is where investment property financing comes into play.

How to finance a rental property? What options do you have? What are the associated risks? Keep reading to find out.

Financing Investment Property: Options You Have

Financing Investment Property: Options You Have

Financing allows investors to leverage their capital, thus increasing their purchasing power and potential returns. Using third-party investment property finance, you can secure funds for acquiring properties that would otherwise be out of reach. This will help you diversify your portfolios and enhance your overall investment strategy or make confident first steps in the realm of real estate investments.

Just like you have multiple property options to invest in, there are numerous financing options to support your buy. To make an informed decision and maximize the expected return on investment, you should thoroughly research and compare your rental property financing options to find the most suitable solution for your investment goals and financial circumstances. You can consider a few types of loans that are most commonly used for investment properties.

Conventional Mortgage Loans

This type of property credit is usually provided by banks, credit unions, and mortgage lenders and is not covered by government guarantees. Typically, you will have to pay from 15% to 25% of the property's purchase price and can count on fixed or adjustable interest rates. Common loan terms span 15 to 30 years.

FHA Loans

It’s a favorite loan type for first-time homebuyers and residential property investors. Lower down payment requirements (only 3.5%) make these loans accessible to lower-income earners and investors with limited capital. However, borrowers must pay mortgage insurance premiums (MIP) throughout the duration of the loan.

VA Loans

Department of Veteran Affairs (VA) loans are exclusive to eligible military service members, veterans, and their spouses. These loans come with competitive interest rates and do not require an upfront payment or private mortgage insurance (PMI), making them particularly attractive for qualifying investors interested in financing rental property.

Portfolio Loans

Offered by banks or credit unions and not sold on the secondary market, these loans are typically more flexible in their underwriting criteria compared to conventional mortgages since they are held in the lender's portfolio. They may suit investors with unique financial situations or properties that don't meet traditional loan standards.

Private Loans

Often obtained from individuals like family members or friends, these are alternative real-estate investment loans outside traditional banking channels. The parties usually negotiate the loan terms directly to tailor them to specific borrower needs. It’s a great option for investors who cannot qualify for conventional financing or need quick funding for time-sensitive investments.

Hard Money Loans

These are short-term, asset-based loans secured by the investment property itself. Offered by private investors or companies, they are known for their fast approval and funding processes. While hard money loans generally carry higher interest rates and fees, they are ideal for investors pursuing fix-and-flip projects or purchasing distressed properties.

Home Equity Loans

Secured by the equity in the borrower's primary residence or other property, such loans can be used to finance investment property purchases or renovations. Entailing lower interest rates compared to other forms of financing, they can provide access to substantial funds and are an attractive option for investors with high equity in their properties.

Things to Consider When Deciding on Investment Property Financing

Things to Consider When Deciding on Investment Property Financing

Financing is a helpful tool that can unlock a whole bunch of opportunities in the property investment landscape. However, to succeed in this realm, you must secure the right financing that will perfectly align with your financial standing and investment goals. Now that you know how to finance an investment property, look into a few key considerations you should take into account before applying:

  • Creditworthiness: Lenders evaluate borrowers based on their credit history, income, assets, and debt-to-income ratio. Maintaining good credit and financial stability and keeping your DIT below 36% is essential for securing favorable financing terms.
  • Down Payment: Your loan terms will be largely determined by the portion of the property’s purchase value you can pay when closing the loan. The larger the upfront payment amount, the lower the interest rate and monthly payment you’ll win.
  • Interest Rates and Terms: Financing options might greatly vary by terms and conditions. Comparing offers from multiple lenders is essential to identify the most advantageous one that is aligned with your specific investment objectives.
  • Cash Flow Analysis: Before you bind yourself with financial commitments, analyze your expected cash flows. Evaluate the expected rental income or asset appreciation capabilities to make sure you can consistently pay mortgage and other related expenses.
  • Exit Strategy: Having a clear exit strategy in place is crucial when dealing with short-term financing options or adjustable-rate loans. You should know how you plan to repay the loan or sell the property in the future to be able to efficiently manage financial risks.

Tax Implications

Real estate investments will inevitably entail certain taxes. However, investment property ownership comes with nice tax benefits.  So, before sourcing financing for rental property, investigate the tax implications you might use to optimize tax payments.

  • Depreciation: Rental properties can be depreciated over time, allowing you to deduct a certain amount of the property's value from your taxable income annually.
  • 1031 Exchange: You can utilize a 1031 exchange to defer capital gains taxes by reinvesting the proceeds from the sale of one investment property into another similar asset.
  • Tax Deductions: Expenses related to owning and operating investment properties, such as property taxes, mortgage interest, maintenance, insurance, and property management fees, are generally tax-deductible.

How to Succeed in Investment Property Financing

Here are some tips that will help you get the required financing that will enable you to achieve your financial objectives in the real estate market and establish a source of consistent income.

  • Keep your credit score high to secure better financing terms and lower interest rates.
  • Diversify your investments across various property types and financing methods to reduce risk and increase potential returns.
  • Thoroughly research potential investment properties, market trends, and financing choices before making any investment decisions.
  • Feel free to negotiate with lenders to achieve the most advantageous terms for your financing.
  • Outline your investment goals, cash flow projections, and exit strategy in detail when selecting financing options and structuring your investments.

Final Thought

With proper financing on your side, you can access premium real estate investment opportunities and get the most out of your investing endeavors without compromising your other financial strategies. However, you should approach financing investment property with diligence and take your time to weigh all the pros and cons of different options to pick the one that will best work for you.