What Newbies Should Know About Financing Investment Properties (Versus Homes)

by | BiggerPockets.com

Think getting a loan for an investment property will be as easy as your home mortgage? Think again.

Lenders are far more strict in their underwriting of investment properties and require more money down. Why? Simple: Borrowers will always default on their investment property loan before they default on their home mortgage.

With higher risk comes higher pricing, lower LTVs (loan-to-value ratios), and generally more runaround.

Here’s what new real estate investors need to know about how investment loans differ from homeowner mortgages.

How to Purchase Real Estate With No (or Low) Money!

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Lower LTV

Plan on having to put down at least 20% of the purchase price if you’re buying an investment property.

There are exceptions, of course (most notably for house hacking, which we’ll delve into later on). By and large, however, plan on putting down 20-40% of the purchase price.

The good news is that you won’t have to worry about mortgage insurance—but that’s really the only good news.

Some conventional loan programs for investment properties allow for 80% LTV, although you should know going in that it’s a best-case scenario. You can also explore real estate crowdfunding websites, which tend to be more expensive than conventional loans, but may be more flexible.

Depending on the lender and loan program, you might also find that pricing goes down alongside LTV. In other words, if you’re willing to put down more money, you may secure a lower interest rate and lower fees.

As a final note, plan on needing at least three months’ payments as a liquid cash reserve.

BRRRR-strategy-deal

Related: The Comprehensive Guide for Financing Your Very First Real Estate Deal

Pricing

It will be higher. The end.

Alright, there’s a little more to know. Plan on both the interest rate being higher and the upfront lender fees being higher.

On paper, conventional lenders often quote that their investment property loans are only 0.25-0.5% more expensive than their homeowner loans. In my experience, it never turns out that way. Expect to add 1-3 percentage points more than an owner-occupied loan rate. That means that if a lender charges 4% interest for homeowner loans, you’ll likely pay 5-7% interest for investment loans.

And don’t forget points. Lenders charge up-front fees for mortgage loans, and one “point” is equal to one percent of the total loan amount. These obviously add up quickly.

It just gets more expensive from there, as you get away from conventional lenders and toward community banks or crowdfunding websites.

Credit

Credit matters, of course, although not as decisively as in homeowner lending.

If your credit score isn’t perfect, you’ll still have options; they’ll just cost you more. A score below 740 will spell higher interest rates, higher lender fees, and lower LTVs. The lower your credit score, the more you can expect to cough up at the table and in ongoing payments.

For borrowers with mediocre credit, conventional loans may not be an option.

Still, investment property financing is often based more on the collateral (the property) than you as a borrower. Remember, lenders know that investors are far more likely to default than homeowners, so they’ve already built some extra caution into the loan programs in the form of lower LTVs.

While a retail lender for homeowners asks themselves, “How likely is this borrower to default,” investment lenders also ask themselves, “Can we still recover our money if this borrower defaults?”

Limitations on Mortgages

Your options start dwindling, the more mortgages you have on your credit report.

Once you have four mortgages on your credit, many conventional lenders won’t touch you anymore. There is a program, however, introduced by Fannie Mae in 2009 to help spur investment that allows 5-10 mortgages to be on a borrower’s credit.

The program requires six months’ payments held as a liquid reserve at the time of settlement. It requires at least 25% down for single-family homes and 30% down for 2-4 unit properties. But with any late mortgage payments within the last year or any bankruptcies or foreclosures on your record, you’re persona non-grata.

There’s also a hard limit of a 720+ credit score for borrowers who already have six or more mortgages.

Own More Than 10 Properties?

Your options are limited.

Small community banks are an option because many keep their loans within their own portfolio. These are a good starting place for investors.

Commercial lenders sometimes lend “blanket” loans, secured against multiple properties. But if you go this route, be sure to ask what happens if you want to sell only one of the properties in the blanket or umbrella loan.

Seller financing is always an option if you can convince the seller to take on the headache (and risk). However, most sellers aren’t interested in becoming your bank.

Hard money lenders are great for flips but usually terrible for long-term rentals. They’re simply too expensive.

Look into crowdfunding websites—new ones pop up all the time and are often unafraid of lending to investors with multiple properties.

And, of course, you can great creative. Perhaps you can get a HELOC on your primary residence? Or maybe your friends and family want to invest money toward your next rental?

landlord-lessons

House Hacking

If all this borrowing talk is starting to get tedious, why not skip investment loans altogether?

You can borrow an owner-occupied mortgage for buildings with up to four units, with cheap interest rates and low (3-5%) down payments. You can even use FHA or VA financing to do it!

The idea is you move into one of the units, with your rents from neighboring units enough to cover your mortgage. In other words, you live for free. Pretty sweet deal, eh?

Related: How I Went From $0 Net Worth to Qualifying for $1M in Real Estate Financing in 2.5 Years

After living there for a year, you can go out and do it all over again, with another four-unit building!

You also score some great hands-on experience managing rental units. If you’re looking for a little inspiration, read this case study of how one newbie house hacked a duplex.

Cash Is King

No matter your real estate investing niche, more cash gives you more options. That means stockpiling cash should become a priority for you.

The less income that you can live on, the better. Some investors even live on half their income and save and invest the rest!

Between down payments, closing costs, cash reserves, renovation budgets and more, investors always need cash and lots of it. As you buy rental properties, set aside all the profits toward your next property.

Through house hacking, you can get away with buying your first property or two with minimum cash. But that will quickly change, so make cash planning a part of your real estate investing strategy.

Here’s a prefab plan for how to make the most of your initial savings, and remember to secure your financing before you actually need it for a deal!

Have any questions or concerns about financing your first few deals? What about financing deals after conventional lenders won’t touch you anymore?

Fire away. The BiggerPockets community has your back!

About Author

Brian Davis

Brian is a rental investor with 15 income properties, who provides free video training to help everyday people start earning passive income at SnapLandlord.com. He's also the co-founder of SparkRental.com, which provides free services & education for landlords. His rental management is almost completely automated by now, allowing him to travel the world (his current home base: Abu Dhabi).

29 Comments

  1. Cindy Larsen

    Great article Brian, as usual. thanks 🙂

    I did have one question though. In the section on house hacking a small multi family, you recommend getting an owner-occupied mortgage for the first property, but only living there for a year, and then doing the same with the second property. Doesn’t this violate some clause in the mortgage when it is no longer owner occupied? If it does violate the mortgage, the bank could foreclose on you, right? In reality, they probably wouldn’t care, as long as you keep making payments on time, but, if interest rates go up significantly, they might be motivated to to get rid of lower interest rate mortgages so they could loan the money out at higher rates. Or, is it perfectly OK with the banks, FannieMae for example, if you no longer owner occupy a property that was financed as owner-occupied?

    • Brian Davis

      Thanks Cindy!
      The loan paperwork includes an “intent to occupy” clause, in which you are signing that you intend to occupy the property as your primary residence. But that doesn’t mean you need to occupy it forever. One year is considered the rule of thumb, for the minimum time required to meet that intent to occupy.
      It may be worth noting that while you can get a second conventional loan, after moving out, usually you can’t get a new FHA loan unless you’ve paid off the prior FHA loan.

    • Allison Kerner

      Hello Cindy and Brian. I was wondering about this too. I was able to get owner occupied conventional financing on 2 properties (four years apart) but it wasn’t easy. I’m trying for a third right now but have been told it’ll be nearly impossible. Underwriters want extensive detail on why I’m applying for an owner occupied loan every 1-4 years. I read columns on BP all the time advising people to house hack every year for lower financing but talking from experience, it’s not as cut and dry. Do these regulations vary based on state? If anyone out there is able to get owner occupied loans every year, I’d love some advice!

      Thanks,
      Allison

      • Brian Davis

        It can definitely be tricky. Keep in mind the article is about what’s allowed generally for conventional loans, but as you said, in practice it can be tricky. Lenders have the option to turn down your loan even if it meets their guidelines.
        Still, you should be able to find a conventional lender who will lend on a third property if you’re legitimately moving into it. They may request a higher down payment, or they may be willing to cross-collateralize your existing home(s).

    • Allison Kerner

      Hello Cindy and Brian. I was wondering about this too. I was able to get owner occupied conventional financing on 2 properties (four years apart) but it wasn’t easy. I’m trying for a third right now but have been told it’ll be nearly impossible. Underwriters want extensive detail on why I’m applying for an owner occupied loan every 1-4 years. I read columns on BP all the time advising people to house hack every year for lower financing but talking from experience, it’s not as cut and dry. Do these regulations vary based on state? If anyone out there is able to get owner occupied loans every year, I’d love some advice!

  2. robert ferrell

    Excellent article! Great tip about coming in with three months payments reserved in the bank. This would definitely be helpful if it takes longer than anticipated to find renters for the property. Nothing is better than making sure you are protected should any unexpected expenses arise!

  3. Tony McCargar

    Brian, good advice. Started 15 years ago buying a home for our college daughter as a second home. Later we sold it to her and her new husband and 1031 into 3 single family homes all in a row. 2 on 1 and a single. Was great until last administration war on oil and gas and coal which Farmington NM is dependent on. One house has been vacant for 6 months another For 8. Tried selling but nothing for 4 months so I’m back making more improvements hoping to better value as well as attract renters. Had been in remodeling business for 38 years but now retired and lack of Rental income is hurting. We saved enough buy another investment in Durango where we live and rent that 1 bed for what we can’t get for 1800sf house. Am trying to just gut it out but life is stressful to say the least. Do you have any magical advise?

    • Brian Davis

      Hi Tony, I’m sorry to hear that about your properties in New Mexico. That’s a terrible feeling.
      Local realtors may be able to give you some tips on what exactly it will take to sell (price, improvements, marketing gimmicks, whatever).
      You could always try leasing gimmicks, such as offering a month’s free rent. The free month could be the 12th month of the lease, and contingent on the renters paying the first 11 months’ rent on time.
      But there’s no easy answer, when there simply isn’t much demand for housing in an area. I’m sorry again to hear it. There’s always the chance that the current administration’s pro-fossil fuels stance will revitalize jobs in that town, but you have no control over that of course.

      • Tony McCargar

        Thanks Brian. Did the realtor thing already and they don’t know what else to suggest. My current direction is to do what I know which is improving the properties and wait it out. If and when we decide to sell at least I’ve added value. (One would think). When all is rented we do have a great cash flow which for retirees that is the key.

  4. Walker Frank

    Great information in this post Brian! One thing I would add is to contact several lenders and shop around for lower rates, lower loan origination fees, or lower down payment requirements depending on your situation calls for. A good lender can be a great asset to your team.

  5. Kris Falcher

    Great article Brian,
    What about a person who is a professional with a career and a good income, buys a primary residence with a conventional loan, moves in, then moves into an apartment and rents the place out? If they keep repeating the process can they have more favorable financing options?

    • Brian Davis

      Hi Kris, that will work the first couple times probably, but as you get a few mortgages on your credit it becomes harder and harder to be approved for conventional financing. As mentioned in the article, at a certain point you have to start looking elsewhere for funding. But you can definitely get started in real estate investing using conventional loans.

  6. Andrew Force

    Thank you for your article. Good points.
    I have a question on non-recourse loans for investment property purchase. I assume the lending bank will always want collateral, thus they would have the tittle of the property in their name. Is there a certain down payment amount or range for which the bank would be ok with the purchased property being collateral versus having to acquire by using a personal guarantee?
    Thanks again.

  7. Brad Ter Beek

    Brian,

    Thanks for the great article. I foundd that 25% down for conventional financing on an investment property was a minimum for Fannie and Freddie to purchase (20% for owner occupied/house hackers). I ultimately used the conventional because the rates were fantastic (4.5% fixed, 30 yr. am) and had to part with just a bit more cash. I’m doing a search now for portfolio lenders in in my state (CT) in order to finance the next deal. This way I can have the mortgage prepped before I even find my next property. But before I do that I have to SAVE, SAVE, SAVE, because as you said “Cash is King!”

    • Brian Davis

      Thanks Brad, and you’re absolutely right, investors should have both good financing set up and sufficient cash BEFORE they make an offer. Otherwise investors are setting themselves up for a mad scramble to put together funds for settlement.

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