The Pros and Cons of Conventional Real Estate Loans

by | BiggerPockets.com

Although conventional lending is perhaps the most common type of real estate loan, it may or may not be the best option for you. There are both advantages and disadvantages to be aware of before obtaining a loan, and the more aware you are, the better loan decisions you can make.

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Pros

Low Interest Rates

There’s no denying it: conventional loans likely have the best rates you’ll find for long-term real estate financing. With investment loans usually .5 to 1 point higher than owner-occupied loans, you can borrow money at incredibly low rates (as of this writing, you can still get investment loans at less than 5% interest). This will help keep your mortgage payment low
and thereby maximize your cash flow.

Related: Conventional Mortgage Loans: The Basics on How They Work

Long Terms

When you borrow from a conventional lender, your loan will likely be able to extend for a long term, maybe even up to 30 years if you’re buying a residential property. This can help keep your payment low, though it will also extend the amount of time you’ll have debt on the house.

first-note-investment

Professional

A conventional lender is in the business of lending, so the entire process is much more defined and professional than a relationship-based loan would be. This isn’t the lender’s first rodeo!

Cons

Max Number of Loans

Conventional loans may have great terms and rates, but real estate investors are capped on the number of conventional loans they can have. The current limit has been raised to 10 loans, though many investors are not even able to get to that limit because of the rise in their debt-to-income (DTI) ratios. In other words, for every loan you obtain (debt), the percentage of your debt to your W-2 income rises, until you are pushed out of the “acceptable” range defined by the conventional lender. I’ll talk more about this DTI issue in the next chapter.

Slow Process

Conventional loans are not fast to obtain. Because of the legal scrutiny your loan must go through and the mounds of paperwork you’ll must provide, the process of obtaining a loan can be arduous, usually taking 30 days or more.

Property Condition

Conventional lenders only want to lend on properties that are in good shape. This can rule out a lot of the best properties for investors, because we tend to focus on properties that are in terrible condition so we can improve their quality and value. If the property is missing any of the basic necessities for home living (for example, it has bad flooring, a poor paint job, a leaky roof), the bank will likely not fund the deal until the issue is fixed.

rental-property-pros

Related: The Investor’s Guide to Qualifying for a Conventional Loan

Not Very Entity Friendly

Conventional lenders are also not very fond of loaning on properties owned by an entity, such as an LLC or corporation, especially for residential loans. In other words, if you want to keep your name off the public record and add some asset protection by purchasing the property with your LLC, a conventional lender will likely never do it. You could, as many investors do, buy the property in your personal name and then transfer it to your LLC, but you put yourself at risk of having the “due on sale” clause called by the bank.

The due on sale clause is a part of nearly every mortgage paperwork that says, “If you sell or transfer the property, we have the right to call your loan due now or foreclose on you.” This has been happening more and more lately in the real estate space, so I can’t suggest that this is a good idea. Be sure to talk to a lawyer and CPA who can help you sort these types of issues out. But the point is this: conventional lenders don’t like entities.

So, should you use a conventional loan? Personally, I love getting conventional loans if I can get them. However, those days have long since passed for me, because I’ve hit the limit on the number of conventional loans I can obtain. If you are still able to do so, I would definitely strongly encourage you to use a conventional loan for your next property. Very few financing strategies can live up to the low cost and stability of a conventional loan.

What kind of funding are you using for your portfolio?

Leave your input below!

About Author

Brandon Turner

Brandon Turner (G+ | Twitter) spends a lot of time on BiggerPockets.com. Like... seriously... a lot. Oh, and he is also an active real estate investor, entrepreneur, traveler, third-person speaker, husband, and author of "The Book on Investing in Real Estate with No (and Low) Money Down", and "The Book on Rental Property Investing" which you should probably read if you want to do more deals.

7 Comments

  1. I was lucky enough to purchase multiple houses with conventional loans back in the good old days of the mid 2000s. NO doc, no nothing. I paid relatively high rates ( 6.5% to 7.5%) since I was an investor. Fortunately, our friendly federal government came around and paid banks to refinance their performing loans. I have no idea why, but the banks could not wait to help me because I think it made them look good with the Dodd-Frank crowd. No Doc, no tax returns, no nothing. So now I have a half dozen 30 year fixed mortgages at 4.5%. Rents keep going up. Guess what I won’t be doing? Selling those houses!

    p.s., this might help explain the entry level housing shortage. It does not make sense to sell a house with a low payment and a low fixed rate mortgage.

  2. Roger StPierre

    There are several options if you have maxed out your conventional sources. Find a good portfolio lender that will lend to you or your personally funded LLC’s. Our bank does this frequently. There aren’t any limits to the number of portfolio loans an investor may get (as long as they qualify of course).
    Another great option is to buy that next investment property with your self directed IRA or Solo 401(k) with a Non Recourse loan and a good downpayment from your self directed plan. Alot of investors don’t realize they can unlock the liquidity in their retirement plan funds and put it to use in real estate.

  3. Ethan Cooke

    Brandon – Thanks for the solid advice. I have used a 30-year conventional loan for each of the 3 properties I own, and I love them for the reasons you state. I must say though, I was shocked to see this article from the author of The Book on Investing in Real Estate with No (and Low) Money Down! Your book is full of creative financing ideas and conventional loans are quite conservative by contrast. What gives?

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