You want to start investing in a rental property, but you don’t have enough funds to start. One great way to start your real estate investment is to use other people’s money and this is what we formally refer to as a rental property loan. In this guide, we’re going to walk you through the 11 types of rental property loans to help you figure out which one fits your needs. Let’s get started.
How Does a Rental Property Loan Work?
As trusted local property managers in Philadelphia, Bay Property Management Group is well-versed in the knowledge and insight into securing the best rental property loans for real estate investors like you. Rental property loans are like mortgages for buying properties to rent out. Typically, you’ll apply for a loan from a bank or lender specifically for buying a rental property. At first, they will always assess your credit, income, and the property you want to buy. You will need a down payment, usually around 15-25% of the property’s purchase price.
Most of the time, the larger your down payment, the lower your monthly payments will be. Then, the lender will offer you an interest rate. This is the percentage you’ll pay on top of the loan amount. Rates can be fixed or adjustable (may change over time).
Next, you’ll agree to loan terms, including the length of the loan (this is usually for 15 or 30 years) and the monthly payment amount. The lender will assess the rental property to make sure it’s a good investment. They’ will look at its value, potential rental income, and condition.
Once approved, you will start making monthly payments to the lender. These payments cover both the loan amount (principal) and the interest.
11 Types of Rental Property Loans
Here are the 11 types of rental property loans you can try to apply as a real estate investor:
1. Federal Housing Administration (FHA) Loan
FHA loan, also known as the Federal Housing Administration loan, is a government-insured mortgage. This is an important point for you to know. When you apply for an FHA loan, the FHA doesn’t actually lend you the money directly. Instead of lending you the money directly, it insures the loan.
What does this mean?
This means if you were to default on your payments, or for example you faced a tough situation and you could not pay your loan on time, the FHA would compensate the lender for you. Because of this insurance from the FHA loan, lenders are now more willing to approve loans for investors like you who might not meet the criteria for conventional loans.
One of the advantages of FHA loans is the lower down payment needed compared to traditional mortgages. With an FHA loan, you may only need to put down as little as 3.5% of the home’s purchase price. This is actually less than the typical 20% down payment for conventional loans.
Another benefit is that FHA loans have more flexible qualification requirements. While you still need to meet certain criteria, like a steady income and a reasonable debt-to-income (DTI) ratio, FHA loans can be easier to qualify for if you have a less-than-perfect credit score.
Remember: While it is true that FHA loans are flexible, they will require you to pay for mortgage insurance, both upfront and annually. This can actually increase your monthly payments.
2. Department of Veterans Affairs Home Loan (VA) Loans
A VA loan is a mortgage loan available through a program established by the U.S. Department of Veterans Affairs (VA). VA loans are available to active and veteran service personnel and their surviving spouses and are backed by the federal government but issued through private lenders. VA loan allows qualified veterans to buy a home or a rental property with either little or no down payment.
Remember: VA loans are only a practical choice for eligible veterans and military members looking to buy a home.
So, if you are not an eligible veteran, it means that VA loans are not for you.
3. USDA Loans (USDA Rural Development Guaranteed Housing Loan Program)
To make things simple, a USDA loan is designed to help people in rural areas buy homes, especially those investors who are not qualified with traditional mortgages. One of the biggest benefits of a USDA loan is that it requires little to no down payment, which can make it easier for you to buy a home, especially if you do not have a lot of savings.
To be eligible for a USDA loan, both the investor and the property you are going to buy must meet these criteria. For the rental property to be eligible for these criteria, it must be in a rural area that is within the USDA’s definition and required location. For the borrower, they typically need to meet the income requirements and have a decent credit history.
Remember: USDA loans are not available for everyone. They are aimed at rural homebuyers, so if you are looking to buy in a more urban area, you need to explore other loan or mortgage options.
4. Conventional Loans
Unlike the loans we previously mentioned, a conventional loan is a type of mortgage that is not backed or insured by a government agency. However, conventional loans are available through private lenders.
Let us say you find a house you want to buy for $200,000. You do not have that much money in your bank account, so you applied for a conventional loan. The lender will look at your financial situation, including your income, credit score, and how much you have saved for a down payment. If they think you are a suitable candidate for a loan, they will agree to lend you the amount you need.
Now, you do not get the full $200,000 upfront. You usually need to put down a down payment, which is a percentage of the total price of the house. Let us say you put down 20%, which would be $40,000 in this case. That means you’re borrowing $160,000 from the lender.
Once you’ve got the loan, you must pay it back over time with interest. The lender will set up a payment plan for you, where you will make monthly payments for several years. Typically, conventional loans must be paid within 15 or 30 years.
5. Hard Money Loans
A hard money loan is like a quick-fix loan for real estate investors. It is typically used when you need almost quick money to buy a property or renovate it. Most real estate investors use hard money loans for a fix-and-flip investment.
Loans from banks can take a long time to approve. But with a hard money loan, you can get the cash you need much faster, sometimes within a few days. Unlike a bank loan where they look at your credit score and financial history, hard money lenders are more interested in the property or collateral itself. They will evaluate the property’s value and its potential to make sure it is a good investment.
Additionally, because hard money loans are riskier for the lender, they come with higher interest rates and fees compared to traditional loans. Also, they usually have shorter terms, often around 6-12 months. This means you will need to pay back the loan quickly, usually with monthly payments or in one lump sum at the end.
Many real estate investors use hard money loans for fix-and-flip projects. They buy a property, renovate it quickly to increase its value, and then sell it for a profit. The fast access to cash and short terms makes hard money loans ideal for these types of projects.
6. Commercial Loans
A commercial loan is like borrowing money from a bank to buy a house or a building that you plan to use for business purposes, like renting out multiple apartments or opening a store.
Instead of paying for the whole property upfront with your own money, you now ask the bank to lend you the rest. Then, the bank looks at things like your credit history, your income, and the property itself to decide if they will give you the loan and how much they will allow to lend you.
So, in simple terms, a commercial loan helps you buy property for your business without having to pay for it all at once, but you must pay back the bank over time with interest.
7. Blanket Loan
Let us say you want to buy many properties all at once. Instead of getting a loan from the bank for each property separately, a blanket loan lets you borrow for all of them together. Instead of juggling multiple loan payments, you only need to make one payment for the entire “blanket” loan.
Blanket loans can be convenient for investors who want to buy multiple rental properties at once because they simplify the whole borrowing process.
However, you need to be careful. If one of your properties is not doing well and you default on paying the loan, for example, your lender can seize all the properties or collateral associated with your blanket loan.
Remember: While blanket loans offer better terms, they also come with a bit more risk because all your properties are tied together under one loan.
8. Private Loans
Private loans are loans offered by individuals or private companies, and that are not from traditional financial institutions like banks. Instead of borrowing from a bank, you’re getting the money from someone else. This could be a family member, a friend, a colleague, or even a private investment company. Just like any loan, you will have terms to agree upon. This includes the amount of money you are borrowing, the interest rate you’ll pay, and the timeline for repayment.
To be honest, private loans often offer more flexibility than bank loans. You might negotiate different terms that suit your needs better. Usually, these loans are secured by collateral, which is often the property itself. This means if you are unable to pay back the loan, the lender has the right to take ownership of the property.
Because of the flexibility, private loans can be quicker to secure than traditional bank loans. Since you’re dealing with an individual or a smaller company, they might not have as much bureaucracy to go through.
Here’s the risk though: For the borrower, interest rates might be higher, and if you cannot repay the loan, you might lose your property. For the lender, they are taking on the risk that you might not pay them back.
9. Seller Financing
Seller financing is like when the person selling the house becomes your lender. Instead of going to a bank for a loan, you agree directly with the seller. Let’s say the house for sale costs $200,000. You might not have $200,000 in cash to buy it, but the seller agrees to sell it to you and accepts, for example, a $20,000 down payment.
Then, you agree on the terms for the rest of the money you owe. Instead of borrowing from a bank, the seller loans you the remaining $180,000. You will make regular payments to the seller, just like you would with a bank loan, with an agreed-upon interest rate and timeframe.
The difference is that with seller financing, you are dealing directly with the person selling the house. It can be a win-win situation because the seller gets to sell their house and potentially make more money over time through the interest you pay, while you get to buy the house without having to go through a traditional bank loan process.
10. HELOC (Home Equity Line of Credit)
A Home Equity Line of Credit (HELOC) is a type of loan that lets homeowners tap into a line of credit based on the equity they’ve built up in their property. Unlike traditional loans, a HELOC works more like a revolving credit line, like a credit card. You can use it for almost any purpose, like investing in rental property. With a HELOC, you can borrow money against this equity whenever needed, up to a certain limit.
The key thing to understand is that a HELOC works differently from a traditional loan. Instead of getting a huge sum of money upfront, you are given access to a line of credit that you can draw from as needed. And as you pay back what you borrow, you can borrow again, just like how you can reuse a credit card balance as you pay it off.
Interest rates on HELOCs (Home Equity Line of Credit) can be variable, meaning they can change over time, so it is important to understand the terms of the loan. And remember, since your home is used as collateral, if you cannot repay what you borrow, you could risk losing your home.
11. Portfolio Loans
Let’s say you are planning to start with getting multiple rental properties. Instead of getting individual loans for each property, a portfolio loan allows you to bundle all your properties together under one loan.
Typically, with a portfolio loan, the lender sees the big picture of your investment strategy, and because of this, you can often get better terms and interest rates. Think about this. Instead of looking at your property, your lender looks at your entire portfolio. This can be especially helpful if you are investing in multiple properties or if some of your properties might not meet the strict requirements of traditional loans.
Since portfolio loans are more flexible, they can also come with slightly higher interest rates or require larger down payments compared to traditional loans.
How to Choose the Right Type of Loan for Your Rental Property
In choosing the right loan for your rental property, you need to be careful. This is because the loan you pick can have a big impact on how you will also manage your finances once you have that rental property. You will need to consider the following:
- Interest Rate – The interest rate is the amount you will pay the lender for borrowing the money. Ideally, you need to look for a loan with a low interest rate.
- Loan Term – Loan term is how long you have to repay the loan. Shorter terms mean higher monthly payments but less interest overall, while longer terms mean lower monthly payments but more interest over time. Be careful when negotiating on loan terms though.
- Down Payment – This is the amount of money you need to pay upfront. A larger down payment typically means lower monthly payments and less risk for the lender. Aim to put down as much as you can afford to reduce your loan amount.
- Repayment Terms – You need to understand how the loan needs to be repaid. Some loans have fixed monthly payments, while others may have adjustable rates that can change over time.
- Lender Requirements – Different lenders have different criteria for approving loans. Make sure you meet the lender’s requirements for credit score, income, and property condition before applying.
How Bay Property Management Group Can Help
Let us say you successfully got that loan you need to start your rental property investment. Now, you must understand that this is the beginning. You now have key responsibilities such as managing your property, your tenants, and your finances. It might be a struggle for you to juggle all the property management responsibilities that come with your rental property.
We want to let you know that Bay Property Management Group is here to help. Our local experts will handle all your property needs. With our local knowledge and resources, we can help you in streamlining all your rental operations. Contact us to learn more about how our services can help you reduce the stress associated with managing your rental properties.
