Investment Property Loan: Definition, Types, and Requirements

An investment property loan, sometimes known as an investment loan, is a type of financing used to purchase a property. The property is used for investment purposes. Real estate investors typically use investment property loans. They use them to purchase rental properties. Examples include vacation homes or other properties that generate income or appreciate. There are several types of investment property loans. The most common are conventional mortgages, FHA loans, VA loans, and hard money loans.

Each type of loan has its set of eligibility requirements and terms. Investors need to consider their options before choosing a loan. Most of these loans require borrowers to have a good credit score. It is because the loans are considered riskier than those for owner-occupied homes. Borrowers must have a stable income source to qualify for these loans. Sufficient income ensures that they are able to repay the loan comfortably. Some lenders check a borrower’s debt-to-income ratio when reviewing the applications. It measures the borrower’s income used to pay off debts.

What is an Investment Property Loan?

An investment property loan is a type of mortgage used to finance the purchase of a property. The property must not be intended to be the borrower’s primary residence. Rather, the property generates income. It generates it either through rental income or by being sold for a profit after its value has increased. These loans are often seen as riskier than loans for owner-occupied homes. It is because there is a greater likelihood of default if the property doesn’t produce enough income to cover payments.

Thus, lenders require a higher credit score and down payment for an investment property loan. They must verify the borrower’s income and debt-to-income ratio to ensure they have the financial stability to repay. These loans have stricter requirements and mandate that the borrower has cash or other assets in reserve. These cover any unexpected expenses or vacancies. 

What are the different Types of Investment Property Loans?

There are several types of investment property loans, including:

• Conventional mortgage. A conventional mortgage is a loan not insured or guaranteed by the government. Borrowers use it to purchase a single-family home or other owner-occupied property.
• FHA loan. An FHA (Federal Housing Administration) loan is a mortgage insured by the government. It is popular for first-time homebuyers and those with lower credit scores. It is because the qualifications for an FHA loan are less strict than a conventional mortgage.
• VA loan. A VA (Department of Veterans Affairs) loan is a mortgage guaranteed by the government. It is for eligible veterans and active military personnel. It is available to people who have served or are serving in the military and their spouses.
• Jumbo loan. A jumbo loan is a mortgage that exceeds the limits set by the Federal Housing Finance Agency (FHFA) for conforming loans. Borrowers use it to finance the purchase of high-priced or luxury properties.
• Portfolio loan. A portfolio loan is a mortgage held by a lender rather than being sold on the secondary mortgage market. They use it for properties that do not meet the standards for conventional loans, such as investment properties.

What are the Requirements to Qualify for Investment Property Loans?

1. Credit Score

A credit score is a numerical representation of an individual’s creditworthiness. It is typically based on their credit history. Lenders use it to evaluate the risk of lending to a borrower.

Importance

Having a good credit score is vital for obtaining an investment property loan. It is one of the factors that lenders consider when evaluating a loan application. Higher credit scores result in lower interest rates and more favorable loan terms. Most lenders use credit scores to determine the risk of default on loan. Thus a higher credit score is a sign of a lower-risk borrower. Additionally, some lenders have minimum credit score requirements for investment property loans. Borrowers with low credit scores find it hard to obtain loans. 

Pros

• More likely to obtain. A high credit score makes qualifying for an investment property loan easier. Thus it results in more favorable loan terms.
• Lower interest rate. A higher credit score means lower interest rates on investment property loans. Thus it saves the borrower money over the life of the loan.
• More loan options. A high credit score opens up more loan options for the borrower. These include conventional loans, FHA loans, and VA loans.
• Higher credit limits. A high credit score increases the chances of obtaining higher credit limits. These are useful for financing multiple investment properties or other large expenses.

2. Debt to Income Ratio

Debt-to-income ratio measures how much of one’s income goes toward paying debts. It is calculated by dividing monthly debt payments by the individual’s gross monthly income.

Importance: 

The debt-to-income ratio is important for investment property loans. It is because it measures the borrower’s financial stability and ability to make loan payments. Lenders prefer a lower debt-to-income ratio. It shows that the borrower has more disposable income and is less likely to default on the loan. Some have maximum debt-to-income ratio requirements for investment property loans. A high debt-to-income ratio makes it difficult to qualify for a loan.

Pros 

• More likely to qualify for a loan. A lower debt-to-income ratio makes it easier to obtain an investment property loan. Once qualified, it results in more favorable loan terms.
• Lower interest rate. A lower debt-to-income ratio results in a lower interest rate on an investment property loan. It, in turn, saves the borrower money over the life of the loan.
• More financial flexibility. A low debt-to-income ratio gives the borrower more financial flexibility. It’s because they have more disposable income to cover unexpected expenses or to use for other purposes.
• Improved credit score. Paying off debts and lowering the debt-to-income ratio improve the borrower’s credit score. Good credit scores have a positive impact on future loan applications.

3. Credit History

Credit history refers to an individual’s record of borrowing and repaying debts. It includes information about the types of credit accounts an individual has. A credit score shows the amount of credit they have used and their payment history.

Importance: 

Credit history is important because it gives lenders a record of the borrower’s loan repayment habits. A good credit history makes qualifying for an investment property loan easier. It results in more favorable loan terms. Poor credit history makes it harder to qualify for a loan. It results in higher interest rates and less favorable loan terms.

Pros 

• Easier to secure financing for other purposes. A good credit history enables the borrower to secure financing for other purposes. These include a car loan or a personal loan.
• It’s easier to get a loan. People with good credit find it easy to qualify for an investment property loan. It results in more favorable loan terms.
• Lower interest rate. People with positive credit get lower-interest-rate loans. Thus it helps to save the borrower money over the life of the loan.
• More loan options. A good credit history opens up more loan options for the borrower. Examples include conventional loans, FHA loans, and VA loans.

4. Employment History

Employment history refers to an individual’s work experience. It includes the companies they have worked for, their positions, and the length of their employment.

Importance: 

Employment history provides lenders with information about the borrower’s income and stability. A stable employment history makes qualifying for an investment property loan easier. Additionally, it results in more favorable loan terms. An unstable or limited employment history makes it more difficult to qualify for a loan. It leads to higher interest rates and less favorable loan terms.

Pros 

• Higher chances of loan approval.  Those who qualify enjoy favorable terms.
• Lower interest rate. A stable employment history leads to a lower interest rate on an investment property loan. It is because it demonstrates to the lender that the borrower has a reliable source of income.
• Improved bargaining power. A stable employment history gives the borrower more bargaining power when negotiating loan terms. It demonstrates their financial stability.
• Greater financial flexibility. A stable employment history gives the borrower greater financial flexibility. It is because they have a reliable source of income to cover unexpected expenses.

5. Sufficient Down Payment

A down payment is an upfront payment made by a borrower to purchase a property. It is represented as a percentage of the property’s purchase price.

Importance: 

A sufficient down payment demonstrates to the lender that the borrower has a financial stake in the property. It shows the borrower is less likely to default on the loan. Some lenders have minimum down payment requirements for investment property loans. Thus a lower down payment results in a higher interest rate and less favorable loan terms.

Pros

• Increased loan approval chances. A sufficient down payment increases the likelihood of getting an investment property loan.
• Lower interest rate. A larger down payment means a lower interest rate on an investment property loan. It is because it reduces the lender’s risk.
• Lower monthly payments. A larger down payment ensures borrowers get lower monthly mortgage payments.
• Equity in the property. A larger down payment means that the borrower has more equity in the property. It is useful if the property appreciates in value or if the borrower needs to sell the property in the future.

6. Evidence of Rental Revenue

Evidence of rental revenue is the documentation showing the income a rental property is expected to generate. Examples include a rental agreement or lease, a property management agreement, or financial projections for the property.

Importance: 

Evidence of rental revenue shows the lender the property’s potential income. It proves that the borrower is able to make loan payments. Proof of rental revenue makes qualifying for an investment property loan easier. Lenders need a higher down payment or interest rate.

Pros

• Easier to get a loan. Evidence of rental revenue increases the chances of getting approved for an investment property loan. Those who qualify get more favorable loan terms.
• Lower interest rate. Providing evidence of rental revenue leads to a lower interest rate on an investment property loan. It is because it demonstrates to the lender that the property is expected to generate income and thus make loan payments.
• Greater bargaining power. Evidence of rental revenue gives the borrower more bargaining power when negotiating loan terms. It is because it demonstrates the property’s financial viability.
• Higher loan-to-value ratio. It allows the borrower to qualify for a higher loan-to-value ratio. Thus they borrow a larger percentage of the purchase price of the property.
• Improved credit score. Making timely rental payments are reported to credit reporting agencies. They, in turn, improve the borrower’s credit score.

7. Rent as a Source of Eligibility

Rent as a source of eligibility refers to using rental income from a property to qualify for a mortgage or other loan.

Importance: 

Rent as a source of eligibility allows the borrower to use the expected rental income from the property to help qualify for the loan. It is particularly useful for borrowers with low income or strong credit history. Thus the rental income is used to demonstrate their ability to make loan payments.

Pros:

• More loan options. Using rent as a source of eligibility allows the borrower to qualify for a wider range of loan options.
• Higher loan-to-value ratio. Using rent as a source of eligibility allows the borrower to qualify for a higher loan-to-value ratio. It means they borrow a larger percentage of the property’s purchase price.
• Greater bargaining power. Using rent as a source of eligibility gives the borrower more bargaining power when negotiating loan terms. It shows the financial viability of the property.
• Improved credit score. Timely rental payments are reported to credit reporting agencies. They improve the borrower’s credit score.

How to Get a Loan for Investment Property?

1. Find an Investment Property Mortgage Lender

The first step in getting a loan for an investment property is to find a lender that offers mortgage loans for investment properties. It is either a bank, credit union, mortgage broker, or online lender. Borrowers must compare lenders to find the best loan terms and rates. When searching for a lender, consider important factors. These include the type of loan offered, the interest rate, the fees, closing costs, and additional requirements. Read reviews or get recommendations from other real estate professionals in the industry. Some lenders specialize in certain types of investment properties.

These include multi-family properties, commercial properties, or properties in certain geographic regions. Find a lender familiar with the type of property to purchase and offer a loan product that meets your needs. It is important to consider the lender’s reputation and financial stability. Borrowers must choose a lender with a track record of successful mortgage lending and who is financially sound. It helps borrowers have a smooth and successful borrowing experience.

2. Complete the Loan Application

After identifying a lender, the next step is to complete a loan application. The loan application requests information about the borrower’s personal and financial profile. These include their income, employment history, credit score, and debt-to-income ratio. The lender uses these details to evaluate an investment property loan eligibility. It helps them determine the terms and conditions of the loan, including the interest rate and down payment requirement.

Borrowers must be accurate and thorough when completing the loan application. Any mistakes delay the loan process or result in the application being denied. Besides the loan application, some lenders request additional documentation to support the application. These include tax returns, bank statements, proof of income, and other financial documents. Lenders use them to verify a borrower’s financial information and to assess their ability to repay the loan. It is important to provide all requested documentation promptly to avoid delays in the loan process.

Once the loan application and supporting documentation are submitted, the lender reviews them and decides on the loan. Suppose the loan is approved. The lender provides the borrower with a loan estimate. It outlines the terms and conditions of the loan. The borrower then decides whether to accept the loan or to continue shopping for other loan options.

3. Give More Supporting Asset Documentation

Besides the loan application, lenders request additional documentation. They support the borrower’s application for an investment property loan. These include tax returns, bank statements, proof of income, and other financial documents. The lender uses these details to verify a borrower’s financial information and to assess their ability to repay the loan. It is important to provide all requested documentation on time to avoid delays. Besides, the lender requests documentation related to the investment property itself.

These include the purchase agreement, property appraisals, and other documents that provide information about the property. Providing comprehensive and accurate documentation helps strengthen the loan application. It increases the borrower’s chances of approval. Borrowers must be upfront and transparent about their financial situation. They must understand the potential risks or challenges that affect their ability to make loan payments.

4. Pay for a Financial Assessment

Some lenders need a financial assessment as part of the loan process for an investment property. A financial assessment is a review of the borrower’s financial profile. It includes their income, assets, debts, and credit history. The lender uses the financial assessment results to determine the borrower’s ability to repay the loan. Additionally, it helps them set the terms and conditions of the loan.

A financial assessment helps the lender understand the borrower’s financial situation. With it, they identify potential risks or challenges that affect the borrower’s ability to make loan payments. Suppose the lender determines that the borrower cannot meet the loan’s terms and conditions. They require the borrower to adjust their financial situation or provide additional collateral. 

5. Analyze Your Closing Disclosure

After approval, the borrower receives a closing disclosure document. It outlines the final terms and conditions of the loan. The borrower must review the closing disclosure to ensure all the terms and conditions are accurate and in line with the agreement. The closing disclosure includes specific details. These include the loan amount, interest rate, closing costs, and other fees. It outlines the borrower’s rights, responsibilities, and potential risks or challenges. Suppose there are any discrepancies or issues with the closing disclosure.

The borrower must bring them to the lender’s attention and request clarification. Once the borrower accepts the closing disclosure, they must sign the document. Lenders need them to provide the necessary documentation or funds to complete the loan. Examples include paying closing costs, escrow fees, and other fees associated with the loan. Once the borrower signs the closing disclosure and provides the necessary documentation, the lender disburses the loan funds to the borrower. The borrower is responsible for making regular payments to the lender per the loan terms.

6. Compile your Funds and Finish

The final step is to compile the necessary funds and complete the loan process. It involves paying closing costs, escrow fees, and any other fees associated with the loan. The borrower is required to provide these funds at the time of closing. It is the point at which the loan is finalized, and the borrower assumes ownership of the property. The lender disburses the loan funds to the borrower, and the loan is considered closed.

The borrower must clearly understand their financial obligations and have the necessary funds to meet them. They must provide a down payment, pay closing costs, or provide additional collateral or security for the loan. Once the loan is closed, the borrower starts making regular payments to the lender per the loan terms. The borrower must make timely and consistent payments to avoid defaulting. Thos who default risks losing the property.

How to Choose the Best Investment Property Loans?

To choose the best investment property loans, borrowers must consider the following factors:

• Interest rate. Borrowers must look for a loan with a competitive interest rate. It is because it significantly impacts the overall cost of the loan.
• Loan term. They must consider the length of the loan term and whether it aligns with their investment goals. A longer loan term results in lower monthly payments. However, it results in paying more interest over the life of the loan.
• Fees and closing costs. They must be aware of any fees or closing costs associated with the loan, as these add to the overall cost.
• Prepayment penalty. Some loans have a prepayment penalty, meaning the borrower is charged a fee for paying off the loan early. They must consider whether a loan with a prepayment penalty aligns with their investment strategy.
• Loan-to-value ratio. The loan-to-value ratio is the loan amount compared to the property’s value. A higher loan-to-value ratio results in a higher interest rate. Likewise, it requires the borrower to provide extra collateral for the loan.

What is the average rate for Investment Property Loans?

The average rate for investment property loans is currently around 3% to 4%. It is per the data from the Mortgage Bankers Association, which tracks mortgage rates for various loan types. Remember that the actual rate a borrower receives is higher or lower than the average rate. It depends on factors such as credit scores, debt-to-income ratio, and the type of property. Some lenders charge higher rates for investment properties due to the increased risk involved.

How hard is it to get an Investment Loan?

It is challenging to get an investment loan. Lenders consider investment properties to be riskier than owner-occupied properties. Thus they are more stringent in their underwriting criteria and need the borrower to meet higher qualifications. To increase their chances of getting an investment loan, borrowers must have a strong credit score and a solid financial profile. These include a low debt-to-income ratio and sufficient income to support the loan. It is helpful to have a substantial down payment. It demonstrates to the lender that borrowers have a financial stake in the property and it reduces the risk of default.

What credit score do I need for a Home Investment Loan?

The average credit score for an investment loan is 680 or higher. The actual score varies depending on the lender and the type of loan product. Generally, borrowers with higher credit scores qualify for more favorable loan terms. These include lower interest rates and fees. Besides credit scores, lenders consider other factors. These include income, debt-to-income ratio, and the type of property purchased.

Can I put less than 20% down on an Investment Property Loan?

Yes, it is possible to put less than 20% down on an investment property loan. Many lenders offer investment property loans with low down payment options, such as 10% or 15% down. However, borrowers must remember that putting less than 20% down results in higher monthly mortgage payments. Additionally, it requires the borrower to pay for private mortgage insurance (PMI). PMI is an insurance policy that protects the lender if the borrower defaults on the loan. It is required when the borrower puts less than 20% down on a mortgage. Putting less than 20% down on an investment property loan results in a higher interest rate or other less favorable loan terms.

Is an investment loan a good idea?

Yes, obtaining an investment loan is a good way to finance the purchase of an investment property. Still, it is important to consider the loan terms and conditions. Borrowers must carefully and thoroughly research the property before committing. They must research the property and consider the potential return on investment. These include rental income, appreciation, and other factors. They must do their due diligence and consider potential risks that affect the property’s value or profitability