Even investors with a few properties under their belt don’t know where to go for financing once they reach the conventional mortgage limit (more on that shortly).
If you’re interested in building a passive income through a rental property portfolio, there are seven excellent sources for funding to help you start buying investment properties of your own. Before putting down your earnest money deposit, make sure you know the best loan options for purchasing a rental property.
1. Conventional Mortgage Loans
The first place that most new investors think to look for financing is a traditional mortgage lender. Many have used conventional mortgage lenders to buy a home or two, and they’re familiar with the process.
Of the options on this list, conventional lenders are among the cheapest. Investors can expect to put at least 20% down on a rental property loan, and sometimes more if they have weak credit.
There are three enormous downsides to conventional lenders for investment property loans. First, they’re slow, often taking 30-60 days to settle. Many real estate investors need to settle quickly if they’re going to score a good deal.
Second, they report to the credit bureaus. While one or two mortgages on your credit report can help your credit, four or five is another matter.
Finally, conventional lenders put a limit on how many mortgages can appear on your credit. Most lenders put the limit at four, and refuse to lend to borrowers with four or more mortgages reporting on their credit.
So while conventional mortgages can work well for your first rental property loan, they’re not a scalable solution. Whenever getting any kind of mortgage, it's essential to ask the lender the right questions.
2. Portfolio Lenders
Conventional mortgage lenders don’t actually keep your loan on their own books. They sell it off to massive mortgage banking conglomerates like Chase or Wells Fargo, and that’s who owns and services your loan from then on.
Portfolio lenders, on the other hand, keep your loan in-house on their own books. These lenders service it for the life of the loan.
As such, they’re not bound by rigid rental property loan programs. They set their own terms, and many specialize in working with real estate investors exclusively. While portfolio lenders typically charge slightly more for their rental property loans, they can usually settle quickly (10-30 days), they don’t report to the credit bureaus, and they don’t put any limits on the number of loans you can have.
Many even offer discounts for more experienced investors!
And there’s some comfort in knowing that the same lender you work with initially will continue holding it for the entire life of the loan.
3. Community Banks & Credit Unions
Local community banks and credit unions also often offer investment property loans and keep them in-house.
These loan programs vary from bank to bank, and unfortunately the only way to discover their terms is by contacting banks individually. But it’s often worth the effort to find a local lending partner you can trust.
In rare cases, you might even find a local bank still willing to offer renovation loan-permanent financing. This is a single loan that covers most of your purchase and renovation costs and then rolls over to a permanent mortgage loan once the renovations are complete. It saves you having to refinance and saves you thousands of dollars in closing costs.
Which is precisely why no big banks offer them anymore. They want those refinancing fees!
4. Private Lenders
No one says you have to go to a bank at all, to finance an investment property. As investors gain experience, often their friends, family members, coworkers, and even acquaintances will start asking them if they can invest money with them.
Consider borrowing money privately from people you know, rather than approaching a formal lender to finance your rental properties. You can negotiate terms directly, but just make sure you know what you’re doing as an investor before risking your friends’ and family members’ money!
5. Seller Financing
Just because you borrow money privately doesn’t mean you have to approach friends and family members. Instead, you could borrow money from the seller to cover the cost of buying.
On the plus side, you can negotiate your own terms with the seller. They may not hit you with as many fees and points, and might even offer a better interest rate.
The main drawback is that sellers don’t want to hold your note forever, so they typically lend for the short-term. That could mean a loan fully amortized over three-to-ten years, which high monthly payments. Or it could mean a loan amortized over 15-30 years, with lower payments, but with a three-, four-, or five-year balloon.
A balloon mortgage must be paid in full upon the balloon maturity date; even though you’re paying as if it’s a 30-year mortgage, for example, you need to refinance or otherwise pay off the loan once the balloon hits after a few years.
6. Your Existing Real Estate Equity
Have equity in your home, or in another rental property?
You can tap into it to buy your next property. And you have several options at your disposal to do it, too.
My favorite option is taking out a home equity line of credit (HELOC), pulling out money to buy a rental, then paying it down quickly. You can rinse, repeat, and keep building your rental portfolio, property by property.
Alternatively, you could take out a second mortgage, or even refinance your current mortgage. But refinancing comes with some drawbacks, such as extending your debt horizon and restarting your loan’s amortization schedule from scratch.
A better plan is to simply offer up your home or other property as additional collateral when you go to take out a separate rental property loan. That can replace the down payment, so you don’t need to come out of pocket.
The downside to all of these tactics is that you risk your own home to finance an investment property. If you default on the loan, the lender forecloses on you, and you have nowhere to live.
7. House Hack
Perhaps the best of all worlds, house hacking lets you live in your investment property, ideally with no net cost to you whatsoever.
House hacking involves finding a way to charge someone else for your living expenses. The classic model consists of buying a small multifamily, moving into one unit, and then renting out the other unit(s), so your neighboring tenants pay enough rent to cover your mortgage payment.
But that’s not the only way to do it. I’ve taken in roommates to cover most of my mortgage. My partner Deni has rented out garage storage space. In a particularly brilliant maneuver, she brought in a foreign exchange student, and the placement company pays enough money to cover her mortgage!
Best of all, you can use a conventional owner-occupied mortgage loan to buy a property with up to four units. That means cheap, standard mortgage pricing, for your first rental property.
It's where you get to live for free.
Final Thoughts on Mortgage Options For Rental Properties
You have plenty of options for investment property loans, regardless of your experience level. If you’re open to moving, consider starting with house hacking. It comes with too many advantages to ignore.
For your first investment property, a conventional mortgage loan can do the trick. But quickly transition to portfolio loans, or more creative options like seller financing and other private loans.
As you become a more experienced investor, you’ll find that there’s no shortage of money to fund good deals. The challenge actually lies in finding those good deals on rental properties, not in funding them.
Do you own any rental properties currently? How did you finance them?
Additional Helpful Huliq Real Estate Resources
Can I buy a home that's contingent - lots of home buyers see homes marked as contingent online and wonder whether it is possible to purchase these properties. Take a look at some excellent insights in the article.
What are allowable money sources for earnest money - see what are acceptable money sources for an earnest money deposit. The funds you use to buy a house have to be from usable sources that lenders allow.
Use these additional articles to make smart home-buying decisions.
About the author: The above article on mortgage sources for rental properties was written by Brian Davis. Brian is a content creator and rental property expert that works for SparkRental. Reach out to Brian for any rental property questions you may have.