One of the biggest hurdles most aspiring landlords face is figuring out where to get investment property loans. Conventional wisdom says to just walk into a bank and see what is in store for you. But the problem is, that may be the worst thing you can do.
“I would say raising capital is one of the weakest things for most entrepreneurs.”
– Robert Kiyosaki
There are a number of different things to consider before you start shopping around. You should also keep in mind the various options available for where to get financing.
Let’s start by considering a few factors before shopping for financing your rental property’s mortgage.
What You Need
You can’t expect to get a decent loan without showing you’ve done your homework. Here are a few questions your creditor may ask you:
- How well do you know the neighborhood?
- Can you show numbers to prove that the property values will continue to climb over the next few years?
- What kinds of new developments (if any) are being built in the area?
- What are the schools like?
This doesn’t require too much digging. A few hours spent on Google and Zillow, plus driving around the area, will go a long way.
It’s all about the numbers. Companies or individuals willing to give you an investment property loan want to make sure they get an ROI worth the risk they’re taking. A few questions they may have include:
- What’s your credit score?
- What’s your income/debt ratio?
- What kind of debts do you have?
- How many streams of income do you have coming in?
- How does the home’s price compare to comparables?
- What kind of rent can you reasonably expect?
- What are the total monthly expenses, including mortgage, maintenance, and taxes?
If the numbers don’t make sense, it will be harder to find an investor.
When you’re first starting out, your lack of experience may concern investors. That’s why you’ll need something to fall back on- such as having a mentor or business partner or being part of a real estate investing club. At the least, if you don’t have experience, they want to see that you’re learning from someone who does.
Some things to think about are:
- Who will manage the property?
- How will you find tenants?
- Do you know local laws for landlords?
- How will you deal with maintenance issues?
They just want to make sure you don’t go in and get blindsided in the first six months. The more you treat this as a business and do the work upfront in planning, the better your chances are of getting the loan.
Now let’s talk about where to go shopping.
Where to Get Your Investment Property Loan
“You can actually borrow your way to wealth.” – Robert G. Allen
It might be very tempting to go to a big bank- especially one you have a history with- to seek out a loan. Most of us are used to dealing with them, and they have considerable money to invest.
Depending on your financial situation, you may be able to make this work. But some people will find it very difficult to get a loan this way. There are a few reasons why I say that.
For one, big banks are much more rigid. They have to be, simply because of the amount of money and people they manage. They’ll have a very good idea of who/what they’re willing to invest in. If you don’t fit those criteria, you’re out of luck.
Something else to consider is they won’t know your market as well as other options. Even if you present a lot of data showing the area is a great place to invest, they will be a tougher sell.
Finally, big banks don’t have an excellent reputation for customer service. If you get in a situation where you need help with your mortgage, you’ll have more hoops to jump through here compared to the alternatives.
Here’s a horror story of a first-time investor who tried to go with a big bank.
Local banks or credit unions
One great thing about smaller banks or credit unions is that they do know your area. That’s part of their specialty, so they’ll have a better idea of whether or not your property is a good investment.
Another nice feature is flexibility. They’ll be more willing to work with you to negotiate a favorable deal for both sides.
The biggest downside is that they will look at very similar factors as a big bank. You’re still likely to get turned away if you don’t have good credit or a favorable income/debt ratio.
This is a great way to go if you can get the owner to do it with you. Just like it sounds, the idea is that the current owner of the home will carry the loan- and thus, the risk. So if you don’t make payments, they will foreclose on the house and own it again, just like a bank would.
So why is it so great? For one thing, the owner probably doesn’t care about your credit score. They may look at it, but that’s not a huge factor.
Other traditional numbers, like income/debt ratio, may not come into play either. They may not even think about asking you for information like that.
Their biggest concern is receiving monthly payments, but they will probably evaluate you differently. They’ll look more closely at your plan to market the home to tenants and manage it. They may want to know how much cash you have in case of emergencies or if the space remains empty, similar to a bank.
Another potential issue is the “due on sale” clause. Brandon Turner from BiggerPockets.com has a great article on this and the overall process. But if you’re a smooth talker and know what you’re talking about, owner financing is a great way to get an investment property loan.
Hard Money Loan
This is a high-interest loan that private individuals or companies usually issue. Because the interest is so high (11-14% typically,) the money is usually used to fix-and-flip homes rather than use a buy-and-hold strategy.
These can work, but you have to be cautious and only use them for their intended use. Don’t get one and then rely on home prices improving by 20-30% over the next few years to make a profit. Borrowing money at a high rate like that and just praying for a bull market is a big gamble.
This term is usually used in the startup world but can also apply to getting rental property investment loans.
You receive money from a wealthy individual (or group of individuals) to fund your project. You manage it and do all of the legwork, and they profit one way or another from their investment.
Some may want equity in the property. Others may provide the funds with a specific interest rate, similar to a conventional loan. Or you may find angels who want a bit of both.
Angels can be anyone from your rich uncle to a seasoned investor you met in your real estate investing club. They can be great backers, but you’ll need to prove you understand the business and investment you’re getting into before they give you their hard-earned dollars.
This is one of the newest kids on the block, but it’s exciting. The idea is similar to crowdfunding projects on sites like Kickstarter. A group of real estate investors can use websites like RealtyShares and Fundrise to invest in real estate without having to deal with things like managing the property or finding a property manager.
There are a number of websites like this out there now, and they’re each a little different. Just keep them in mind as a possible option – especially if you’re more interested in getting investment property loans for commercial properties than smaller, residential buildings.
Friends and Family
There are a few ways to have loved ones help you get a loan for real estate. One popular method is to have them co-sign. That way, you share the risk. If things go south, your loved one is liable for the whole loan, which will likely hurt (or kill) your relationship.
Another way is for them just to give/loan you the money. It’s not the best option because mixing business and family usually doesn’t turn out well. But nonetheless, it is an option.
Sometimes you just have to go “all in” and pull together any funds you have available. Maybe you take out some of your retirement funds. Or if you have a lot of equity in your home, you can take out a second mortgage and put it towards the rental property.
This isn’t a secure way of doing things, nor is it very creative. But it can be done if you have assets available and are in a position to take the risk.
Keep in mind that you can always use retirement funds for your investment property. This article explains how you can actually protect your real estate investment within your IRA, providing some excellent tax advantages.
It’s not exactly the holy grail, though. As this article from Kiplinger points out, some of the benefits of owning a rental property, such as reducing property taxes or accounting for depreciation, can’t be used if it’s held within an IRA.
Getting Property Loans Takes Work!
“The brick walls are there for a reason. The brick walls are not there to keep us out. The brick walls are there to give us a chance to show how badly we want something. Because the brick walls are there to stop the people who don’t want it badly enough. They’re there to stop the other people.” – Randy Pausch
Unfortunately, there’s no “right” way to do this. But the good news is that you can be creative with financing a home.
Maybe you combine several of the methods above. Or you talk to a seasoned investor who can give you great advice on how to get investment financing from another source.
Either way, just keep in mind that investing does have a learning curve and takes work. But once you get going and become a master of obtaining financing for rental properties, the world is your vacant lot to build up.