In recent years, the rental loan has become a better way to finance an investment property for real estate investors. These loans look similar to conventional mortgages, but they can be closed much faster and require less process.
What is a rental loan and what type of lenders offer it?
A rental loan is long-term financing provided to real estate investors by private lenders (or hard money lenders). These loans are made to investors that are building a portfolio of single-family (1-4 unit) investment properties. Their strategy is to generate cash flow through rental income and build generational wealth from debt paydown and property appreciation. Townhouses and condos are also included.
The most common type of rental loan is a 30-year fixed, fully amortizing loan. This is very similar to a conventional mortgage that are you no doubt familiar with already. Adjustable rate loan products are sometimes available as well.
Aside from private rental loans, you can also consider other types of rental property financing options, such as an FHA loan or conventional financing.
How is it different from a conventional mortgage?
The rental loan is emerging as a competitive alternative to conventional mortgages because there are fewer borrower requirements and these loans can be funded much faster. This means less time collecting documents and more time focused on executing your projects. You are also less likely to experience significant delays in closing your loan. This is commonplace in the conventional mortgage industry right now.
These loans also differ in several additional ways:
You are limited on the number of conventional mortgages that you qualify for. Many bank lenders approve investors for up to four loans and then tighten standards to make it more difficult to qualify for additional properties. Fannie Mae loans cap out at 10 per investor.
Another benefit of working with private lenders is that you can combine multiple assets and refinance a portfolio of rental properties in one transaction. This is guaranteed to save you lots of time and reduce your out of pocket fees.
In the past, private rental loans required much lower loan-to-values (LTVs). This is no longer the case and you can now qualify for low down payments and up to 80% LTV. Rental loans also do not have a required minimum cash to close down payment amount. If you purchased your property below market and created substantial value from the rehab, it is possible for you to cash-out all of your equity.
You can expect to pay higher interest rates – 0.5% to 1.0% higher on a rental loan interest rate.
Most private loans are not reported to credit reporting agencies. Conventional loans, however, will be reported and they could affect your credit score.
What are the advantages of a real estate investment property loan?
Speed: Private rental loans can be closed much faster than conventional mortgages. In some cases this can be months, saving you significant amounts of money and allowing you to recycle your capital faster. A general guideline is that the rental loans can close as fast as one week after the receipt of the appraisal report.
Loan Underwriting Requirements: Private lenders are most focused on the cash flow potential of the asset. Therefore, many do not require proof of personal income such as W-2s and tax returns. Private lenders focus on three areas when evaluating a loan opportunity.
Loan to value (LTV): the basis for this calculation is the appraisal valuation report. Many private lenders will go up to 80% LTV with the best rates on those loans that are 60% LTV.
Credit Score: you can expect a minimum credit score of around 660. A score of >740 will help qualify you for the best interest rates.
- Debt service coverage ratio (DSCR): this ratio is a measure of the ability of the property’s cash flow to cover it’s expenses. 1.10x is generally a minimum required by private lenders.
How is the DSCR calculated?
The best way to think about DSCR is simply property revenues divided by property expenses.
Revenues are your annual rent collected from the tenant.
Expenses are made up of four elements:
- Principal and interest (P&I) – this is your monthly payment annualized
- Annual insurance premium
- Property tax bill
- Any HOA fees (if applicable)
How do you qualify for a rental loan?
Lenders can quickly pre-qualify you for a rental loan. This is a summary of the typical requirements that an investor will need to meet:
- Loan size: up to $2.0 million
- Property value: not less than $100,000
- Lease: unleased can be accepted and no seasoning requirements
- FICO: minimum of 660
- Leverage: up to 80%
- DSCR: minimum of 1.10x is a general guideline
- Property appraisal report
What are the key documents that are required?
There are fewer documents required compared to a conventional mortgage. These are the common items needed to finance an investment property loan:
- Business entity documentation
- Property tax bill
- Evidence of insurance
- Proof of rent received
- Evidence of commercial purpose – you can’t use the property for personal reasons including as your primary residence
- 6 months of cash reserves
- ID verification
- Property management experience – you can qualify if it is your first time but you may pay a higher rate
Get your next rental property loan started today
If you are a real estate investor, investment property rental loans can be a great tool to help you scale your business and deliver a portfolio of cash flowing rental properties.
While the loan rate may be slightly higher, the speed and fewer qualification requirements can provide you greater benefits in the long-term. Spend less time collecting paperwork, focus on your projects, recycle your capital, and close more deals.