For investors looking for a reliable, passive income stream, real estate is always a top choice. On the other hand, the cash necessary to jump into property ownership can be steep, and most investors start by taking out a loan. There are many types of investment property loans, each with their own pros, cons, and the best situation in which to be used. Here’s what you need to know about the different types of investment property loans.
1. Conventional Mortgage
Many of us are familiar with this type of loan from financing our own residences. Unlike homeowners, however, there are typically no programs that allow for anything less than a 20 percent down payment. Approval and interest rates are based on the borrower’s credit history, with a score of 620 being the minimum for approval and 740 for lower interest rates. Some lenders may also require six months’ worth of payments in cash reserves.
2. Hard Money Loan
These loans are acquired from other investors who specifically look for real estate projects to back. They can be quicker to obtain as there’s not a multi-level bureaucratic application process, but often have steep interest rates and very short repayment schedules. For those reasons, a hard money loan is best suited for those who intend to “flip” or renovate and quickly resell a property.
3. Private Money Loan
Private lenders are typically not professional investors; instead, they are private individuals who are merely looking for a good return when investing their cash. Whether it’s a friend, family member, or someone you know professionally, private loans are a good choice for anyone who cannot be approved for a bank loan, or for those who need more flexible terms than banks typically provide.
4. Home Equity Loan
For homeowners who have paid down their mortgage or whose homes have appreciated significantly in value, the difference between the current value of the property and the balance owed on the mortgage is called equity and is considered an asset that you own. That equity can be used to obtain a secured loan, typically called a home equity loan, and the equity is used as collateral to secure the loan. The qualifications are similar to a conventional mortgage and tend to have slightly higher interest rates as well. The risk for defaulting on the loan can mean the loss of your primary residence. So, only choose this option when investing in a reliable source of income, such as a rental property with a good history.
5. Commercial Investment Loan
Commercial properties are solid choices for investments, but often require substantially more capital to get started. Commercial loans make these large sums of money available; however, the borrower will have the burden of convincing the bank that the investment is sound by providing a business plan. Along with estimated income potential, the plan should also include necessary building improvements and other cash flow issues that may arise.
Making the Right Decision
Choosing the best loan for your investment property is simply a matter of assessing your current financial situation, understanding your goals, and working within the parameters of different lenders. In cases where you’ll need a steady income to repay a long-term loan, consider hiring a property management company that is experienced with keeping costs down to maximize the income potential of your next investment.
