Ultimate Guide to Investment Property Loans

Buying a commercial property, apartment building, mixed-use complex, or other type of investment property can be a costly endeavor. Fortunately, investment property financing is available if you are eligible.

It’s important to understand how investment property loans work, their pros and cons, what’s required to qualify, the costs involved, how to choose the right investment property loan, and where to shop for financing. Read on for helpful information and tips.

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What an Investment Property Loan Is

An investment property loan is a type of mortgage or financing that can be used to purchase a property that will serve as an investment and generate income, including rental revenue, instead of serving as a primary residence you will occupy as an owner. Investors, landlords, and others pursue investment property loans to buy rental, commercial, retail, and mixed-use properties.

How Investment Property Loans Work

Investment property loans work much like traditional primary mortgage loans in that they are long-term, low-interest loans secured via a piece of real estate as collateral. But they may require a bigger down payment and a higher interest rate than a loan for an owner-occupied property/primary residence.

That’s because lenders typically regard investment properties as a greater risk, as the borrower’s ability to generate income from the property is not guaranteed.

Pros and Cons of Investment Property Loans

Shashank Shekhar, CEO of Instamortgage, explains that investment property loans offer several benefits over other types of loans.

“They often allow you to borrow larger amounts of money than other forms of financing, which can be helpful when purchasing more expensive properties,” he says. “Many investment property loans also offer fixed interest rates, which can provide stability and predictability in monthly payments. These loans can also present tax benefits, such as the ability to deduct mortgage interest paid and property taxes from rental income. Plus, by making regular payments on an investment property loan, you will build equity in the property, which can potentially increase its value over time.”

Jordan Woolf, a real estate investor and CEO of We Buy Houses in Bama, notes that, because investment property loans are like traditional mortgages, “it makes applying for and closing more familiar to borrowers who have previously financed a primary residence.”

On the downside, investment property loans commonly come with higher interest rates than traditional home loans, which can make them more costly over the long term. In addition, you’ll likely be required to make a larger down payment than you would for a primary mortgage loan. And it can be a bit more challenging to find a lender that offers investment property loans.

“Lenders often have more stringent qualification requirements, too, and investment property loans may have prepayment penalties or other restrictions—possibly limiting your flexibility to refinance or pay off the loan early,” cautions Woolf.

Investment Property Loan Requirements and Loan Qualifications

Here is what you will probably need to be eligible for an investment property loan:

• A good credit score: Lenders often require borrowers to have a minimum credit score of 620 to 680. The higher your score, the lower your interest rate will probably be.
• A favorable loan-to-value (LTV) ratio: Your LTV ratio compares the loan amount to the appraised value of the property. Lenders usually want a lower LTV for investment property loans—typically 75% to 80%.
• A sizable down payment: An LTV requirement of 75% to 80% means you must provide a down payment of 20% to 25% of the investment property’s purchase price, in most cases, although some lenders require less.
• A preferred debt-to-income (DTI) ratio: Your DTI ratio compares your monthly debt payments to your gross monthly income. “For investment property loans, lenders prefer a DTI ratio 43% or lower, although some may accept a higher DTI ratio, depending on other factors like credit score or cash reserves,” adds Woolf.
• Stable income: Lenders want to see that you have a verifiable and stable source of earnings, which can lower their risks. Be prepared to provide documentation like paystubs, W-2 forms, and/or tax returns.
• Cash reserves: Your lender will feel better if you can present proof of sufficient cash reserves on hand for a particular period, such as six months, to cover your mortgage payments and other expenses associated with the investment property.
• Property management experience: “Some lenders may require you to show your ability to manage an investment property effectively, which can include providing a business plan or showing prior experience in property management,” says Woolf.
• Property appraisal: The investment property you want to purchase will need to be appraised to determine its value and ensure it meets the lender’s underwriting guidelines.
• Potential rental income: “Lenders may consider the property’s potential rental income when determining loan eligibility,” notes Shekhar.

Investment Property Loan Costs

Any loan will come with financing costs—the total amount you will pay out-of-pocket over the life of the loan in interest, fees, and other expenses. Typical investment property loan costs you’ll need to pay include:

• Interest in the form of a fixed or variable interest rate: Investment property conventional fixed mortgage rates are often at least 0.5% and 1% higher than the fixed rates for primary mortgage residential loans.
• Loan origination fees: Your lender may charge these fees for processing the loan application, which can range from 1% to 5% of the loan amount.
• Closing costs: These are the fees related to the purchase of the property, such as appraisal fees, attorney fees, and title search fees. Expect to pay between 2% and 5% of the property’s purchase price in closing costs.

“Currently, if one of our borrower clients had a 750 credit score and was purchasing a $450,000 investment property with 15% down, the fixed interest rate today would be 6.625% and their closing cost would include an origination charge of $1,498 and $3,825 in discount points,” explains Bobby Atkisson, senior vice president with Nationwide Home Loans Group.

Selecting Investment Property Loans

Several types of loans are commonly used for investment properties. These include:

1. Conventional loans, which can be obtained from banks, credit unions, and mortgage lenders and can be used for a variety of investment properties such as single-family homes, condos, and multi-unit properties.
2. Portfolio loans, which are offered by lenders who keep the loans in-house rather than selling them on the secondary market.
3. Hard money loans, which are also available for short-term financing and are typically used for investments that require significant renovations or quick fix-and-flip projects.
4. Commercial loans, which are designed for larger investment properties with over four units and are preferred by investors who want to borrow solely based on the property's income.

Getting a Property With an Investment Property Loan

Many types of properties can qualify for an investment property loan, including multi-unit properties, single-family homes, condos, townhomes, vacation rentals, and commercial properties like office buildings, warehouses, and retail spaces.

Top Investment Property Lenders

The right investment property lender for you will depend on many factors, including your ability to qualify, the interest rate and terms offered, the total loan costs, and more. Experts recommend shopping around among several lenders in comparing loan offers carefully. Make your final decision based on more than just the interest rate/APR—also consider the closing costs and fees involved, loan restrictions imposed (such as an inability to pay off the loan or refinance early), and financial strength and customer ratings of the lender.

Here are several lenders that offer investment property loans:

• Beeline
• Angel Oak Home Loans
• Citibank
• Flip Funding
• Homefinity
• LendingOne
• Lendio
• Nationwide Home Loans Group
• New American Funding
• Optimum First Mortgage
• Patch Lending
• PennyMac Financial Services
• Residential Capital Partners
• Rocket Loans
• U.S. Bank

The Bottom Line

It pays to do your due diligence and better understand how investment property loans work, what’s needed to qualify, and where to find applicable lenders.

When it’s time to choose a financing source, “be prepared to provide the lender with a clear business plan for how you intend to make money with the investment property,” continues Ang. “Remember that investment properties need to have some way of generating steady revenue.”