8 Types of Rental Property Loans and How Each Works

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8 Types of Rental Property Loans and How Each Works

Using other people’s money by getting a loan on a rental property can be a good way to increase potential returns as long as you conservatively balance risk with reward.

In this article, we’ll look at the options for getting a rental property loan and discuss how to analyze cash flow and property value to help you make the best investment decision.

How Rental Property Loans Work

As a rule of thumb, loans for a residential rental property come with slightly higher interest rates and require larger down payments. Rental property loans are still fully amortized over 30 years so that the payment amount is the same every month, which makes putting together an accurate pro forma for cash flow easier.

Interest rates are higher and down payments are bigger because lenders view investment property loans as being more risky compared to a mortgage for an owner-occupied home. That’s because banks know from experience that if the investment doesn’t go as planned, an investor-borrower is more likely to walk away and give the keys back to the bank.

However, the slightly more restrictive terms on a rental property loan can work in favor of the real estate investor. Interest payments can be completely expensed as a tax deduction by investors. A bigger down payment creates a lower loan-to-value (LTV) ratio, with a lower mortgage debt service payment amount and potentially increased cash flow.

Although every lender is different, these are some of the typical requirements to expect when applying for a residential rental property loan:

  • Minimum credit score of 620
  • Maximum of 36% debt-to-income (DTI) ratio
  • Down payment of 25% or more based on the property type and borrower credit
  • Interest rates and loan fees slightly higher to compensate lender for additional risk
  • PMI (private mortgage https://paydayloansohio.net/cities/mount-gilead/ insurance) is not applicable when the down payment is 20% or more (LTV is less than 80%)
  • Borrower must have cash reserves to cover six months of mortgage payments
  • Single-family, small multifamily, condos, and townhomes qualify for residential rental property loans

Options for a Rental Property Loan

It’s much easier and less expensive to find a loan option for a residential rental property like a house or a duplex compared to a large apartment building or commercial property. If you’re shopping around for a rental property loan online, you can get a free rate quote from an experienced mortgage professional on Stessa .

Here are some of the options to look at when you need a loan for buying a rental property or refinancing an existing mortgage:

1. Conventional

Conventional or conforming loans are mortgages that most people are familiar with. They are offered by traditional lenders like banks or credit unions, and also by mortgage brokers who work with a variety of lenders and can help you find the best deal.

Interest rates are usually lower than other options provided you have a good credit score, and down payments may be less than 25%. Conforming loans must meet Fannie Mae or Freddie Mac guidelines. While Fannie and Freddie allow up to 10 mortgages by the same borrower, banks often set a lower limit of around four loans total.

2. FHA

Federal Housing Administration (FHA) loans are also offered by traditional lenders and mortgage brokers. Credit score requirements and down payments are usually lower than a conventional loan, and income from an existing rental property can be used to help qualify.

FHA loans are a good option for multifamily property investors looking for a rental property loan for a new purchase, new construction, or renovating an existing property. To help qualify for an FHA multifamily loa n, the investor will need to use one unit as a primary residence for at least one year.

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