With a total market share of over $435 billion, rental properties have become a ‘must have’ in real estate portfolios. With a 1.1 % annual appreciation rate in 2020, real estate investors can earn on an average $500 to $1800 per month through rental properties. Allowing investors to build a passive income. Investors are pouring money to purchase such lucrative rental properties, for those who do not have deep pockets can take a loan to buy a rental property.
Loan options for rental properties:
Investors can opt to take from government-backed loans (FHA, VA, and USDA), conventional loans (conforming loans), or go for alternate lenders (hard money loans) to invest in a rental property.
1. Government Agency Loans
Agency loans are insured by government agencies like the Federal Housing Administration (FHA), the U.S. Department of Veterans Affairs (VA), or the U.S. Department of Agriculture (USDA) rural development. These types of loans are a low-cost option for investors. Investors can take loans with interest rates falling between 3.375 – 3.625% APR and require an investor to put 3% to 4% of the loan amount towards the down payment. The average credit score required to take an agency loan can be 620-640. Investors with a low credit score (lower than 580) can also qualify for a loan but with an almost 10% interest rate.
2. Conventional Mortgage Loans
Another option for investors is conventional loans (conforming loans). These types of loans generally have a higher interest rate than agency loans and are provided primarily on the credit score of a borrower. Conventional loans have a rigorous underwriting process that can take months to approve loans, something that many investors find inconvenient to deal with. Some banks look deep into the debt-to-income ratio and require an investor to have a steady income to qualify for a loan.
3. Hard Money Loans
Asset-based hard money loans have emerged as a reliable funding source for investors. Investors find hard money loans more convenient than agency loans or conventional loans. Faster loan approval with minimal documentation provides better opportunities for investors to invest in a rental property. Though the cost and interest rates of a hard money loan are higher than conventional loans, the loan terms can be easily negotiated with the lender. Conventional loans are often compared to hard money loans for financing an investment property, there are significant differences in both loans.
Difference between Conventional Loans and Hard Money Loans
Though the intention to take either loan is the same, real estate investment, the terms, and conditions laid by the lenders are different from each other. There are significant differences between conventional loans and hard money loans. Some of them are as follows,
1. Duration of the loan
Conventional loans offer mortgage loans with an amortization period of 15, 20, or 30 years. Hard money loans are primarily taken by investors on a shorter term, generally between 6 months to 2 years to repay the loan.
2. Interest Rates
The interest rates of a conventional loan are slightly lower than the hard money loans, typically 1% to 6%. Whereas hard money loan interest rates start from 7% and go up to 15%, depending on the conditions of the loan.
3. Down Payment
Investors are required to put 3% to 20% of the loan amount towards the down payment. An investor should have the ability to put 10% to 50% of the loan amount on a down payment in order to get a hard money loan.
4. Documentation and Underwriting
Conventional loans require an investor to produce numerous documents in order to verify their income, assets, debts, and credit history to get a conventional mortgage loan. The hassle-free approach towards loan approval is a feature of hard money loans that require minimal paperwork and a simple underwriting process to acquire a hard money loan.
5. Closing Costs
Conventional loans generally have closing costs of 2% to 5% with an origination fee of 0.5% of the loan amount. Conventional loans require an investor to opt for private mortgage insurance (PMI) with which can cost an additional 0.3% to 1.5% annually.
Hard money lenders will typically charge an origination fee of 1% to 3% adding to the renovation and construction costs. The closing costs are calculated on a hard money loan by determining the loan-to-value ratio. A higher LTV ratio may result in higher interest rates and other associated costs.
How to Get a Hard Money Loan for a Rental Property?
The process to obtain a hard money loan for a rental property is simple and requires the following things:
Applying for the Loan
An investor will have to make a formal application with the basic information about a borrower and the property on offer as collateral. An investor should sit down with a hard money lender and provide a clear idea of their financial requirements. A borrower should provide information about the following things:
1. The potential value of the property you wish to purchase
2. Financial planning (funds for the down payment)
3. Budget of repairs and renovation
4. A full-proof exit strategy
A borrower can provide information on their previous successful real estate investment projects, your loan can be prioritized on your overall experience and investment expertise.
Hard money loans are primarily provided on the after-repair value (ARV) of the property; you don’t need a decent credit score to qualify for a hard money loan. However, you must have the ability to pay 10% to 50% of the down payment. Have ample cash reserves to bear the closing costs and holding costs of the hard money loan as well as the related taxes, monthly down payments, and other associated costs.
Documentation and Underwriting
Investors need fewer documents to acquire a hard money loan. Only the documents are essential to verify your identity, assets, and property details. Investors can obtain a hard money loan by producing the following documents.
1. Purchase contract
2. Two forms of identification
3. Proof of insurance
4. Proof of funds
Some lenders may require a deed of trust and a promissory note to close a hard money loan. Proof of income, title insurance, and homeowner’s insurance documents are sufficient to refinance a hard money loan.
The Bottom Line
Rental properties are a great way to invest in real estate and grow your investment portfolio. Rental properties offer investors benefits like stable passive income, value appreciation, gain credit score, inflation protection, etc. There are several loan options available for investors to invest in a rental property.
The best way to invest in a rental property is to apply for a hard money loan from seasoned lenders like 14th Street Capital. Rated amongst the best hard money lenders for real estate investors, 14th Street Capital provides rental loans with minimal documentation and flexible terms. Whether you need a rental loan for the purchase, refinancing, or cash out, 14th Street Capital is your best funding source for real estate investment.