Investing in rental property can feel like a significant step. It is a smart way to generate passive income and can maintain its value in a volatile market with fluctuating stock prices. If you find the right property, it may not require you to perform a great deal of maintenance or upkeep.

However, purchasing rental properties requires some cash up front. You must also secure the proper type of financing. It is important to understand the various types of rental property loans and how to qualify for them.

Loans for Rental Properties

Qualifying a Loan

Loans for investment properties are distinct from loans for principal residences. When approving a loan for a primary residence, a lender considers your income, debts, and credit score.

A rental property is viewed as a greater risk. If the property is vacant, you incur a financial loss. Therefore, lenders must consider additional factors prior to approving a loan for real estate investments.

Down Payment

Some primary residence mortgages require little or no down payment. For rental properties, lenders require a larger down payment to offset the loan's inherent risk. Typically, this is between 10 and 25 percent of the home's value.

Cash Flow

The lender, as well as you, will want to understand the rental property's cash flow. Cash flow is the difference between total rental income and total expenses. In addition to the mortgage payment, your expenses will include taxes, insurance, and other costs associated with home ownership.

A profitable real estate investment will exceed the break-even point. This is also known as Debt-Service-Coverage-Ratio or, abbreviated DSCR. You should be realistic regarding your cash flow. Consider the impact of maintenance, repair, and other expenses. Consider whether you would pay a property manager to assist you if you are considering a property with multiple units.

Your Credit Profile

Your credit score will be considered as part of the loan approval process. If your score is high, it indicates that you have successfully fulfilled your obligations in the past. A lower credit score may cause a lender to be more cautious.

If you plan to acquire multiple investment properties in the future, you will have an easier time obtaining financing. A well-established real estate loan portfolio will demonstrate to a lender that you effectively manage your investments.

Types of Loans for Rental Properties

The lender's approval guidelines will vary based on the type of rental property you are considering. Single-family homes with one to four units are treated differently than multifamily homes with five or more units. The loan types available will also depend on the lender you select.

Conventional Loans

If you obtain a conventional loan, you will obtain a mortgage from either a physical or an online bank. A conventional loan adheres to the underwriting guidelines of government-sponsored mortgage companies Fannie Mae and Freddie Mac. It can be challenging to qualify for a conventional rental property loan.

A conventional loan requires a sizeable deposit. Additionally, you must have an excellent credit score and a low debt-to-income ratio. The lender will want to see that you can afford the rental property's monthly loan payment in addition to your primary residence.

Lenders will also evaluate your assets, such as your savings accounts. Due to the fact that future rental income is not factored into your current debt-to-income ratio, you will typically also need six months of cash reserves.

Home Equity Loan

If you have a substantial amount of equity in your current residence, you can use it to finance your investment property. If you own your primary residence free and clear, you can refinance it and use the proceeds to purchase a rental property. In this case, the lender will not consider your rental property, and you will only qualify for your home loan.

If you lack sufficient equity, you can use the equity you do have as a down payment. As you are increasing your debt to finance the acquisition of a rental property, this may make some conventional loan lenders nervous.

Using the equity in your own home increases your risk. If you were unable to make payments for any reason, you could lose both your home and your rental property.

Rental Loans

Utilizing a private lender is an alternative to a conventional loan. Private creditors may provide flexible terms. Unlike conventional loans, which rely heavily on the borrower, private lender rental loans place greater emphasis on the property and its cash flow.

One conventional loan can only be used to finance a single property. You can also obtain a rental portfolio loan through a private lender. This loan allows you to consolidate the financing of multiple properties into a single loan, thereby streamlining your payments and reducing loan processing fees.

Consider forming a limited liability company as the "owner" of your investment property. This provides you with some legal protection in the event of liability or litigation. A conventional loan cannot be taken out by a limited liability company, but a rental loan can.

Your investment property can be purchased or refinanced with your rental property loan. A cash-out refinance is also an option if you have built up some equity. The cash can then be used to fund your next investment property.

Fix-and-Flip Loans

You may have discovered an investment property with great potential but requiring maintenance. A fix-and-flip loan is an alternative form of investment in rental property. This real estate financing takes into account the property's after-repair value.

Rehab-and-flip loans are short-term. After completing the repairs or rehabilitation, you would sell the property and repay the loan.

Conventional loans are not intended for purchase-and-resale transactions. Due to the fact that they only consider the property's current value, you would be unable to obtain the necessary funding to finance the project. You can obtain a rehab loan from private lenders.

Financing Your Rental Properties

As you seek to expand your real estate portfolio, you should seek out lenders with rental property expertise. These lenders comprehend the cash flow and income potential that a rental property can provide as an investment.