What types of lenders will help you finance an investment property? What’s the process of obtaining a loan?
If you don’t have the cash on hand to buy properties outright, Brandon Turner states it’s essential to understand your leverage options. In The Book on Rental Property Investing, he examines three specific lender types: conventional, portfolio, and private.
Keep reading to learn more about these types of lenders and how to get a loan.
1. Conventional Lending
Turner explains that you can acquire a conventional loan by going to a few types of lenders, such as a bank or credit union. These loans tend to be stable and trustworthy. They also provide longer terms and lower interest rates than most other options, giving you longer to pay the loan back.
However, conventional loans have strict application criteria, including minimum buyer credit scores and conditions around how much you can borrow. These criteria exist because many lenders bundle together mortgages they’ve approved and sell them to governmentally-backed organizations. These organizations want to reduce their risk and ensure the loans they buy are paid back—therefore, they require the lenders to set strict lending criteria.
(Shortform note: Conventional lenders often have stringent lending criteria for rental property investment loans specifically—usually more than on loans for residential purchases. This is due to the very fact that the borrower will be renting out the property rather than living there. To the lender, this raises the fear that, should the investment not pan out, there’s less incentive for the borrower to follow through with the terms of the loan than if the property were their actual home.)
2. Portfolio Lenders
According to Turner, portfolio lenders can be the same institutions as conventional lenders, such as banks or credit unions—but not always. They curate their own loans rather than selling them on to government organizations. This means less stringent oversight of the loans, making it easier to qualify for one (as long as you have good credit). Also, you’re more likely to secure more simultaneous mortgages with a portfolio lender and their eased restrictions, allowing you to build your rental property empire.
However, loans from portfolio lenders can have shorter terms, giving you less time to pay off both the principal and interest. Further, the lenders may be harder to find—some don’t even use the term “portfolio,” so you may have to hunt them down.
3. Private Lenders
Turner points out that private lenders can offer terms freer of the restrictions conventional lenders demand. These loans are especially useful if you’re interested in purchasing a property that needs a lot of work, something that usually dissuades conventional lenders from getting on board. Armed with the private lender’s investment, you can fix up the property, refinance the mortgage with a bank later on, and pay back the initial private lender in full. The short-term quality of these loans often allows the lender to ask for a higher interest rate to make their investment worthwhile.
(Shortform note: Because, as Turner indicates, many private loans are intended for the short-term renovation of a property and lead to eventual refinancing, you’ll sometimes see these referred to as “bridge loans.” As the name suggests, they’re intended to get you from one point to another, not be an end in themselves. Current industry standards for bridge loans see most lenders fronting the entire value of the property and 90% of the renovation costs. Some experts warn that if a lender offers you the full 100% of the latter, that’s a warning sign that their professionalism may be suspect, and you should further investigate their credentials.)
Tips for Securing a Loan
Turner insists that one of the fundamentals for obtaining a loan is understanding how a lender (in other words, a banker or underwriter) thinks. Most importantly, know that despite how many denials people receive, lenders need to lend money to survive. In other words, they have to approve some loan applications. If you decrease their sense of risk, they’re more likely to approve you. Therefore, do everything you can to diminish that initial sense of risk.
(Shortform note: One way to play to lenders’ risk-averse preferences is to know their most common pain points. This often means avoiding behaviors that disrupt their process. A common “red flag behavior” lenders cite is when would-be borrowers try to apply a loan they received from family or friends to their down payment, which is usually against financial regulations. Another is making sudden changes to your financial situation in the process of seeking the loan, such as accepting a job offer or a considerable pay increase. Whenever possible, delay these activities until after closing on your new property to keep the process smooth and orderly for your lender.)
Turner adds that lenders want to know if you have enough financial stability to take on the debt. So, have proof of things like cash reserves, insurance, and your (preferably high) credit score prepared before you speak to one. Also, lenders are concerned by many of the same property characteristics you are, such as condition, type, and location. Therefore, strive to make these features look as attractive and problem-free as possible for initial inspections.
