One of the great advantages of real estate is that you can leverage other people’s money to build your own portfolio of assets. You put up a little of your own money, lenders supply the rest, and then your tenants pay off the loan.
Meanwhile, your loan payments stay fixed even as your rents rise each year. And as your property appreciates in value, real estate investors need more than one source of funding as they build their portfolio.
Instead, they should think in terms of building a “financing toolkit” — a series of options at their disposal to fund any deal that comes along. But each deal comes with its own unique twists.
7 Ways to Finance Investment Property
These include needing to settle lightning fast, needing a complete gut renovation, or requiring flexibility for the seller to stay on as tenants.
Start adding the following sources to your own personal financing toolkit as you scale up as an investor.
1. Owner-Occupied Mortgages for House Hacking
Owner-occupied mortgages offer lower interest rates, lower lender fees, and vastly lower down payments than investment property loans. The catch? You have to actually move in and live there for at least one year.
You could move into a single-family home for a year, then move out and keep the property as a rental. But it’s a slow way to build your portfolio, and you usually hit the limit of home mortgages after your fourth property (more on that shortly).
Instead, some investors use a technique called house hacking, in which they buy a duplex or other small multifamily property and move into one unit. They then rent out the other units, aiming to cover their home ownership costs with the rents.
Most homeowner loan programs allow properties with up to four units. With a VA loan, for instance, you could qualify for a 0% down payment.
And FHA loan requirements remain modest, with a minimum credit score of 580 for a 3.5% down payment. One word of caution, however, about FHA loans: they no longer allow borrowers to remove mortgage insurance, regardless of how much equity you build.
Conforming loans, in contrast, allow borrowers to remove PMI after they pay their balance below 80% of the property value. As a final thought, if you’re a first-time homebuyer, you could even qualify for a down payment grant to slash your down payment even further.
2. House Hacking Through a Kiddie Condo Loan
As a variation on the house hacking tactic outlined above, parents can use their grown children to fulfill the occupancy requirement for FHA loans. It works like this.
Known unofficially as “kiddie condo loans,” you and your grown child buy a property together, perhaps while they are in college or graduate school, or just after graduating.
They move in and bring on either housemates or rent out the attached units. You don’t have to move anywhere, but you still get the low down payment of an owner-occupied mortgage.
As an added bonus, your child can manage the property for you and learn valuable lessons about real estate investing and property management.
3. Conventional Investment Property Loans
When new real estate investors go to buy their first investment property, they typically call up the same mortgage broker that helped them buy their own home.
Which can work, at least for a little while. On the plus side, conventional loans tend to offer relatively low interest rates and reasonable lender fees.
They come with several enormous limitations, however. First, they’re slow, typically taking around a month to close. That doesn’t work when you need to move fast to appease a desperate seller.
Second, they report to the credit bureaus. While one or two mortgages can help improve your credit (assuming you pay on time every month), four or more mortgages can damage your credit score.
Finally, these lenders only allow a few mortgages to be reported on your credit before they stop lending to you. For most conventional loan programs, the limit is four mortgages reporting.
Which means conventional loans only work for the first few deals, and then you have to look elsewhere for financing.
4. Portfolio Loans
Portfolio lenders keep your loan in-house—in their own portfolio—rather than selling it off to a nationwide conglomerate like most conventional lenders do.
They include hard money lenders, online crowdfunded lenders like LendingHome, and local community banks. These lenders tend to focus less on your income and credit and more on the property, the deal, and your experience as a real estate investor.
That said, they still impose minimum credit requirements and lend a lower loan-to-value ratio (LTV) to borrowers with weaker credit.
Do some comparison shopping for investment property loans before committing, and collect as many quotes as you can.
Have equity in another property, such as your home, a vacation property, or another rental? Tap into it with a HELOC to cover your down payment.
A home equity line of credit, or HELOC, is a rotating line of credit that you can draw on as desired. Think of it like a credit card that’s backed by a lien against your property.
By tapping your HELOC for the down payment, you can potentially invest with no money down.
6. Credit Cards
I once bought and renovated an investment property using credit cards. You can either take a cash advance or use a service like Plastiq to transfer the money to a title company with no cash advance fee.
After purchasing, you can put the cost of materials for the renovation directly on your card with no cash advance fee. And many contractors nowadays accept credit cards, although some charge a convenience fee.
If you don’t have sufficient credit card limits currently, try a service like Fund & Grow to negotiate and open new business credit cards and lines for you. They can help you open between $50,000 and $250,000 in new business credit lines, depending on your credit.
7. Private Notes
At the more advanced end of the financing spectrum lie private notes. A real estate note is simply the legal document that you sign when you borrow money, so a private note is a private loan from an individual.
That could be a friend or family member, or people that you’ve established trust with over time. I’ve lent private notes to other real estate investors I know and trust and earned a strong return while collecting interest like clockwork.
As you build a track record as a real estate investor, you can increasingly dispense with corporate lenders altogether and raise money privately.
That leaves you free to negotiate your own terms, such as low (or no) fees and an interest rate that both you and your lender can live with.
Financing Investment Property: Final Thoughts
Think of the investment property loan options above as a progressive ladder. Owner-occupied house hacking mortgages are ideal for your first property, enabling you to live for free in some cases.
Investors quickly burn through their allowed conventional loans and graduate to portfolio loans. From there, many start using tricks like HELOCs and credit cards to help cover their down payments with portfolio lenders.
Eventually, many stop using portfolio lenders and start raising money privately through notes. But that doesn’t mean you can’t tap into lower levels on the ladder where appropriate.
You can score a great interest rate and LTV on a kiddie condo loan, for example, and pay lower interest than you would with a portfolio or with private lenders.
The more options you have at your disposal to fund deals, the better equipped you’ll be to close every good deal that comes your way.
Good to know: Guidelines according to Fannie Mae (November 3, 2021):
- There must be a 1-year history of receiving the rental income
- Rental income is likely to continue
- Income must be properly documented
- The rental property being financed must be a 1-4 unit investment property