It may seem as if everything these days is owned by large corporations. We hear about massive conglomerates like PepsiCo and Unilever, which own hundreds of brands. Many small businesses have been at a disadvantage over the past few years. But you might be surprised to learn that at least one industry isn’t dominated by big business – residential investing. The most recent U.S. Census information tells us that seven in ten rental properties are owned by individuals and families, not companies.

What makes residential properties so enticing to investors? They’re resistant to depreciation and inflation, bring in recurring income, and reduce taxable net income. Multi-family housing and mixed-use properties offer investors a way to diversify their income without buying multiple properties. And, when one tenant moves out, the property still turns a profit from the remaining tenants. So, what do you need to know about making a residential property investment that works for you?

Fit Financing to Purpose

When it comes to financing your residential investments, getting an investment loan looks a bit different from getting a home mortgage. First, expect to provide a higher down payment, around 25%. Interest rates will also be higher to mitigate lender risk. Lenders see a residential investor as more likely to abandon the property than a homeowner.

On the bright side, your personal credit is less crucial when it comes to being approved for a loan. Lenders use the value of the property and its potential earnings to guide their decisions. You can typically also deduct the interest you pay on these properties from your taxes at the end of the year.

Your loan must match the intended use of the property, beyond just being a residential investment loan. Here are a few categories that need tailored financing.

Multi-family

A multi-family investment property is typically a building with four or more residential units. They can be small cottage properties or high-rise apartment complexes. These are long-term rentals, where leases are for a year or more. Multi-family properties are easier and less expensive to maintain than having several separate residential properties because you can combine yard maintenance, roof repair, and utility services.

Mixed-use

A mixed-use property has at least two units with different zoning. They are most commonly a mixture of residential and commercial but can combine other types of real estate as well. These might be buildings with shops on the ground floor and apartments above or an office complex with an attached parking structure. This type of investment offers a diverse income stream that’s more resilient than either residential or retail alone.

Short-term rental

The rise in privately-owned vacation rentals is evident in the success of platforms like Airbnb and Vrbo. Travelers can spend time in a more personal space and feel like they’re supporting the local community rather than chains. While they’re less dependable than long-term lease properties, they’re also more flexible, allowing the property owner to change prices to respond to the market.

Types of Residential Investment Loans

There are three main groups of residential investment loans: commercial, government, and short-term loans. Contained within each group are different lending sources with varying qualification criteria and loan terms. Which loan you need will depend on the type of property you’re investing in. Let’s take a closer look.

Conventional Loans

Conventional residential investment loans come from banks, credit unions, and insurance companies. They have to conform to Freddie Mac and Fannie Mae guidelines and are not backed by the federal government.

Most conventional loans require a 15% to 25% down payment from the borrower. They tend to have lower interest rates but are more difficult to qualify for than private loans. If you have a credit score of at least 740 and make a 30% down payment, the average APR for a conventional loan is 4.75%.

Conventional loans are best for investors buying their first properties, those who want to refinance an existing loan, and those who aren’t in a time crunch. To qualify, you’ll need at least six months’ cash reserves. Future income isn’t calculated into the property value.

Government Loans

Government loans come from federal agencies and are backed by federal funds. Agencies like the Small Business Administration (SBA), Federal Housing Administration (FHA), and the Department of Veterans Affairs (VA) are just a few sources.

Compared with conventional loans, government loans have lower down payments and credit score requirements. However, each agency has specific eligibility requirements that can work either for or against you. For example, if you’re an active-duty service member, a veteran, or a veteran’s family member, you can get a loan with no down payment. But you won’t qualify if you aren’t in the military.

Government-backed loans are good for investors that fit into specialized groups, those with low credit scores, and investors that have had issues getting approved by other lenders. The SBA, for example, only extends real estate loans to businesses that have been turned down before.

Short-term Loans

In contrast to conventional and government residential investment loans, short-term loans are for real estate investors who want cash now and don’t intend to need the loan for more than three years. These loans typically come from private investors and investment firms. They are categorized into “hard money” and “bridge” loans.

Borrowers will find that getting a short-term loan can be faster and easier than other types of loans. These loans will facilitate competing in a cash market but make up for it with higher interest rates. The average short-term interest rate is between 8% and 12% depending on the lender and location.

If you’re seeking to fix and flip properties, short-term loans are the way to go. You can pay off the loan as soon as the property sells or convert it to a conventional mortgage. Some loans cover the rehab as well as the purchase price to avoid having to take out separate loans.

What to Know When Seeking a Loan

Residential real estate investment comes with its own vocabulary. You should be familiar with these terms before you start hunting for a loan so that you can evaluate your chances of success.

Capitalization Rate (Cap Rate)

The capitalization rate, or cap rate, measures the potential return on the property investment. Cap rate = net operating income/property value

Debt Service Coverage Ratio (DSCR)

The DSCR shows how much cash is left after expenses have been met. DSCR = NOI/debt payments

Rent Ratio

The higher the rent ratio, the better, meaning that the property will bring in more cash flow. Rent Ratio = monthly rent/property cost

Remember, when you’re calculating the cost of a property, you need to include more than just the purchase price. Expenses will more than likely include interest payments, taxes, management fees, maintenance, HOA fees, and utilities.

How to Find a Residential Investment Loan

With all of the available loan types, qualification criteria, and funding sources, identifying the best residential investment loan can be challenging. You’ll need to examine your expenses, credit, and debt coverage, as well as organize all relevant documentation. Your outlook will change depending on the property’s location, how the market is performing, and your lender.

So, what’s the best way to navigate your residential investment loan search? After you have a basic idea of what you’re looking for (multi-family, mixed-use, owner-occupied, etc.), the easiest next step is to contact a reliable loan broker.

Contact our team today to learn more about your investment real estate funding choices. We evaluate your real estate investment goals and match you to lenders that make the most sense, helping you to bypass the risk of denials and damage to your credit caused by repeated credit pulls and incomplete applications during your financing search.

We will work with you to identify the loans for which you qualify, and help you complete a comprehensive application package. We will provide unbiased information, sound recommendations, and transparent costs and terms. Our loan brokerage is your best tool for residential investment financing.