Best Financing Options for Investment Properties | InvestorKit

Conventional Mortgage Loans

Interested in venturing into property investment and financing? Before diving headfirst into the deep end, it’s important to carefully consider which loan best aligns with your long-term financial goals, especially when buying property for investment purposes. With numerous available routes for financing real estate investments, the right financing strategy will empower you to make a successful purchase and maximise returns.

In this guide, we’ll list down essential information on the best investment home loans for budding investors — so you make informed decisions, prepare for potential challenges, and build a thriving property investment portfolio.

Conventional Mortgage Loans

When determining how to finance an investment property, most people have encountered the concept of conventional mortgages, a true pillar of real estate financing. These are your atypical mortgages that aren’t backed by the government, commonly used to secure homes or residential property investments. They usually require a 20% down payment (sometimes less for primary residences), offering a degree of stability with fixed or adjustable interest rates. 

Common types of mortgages include variable rate loans, which can start off at a lower fixed rate, but vary periodically based on market fluctuations; and fixed rate loans, which maintain a consistent interest rate and monthly payment throughout the loan term. To get mortgage approval, lenders will first scrutinise your creditworthiness, income, and assets. This is to ensure that you can comfortably afford both the loan and any existing debts. While often offering lower interest rates than other options, conventional loans come with stringent qualification requirements and can have lengthy approval processes.

Pros:

• Lower Interest Rates: Generally offer more competitive interest rates compared to alternative financing options.
• Longer Repayment Terms: Provide longer repayment periods, leading to lower monthly payments.
• Stability: Those who opt for fixed-rate mortgages have predictable monthly payments, facilitating long-term financial planning.

Cons:

• Strict Qualification Requirements: Demand strong credit scores, substantial down payments (20% or more), and significant documentation, potentially becoming a significant barrier for many investors.
• Long Approval Process: The approval and underwriting process can be time-consuming, which can delay property purchases.
• Potential Rate Increases: Variable-rate mortgages can lead to higher payments if interest rates rise.

Hard Money Loans

Hard money loans are sought after by house flippers or project developers who plan to renovate or develop a property in turn for profit. Since taking out a home loan for investment property can be an extensive process, these loans are a fast-paced alternative, particularly suited for short-term projects. Unlike traditional mortgages, they aren’t funded by banks or other common financial institutions, but by private lenders instead. As such, your creditworthiness isn’t a determining factor when seeking loan approval.

In this scenario, lenders prioritise the property’s potential after-repair value (ARV), which is the estimated property value post-renovation or development. This makes these loans accessible even for borrowers with less-than-perfect credit. Funding can be secured quickly, making them ideal for time-sensitive investments. However, this speed comes at a cost — expect higher interest rates, shorter repayment terms, and possibly higher fees.

Pros:

• Speedy Funding: Offer faster access to funds compared to conventional real estate investment loans, which is crucial for time-sensitive projects like property flips.
• Focus on Property Value: Prioritise the property’s ARV, making them more accessible to borrowers who may not qualify for traditional financing.
• Flexibility: Can be a valuable option for borrowers facing credit challenges or needing to close a deal quickly.

Cons:

• High Interest Rates: Typically carry significantly higher interest rates compared to conventional loans, potentially eating into profits.
• Short Repayment Terms: Often have shorter repayment periods, increasing the pressure to repay the loan quickly.
• Higher Fees: May involve costly origination fees and closing expenses compared to other financing.

Home Equity Lines of Credit (HELOCs)

A home equity line of credit, or HELOC, is basically like a revolving credit card, but instead of borrowing against your credit score, you borrow against the value of your home. The amount of credit you can access with a HELOC depends on several factors, including your home’s equity, your credit score, and your debt-to-income (DTI) ratio. When obtained, buyers adhere to a draw period (commonly 10 years) to borrow from your credit line as needed; and subsequently, a repayment period, around 15 to 20 years, to pay back the borrowed amount plus interest.

Leveraging the equity in your primary residence can provide a powerful funding source for real estate investments, having the opportunity to unlock significant capital for down payments, renovations, and even full property purchases. While offering competitive interest rates, these options carry inherent risks. Not only do they put your primary residence at stake, but unpredictable interest rates on HELOCs can introduce uncertainty into your financial planning and introduce the risk of debt reloading.

Pros:

• Flexible Funding: Access substantial capital through your HELOC funds, which can be used to cover down payments.
• Competitive Interest Rates: Often offer lower interest rates compared to other financing options.
• Competitive Advantage: Buyers can make faster decisions and close deals quickly, especially in cash-offer situations.

Cons:

• Risk to Primary Residence: Puts your primary home at risk of foreclosure in case of default.
• Equity Limitations: The amount you can borrow is limited by the equity in your home.
• Variable Interest Rates: HELOCs often have variable interest rates, leading to fluctuating monthly payments and increased financial uncertainty.

Private Money Loans

Private money loans, sourced from individuals like friends, family, or other investors, offer a unique avenue for real estate financing. Typically, these lenders are high-net-worth individuals. Private loans can be a lifeline for borrowers with suboptimal credit, as they often have less stringent qualification requirements. They’re also usually short-term, interest-only, and boast greater flexibility compared to traditional bank loans. 

However, investors need to pay up to enjoy this flexibility. Private money loans typically carry higher interest rates and fees compared to other real estate investment loans, reflecting the increased risk assumed by the lender. To add onto that, the personal nature of these loans can introduce complexities, particularly when borrowing from friends or family, as the potential for strained relationships looms in case of default.

Pros:

• Faster Approval Process: Often have a quicker and less stringent approval process compared to traditional loans.
• Better Accessibility: Can provide financing options for individuals who may not qualify for traditional bank loans.
• Flexible Terms: Loan terms can be tailored to the specific needs of the investment, such as shorter terms, interest-only payments, or higher loan-to-value (LTV) ratios.

Cons:

• Higher Interest Rates and Fees: Typically carry significantly higher interest rates and fees compared to traditional loans.
• Increased Risk: Offer less regulatory oversight and protection compared to loans from established financial institutions.
• Potential for Strained Relationships: Borrowing from friends or family can introduce personal dynamics and complicate relationships, especially if repayment becomes an issue.

Real Estate Crowdfunding

An innovative and modern approach to financing investment property, real estate crowdfunding utilises online platforms or social media sites to raise capital from a large pool of individuals, often with smaller investment amounts. These platforms act as matchmakers, connecting projects with a diverse crowd of investors and putting your property on the map. Crowdfunding also reduces reliance on traditional bank financing, providing lower interest rates and fewer requirements.

But as with many online investment platforms, it presents several unique challenges. The risk of fraud is a top concern, demanding meticulous due diligence. Moreover, the process of running a successful crowdfunding campaign can be time-consuming, requiring significant effort to market the project and build investor relationships. Navigating the complex regulatory landscape surrounding crowdfunding can also be overwhelming, as rules may vary by jurisdiction.

Pros:

• Diverse Funding Sources: Tap into a broader pool of investors, expanding funding opportunities.
• Lower Interest Rates: May offer more competitive interest rates compared to traditional financing.
• Marketing and Publicity: Can generate significant marketing and publicity for your venture.

Cons:

• Risk of Fraud: The decentralised nature of crowdfunding increases the chances of fraud and scams.
• Time-Consuming Process: As this funding is purely voluntary, it will take time and effort to reach your target amount.
• Complex Regulations: Crowdfunding can be subjected to complex regulations and compliance requirements.

Government-Backed Loans

Government-backed loan programs offer a lifeline for many homebuyers, particularly first-time homebuyers and those with lower credit scores. These programs often feature more flexible credit guidelines and lower down payment requirements, making homeownership more accessible. However, they also come with certain limitations. Additional fees and mortgage insurance premiums are common, and these programs may have restrictions on the types of properties eligible for financing.

The Australian government offers various programs to assist first-time homebuyers. The First Home Guarantee (FHBG) allows eligible first-home buyers to purchase a property with a deposit as low as 5% by providing a government guarantee to lenders. This helps borrowers avoid paying lenders mortgage insurance (LMI). The Family Home Guarantee targets single parents with at least one dependent child, enabling them to enter the market with a 2% deposit. Finally, the Regional First Home Buyer Guarantee (RFHBG) supports first-time buyers purchasing newly constructed homes in designated regional areas.

Pros:

• Increased Accessibility: Make homeownership more accessible for first-time homebuyers and those with lower credit scores.
• Lower Down Payment Requirements: Often require lower down payments compared to conventional mortgages.
• Potentially Lower Interest Rates: May offer more competitive interest rates for qualified borrowers.

Cons:

• Additional Fees and Premiums: Involve additional fees and mortgage insurance premiums, increasing the overall cost of borrowing.
• Limited Eligibility: May have restrictions on the types of properties eligible for financing investment property and the number of units that can be purchased.
• Possible Government Intervention: Potential for increased government intervention in the housing market, which could impact investment strategies.

Conclusion

When it comes to financing investment property, It’s clear that there is a diverse range of funding options to consider, from traditional mortgages to creative solutions like crowdfunding. By carefully evaluating your financial situation and investment goals (plus seeking professional advice on property investing!), you can strategically leverage these options to achieve your real estate aspirations.
Still having trouble with your financing strategy? Speak with our expert property consultants to gain more insights into each loan option so you can make informed decisions.