5 Financing Options for Investment Properties

If you're looking to purchase an investment property, you'll usually look into different options for financing the purchase. Whether you don't have cash-on-hand to purchase the property outright, you're looking to take advantage of magnifying your potential return on investment or you'd like the tax advantages financing can offer, there are multiple reasons you may turn to financing for your investment property purchase. When looking into financing options for an investment property, you've got plenty of options—and plenty of factors to consider.

Pros and Cons of Paying In Cash

Buying an investment property for cash can have both potential pros and cons for an investor.

The major pro is that paying in cash will reduce the risks associated with debt financing. If the economy experiences a downturn and makes finding tenants harder, you might find it difficult to make loan payments without steady rental income, so paying in cash allows you to avoid having a hefty loan payment to worry about in a time of economic downturn or hardship.

However, there are a few cons to paying cash, primarily, that it ties up a significant amount of cash in a relatively illiquid asset. This means the cash won't be readily available if you wanted to use it to make another investment with or if you needed to use it for something else.

Paying in cash also means you'll lose one of the most significant tax advantages of owning a property—the ability to deduct interest payments as an expense of owning the property.

How to Make the Financing Process Easier

Investors can take a number of steps to make the financing process easier and smoother.

Making a sufficient down payment on a mortgage for the property will generally help investors get better financing terms than someone with a much lower down payment. A larger down payment shows that the purchaser has more skin in the game, all things being equal investors with more equity are probably more likely to do all they can to avoid losing their property by defaulting on their payments.

There are a number of loan options for investment property including:

• Investment property mortgages are similar to a conventional mortgage, but they are tailored to investment properties. Down payment requirements may vary based on a number of factors about the property including the number of units.
• Commercial residential real estate loans are typically geared towards experienced real estate investors who often own several investment properties. These loans may often be issued by alternative lenders who may be more concerned with the profitability and cash flow of your other investment properties as much as with your credit score. These loans are sometimes referred to as “hard money” loans because they are secured by the property itself and less dependent on the characteristics of the borrower.

Having a better credit score will help in both obtaining the financing the investor seeks and in getting a better interest rate and other favorable terms on the loan. This is generally the case with most types of business financing you might seek, as well as with personal mortgages or other personal loans.

If you have a relationship with a local banker, they may be more willing to do the deal than if you walk into some bank that you have never dealt with cold. In fact, if you are considering growing your portfolio of investment properties it is a good idea to cultivate a relationship with a bank and a banker at the bank.

While you will still need to pass the bank’s loan approval process and any credit reviews, as in many business relationships the personal touch can help. This applies not only to obtaining financing for your investment property, but also for other services the bank can provide to help your real estate investing business.

Additional Financing Options for Investment Properties

Beyond a conventional mortgage, there are other forms of financing you can consider for an investment property purchase.

Seller Financing

If the seller of the property is eager to sell or has had the property listed for a while, they may be willing to finance the purchase and offer favorable terms. Even though you aren’t getting financing from a bank or another type of financial institution you'll still want to go through most of the same steps that would be required if you were financing through those traditional options.

You'll want to have a lawyer involved to review any contract from the seller, as well as do a title search to ensure that you have a clean title to the property and that there are no liens on the property that could come back to cause problems later on.

Home Equity Loans

You can also use a home equity line of credit on your residence or another property you own as a way to finance your investment property. Before taking this route, it’s important to fully analyze and ensure that you won't be taking on excessive risk. Also, make sure this type of financing doesn’t leave you over-leveraged in the event of an economic downturn or an adverse financial event in your life.

Peer-to-Peer Lending

Also known as real estate crowdfunding and social lending, these platforms will lend money to real estate investors—the money is raised from a number of smaller investors in the platform. The advantage for you, if you're the investor, is that you can access funding for the investment property that might be harder to finance via a more conventional lender like a bank. In return, you can typically earn higher returns from within the platform than with more traditional fixed-income investments.

It’s important to utilize the services of a knowledgeable real estate attorney and other professional advisors through the process. Investment property can be a lucrative investment option, a key part of the ultimate profitability of an investment property is finding the best financing alternative for your situation.