How to finance your first investment property

1. Conventional Mortgage

A conventional mortgage is the most common way for first-time investors to finance an investment property. It’s similar to the mortgage you’d use to buy a primary residence, but with a few key differences.

Requirements:

Down Payment: Typically 20% to 25% of the property's purchase price. Some lenders might require a higher down payment, especially for multi-unit properties.
Credit Score: A credit score of 620 or higher is usually required, though a higher score (700+) will give you better terms and lower interest rates.
Income and Debt-to-Income (DTI) Ratio: Lenders will look at your DTI ratio (how much you owe each month compared to your income) to ensure you can handle the mortgage payments along with any other debts.

Pros:

Lower Interest Rates: Since conventional mortgages are offered by banks and other traditional lenders, you may qualify for competitive rates.
Fixed-Rate Options: Many conventional loans offer fixed interest rates, which can give you predictability in monthly payments.

Cons:

Strict Requirements: You’ll need a significant down payment and a good credit score to qualify.
Higher Risk for Lenders: Because you’re buying an investment property, the lender may consider this a higher-risk loan.

2. FHA Loan (for Multi-Unit Properties)

If you plan to purchase a multi-unit property (such as a duplex, triplex, or fourplex) and live in one of the units, you can use a FHA loan. FHA loans are typically used for primary residences but allow you to finance properties with up to four units if you intend to live in one of them.

Requirements:

Down Payment: As low as 3.5%, making it a great option for those who don’t have a large cash reserve for a down payment.
Credit Score: Typically requires a minimum 580, though some lenders may accept a score as low as 500 with a higher down payment.
Occupancy Requirement: The property must be your primary residence for at least one year.

Pros:

Low Down Payment: The low down payment requirement is ideal for first-time investors with limited funds.
Easier Qualification: FHA loans have more lenient credit score and income requirements compared to conventional loans.

Cons:

Occupancy Requirement: You must live in one of the units for at least a year, so this isn’t an option for investors looking for strictly rental properties.
Mortgage Insurance: FHA loans require mortgage insurance premiums (MIP), which will increase your monthly payment.

3. VA Loan (For Veterans and Active Military)

If you’re a veteran or currently serving in the military, you may qualify for a VA loan, which is one of the most favorable loan options available.

Requirements:

No Down Payment: VA loans typically offer 100% financing, meaning you don’t need to put any money down.
Credit Score: A credit score of 620 or higher is recommended, but not always required.
Occupancy Requirement: Similar to FHA loans, the property must be your primary residence, but you can buy a multi-unit property with up to four units and live in one.

Pros:

No Down Payment: You don’t need to worry about saving for a down payment.
No Mortgage Insurance: VA loans don’t require mortgage insurance, saving you money.
Lower Interest Rates: VA loans tend to have lower interest rates than conventional loans.

Cons:

Eligibility: Only veterans, active-duty military members, and certain spouses are eligible.
Occupancy Requirement: You need to live in the property, which may not be ideal for investors looking for strictly rental properties.

4. Hard Money Loans

If you’re purchasing a property that needs a lot of work, or you want to move quickly, hard money loans can be an option. These are short-term loans provided by private lenders, often used for fix-and-flip properties.

Requirements:

Down Payment: Typically 10% to 20% of the property’s purchase price.
Credit Score: Hard money lenders are often less concerned with your credit score and more focused on the value of the property.
Term: Hard money loans are usually short-term (6 to 12 months) and come with higher interest rates.

Pros:

Fast Approval: Hard money loans can close much quicker than traditional financing, which is ideal for competitive markets or time-sensitive deals.
Flexible Requirements: These loans are often more flexible than conventional financing, especially in terms of credit score.

Cons:

High Interest Rates: Interest rates can be as high as 10% to 15%, making them an expensive option.
Short-Term Loan: These loans are short-term and may require you to refinance or sell the property quickly.
Risk of Losing Property: Since these loans are often secured by the property itself, failure to repay could result in losing the property.

5. Portfolio Loans

A portfolio loan is a type of loan held by a bank or lender that doesn’t sell the loan on the secondary market. Since they aren’t bound by Fannie Mae or Freddie Mac guidelines, they can be more flexible.

Requirements:

Down Payment: Typically ranges from 15% to 30% of the purchase price, depending on the lender and property type.
Credit Score: Lenders may have more flexibility regarding credit score, but typically a score of 650+ is needed.
Income Verification: As with other loans, you’ll need to prove your ability to repay the loan.

Pros:

Flexibility: Lenders offering portfolio loans can provide customized loan terms.
Ideal for Unique Properties: These loans may be suitable for properties that don’t meet the strict requirements of traditional mortgages.

Cons:

Higher Interest Rates: Interest rates may be slightly higher than conventional loans.
Limited Availability: Not all lenders offer portfolio loans, and you may need to shop around.

6. Cash or Home Equity Loan

If you have significant equity in your home, you can leverage it to finance an investment property. Using a home equity loan or home equity line of credit (HELOC) gives you access to cash for a down payment.

Requirements:

Equity: You must have enough equity in your primary home, typically at least 20% to 30%.
Credit Score: Lenders typically require a credit score of 620+, but the terms will be better with a higher score.

Pros:

Lower Interest Rates: Home equity loans and HELOCs tend to have lower interest rates than other types of loans, especially compared to hard money loans.
Access to Cash: If you have significant equity, this option can give you the funds needed to make a down payment.

Cons:

Risk to Primary Residence: Using your primary home as collateral means that if you can’t repay the loan, you risk losing your home.
Not Always Ideal for New Investors: If you don’t have enough equity, this option may not be available to you.

7. Private Lenders or Investors

You may also find financing through private lenders or investors who are willing to provide the capital you need in exchange for a share of the profits, equity, or interest payments.

Requirements:

Down Payment: Typically 10% to 30%, but terms can vary based on the lender and property.
Credit Score: Private lenders may not have strict credit score requirements but will expect a solid business plan and a clear exit strategy.

Pros:

Flexible Terms: Private lenders can offer more flexible terms and quicker approvals than traditional financial institutions.
No Bank Involvement: These loans can bypass the more rigid requirements of banks and credit unions.

Cons:

Expensive: Private lenders often charge higher interest rates than traditional lenders, and may expect a piece of the property’s future profits.
Potentially Risky: If you can’t repay, you might lose control of your property or project.

Conclusion

Financing your first investment property requires careful consideration of your options. Conventional mortgages, FHA loans, and VA loans are great choices for those with good credit and a solid down payment. Hard money loans, portfolio loans, and private lenders offer more flexibility but come with higher costs and risks. Ultimately, the best financing option for you will depend on your financial situation, investment goals, and the type of property you're buying.