Rental Property Financing Options: Every Loan Type Explained

You can finance a rental you will not live in with a conventional investment loan (15% down for one unit, 25% for two to four, plus six months of payments in savings), a DSCR loan that qualifies you on the property's rent instead of your income, a bank portfolio loan, or short-term hard money for a property that needs work. If you will live in one unit of a 2- to 4-unit building, owner-occupant loans take less cash: 3.5% down with FHA, 5% with a conventional loan, and no down payment with VA for eligible veterans. Seller financing and a home equity line of credit (HELOC) on your own home can cover all or part of the price.

Conventional loans for a rental you will not live in

These loans follow the rules of Fannie Mae and Freddie Mac, which buy conventional loans from lenders. Freddie Mac caps the loan at 85% of the value on one unit and 75% on two to four units, which sets the 15% and 25% minimums.

• Credit. Fannie Mae has no minimum credit score for loans its automated underwriting system, Desktop Underwriter, approves. A lender can still set its own minimum.
• Mortgage insurance. Below 20% down, you pay private mortgage insurance (PMI), most often as a monthly premium.
• Reserves. Fannie Mae requires six months of the new loan's principal, interest, taxes, insurance, and association dues in savings after closing. If you own other financed properties besides your home, it adds 2% to 6% of those loans' balances, rising with the number of financed properties you have.
• Price. Freddie Mac charges the lender a one-time fee on every rental loan it buys: 2.125% of the loan at 25% down, 3.375% at 20% down, and 4.125% at 15% down. A credit score fee comes on top; at 25% down it is zero for a score of 780 or higher and 2.125% for a score below 640. A larger down payment and a higher score both shrink these fees, so ask each lender to show how they change the rate and the points (upfront fees, each equal to 1% of the loan) it quotes you.

Conventional loans for investment property covers income documentation and the approval process.

Loans for a 2- to 4-unit home you will live in

Living in one unit and renting out the others, a strategy called house hacking, opens up owner-occupant loans with smaller down payments.

• FHA. One borrower has to occupy the property within 60 days of closing and plan to live there for at least one year. You pay an upfront mortgage insurance premium of 1.75% of the loan plus an annual premium. On a 30-year loan of $726,200 or less, the annual rate is 0.55% for the life of the loan at 3.5% down, or 0.50% for 11 years with 10% or more down.
• FHA on 3 or 4 units. The appraiser's rent for every unit, including yours, minus the greater of the appraiser's vacancy and maintenance estimate or 25%, must at least equal the monthly principal, interest, taxes, and insurance. FHA calls this the self-sufficiency test.
• VA. Eligible veterans and service members who will live in the home can buy up to 4 units with no down payment if the price does not exceed the appraised value. There is no monthly mortgage insurance, but you may owe a one-time VA funding fee. With full entitlement, the amount VA guarantees, there is no VA loan limit. If part of your entitlement is still tied to another VA loan, the lender may require a down payment. To count rent from the other units, VA requires cash reserves that cover at least six months of principal, interest, taxes, and insurance, plus documented experience managing rentals or other collection work that shows you are likely to succeed as a landlord.
• Conventional. Freddie Mac allows 95% financing, or 5% down, on 2- to 4-unit homes you live in. In high-cost areas, a loan above the standard conforming limit (a super conforming loan) is capped at 85% for two units and 80% for three or four. Below 20% down you pay PMI, and Fannie Mae requires six months of payments in reserve.

DSCR and portfolio loans

A DSCR loan qualifies you on the debt service coverage ratio: the property's monthly rent divided by its monthly payment of principal, interest, taxes, insurance, and association dues. A house that rents for $2,400 with a $2,062 payment has a DSCR of 1.16 ($2,400 divided by $2,062).

Each DSCR lender picks its own minimum ratio, down payment, credit score, reserves, and prepayment penalty, and decides which costs go into the payment, so compare written terms from at least three lenders. DSCR loans explained covers the qualifying math.

A portfolio loan is one a bank or credit union keeps on its own books instead of selling it to Fannie Mae or Freddie Mac. The lender writes its own rules on down payment, credit, and how many properties you can own, which helps when you or the property fall outside Fannie Mae and Freddie Mac limits.

Hard money and seller financing

A hard money loan is a short-term loan from a private lender that relies mainly on the property's value. Investors use it to buy and renovate a property that will not qualify for a long-term loan in its current condition, then repay it by selling or refinancing, the sequence in the BRRRR strategy. Before you sign, get these terms in writing: the rate, the points, the term, any fee to extend it, and the draw schedule, which sets when the lender releases renovation money as work is completed. Hard money loans explains how these loans are priced.

In seller financing, the seller lends you part or all of the price under a promissory note secured by a mortgage or deed of trust on the property. You negotiate the down payment, rate, repayment schedule, and any balloon payment (a lump sum due before the loan would otherwise be paid off). Two checks protect you:

1. The seller's own mortgage. If the seller still owes on the property, read that mortgage for a due-on-sale clause, which lets the lender demand the full balance when the property is sold. Confirm the seller owns the property free and clear, or get that lender's written consent before you sign.
2. The paperwork. Have a title company or real estate attorney record the deed and the mortgage or deed of trust, and buy an owner's title insurance policy.

Using a HELOC on your home

A HELOC lets you borrow against the equity in the home you live in, meaning its value minus what you owe. Before you apply, ask the lender financing the rental whether it accepts HELOC funds for the down payment and how it will count the HELOC payment in your debt-to-income ratio (your monthly debt payments divided by your gross monthly income).

The Consumer Financial Protection Bureau lists these risks:

• HELOCs generally have a variable rate, so the payment can rise even if you borrow nothing more.
• When the draw period, the time you can borrow from the line, ends, you repay the balance over a set period, often 10 or 15 years, or all at once as a balloon payment.
• Your home secures the line, so falling behind can cost you the home, and you generally must pay the line off in full when you sell.
• The line's terms may bar you from renting out the home that secures it.

Add the HELOC payment to the rental's monthly costs and confirm the rent still covers everything before you draw on the line. For the order of steps from budget to closing, see how to buy your first rental property.