COMMERCIAL LOAN GUIDE
A Guide to Fund Your Investment Property
Having an investment property (or several of them) can be an excellent way to create real wealth. This type of real estate asset allows you to build equity each month while enjoying market appreciation potential, and of course, a reliable cash flow from rental income.
Many people have successfully achieved financial independence with investment properties—and there’s no reason you can’t do the same.
However, unless you have saved up enough cash to buy a property outright, you’re probably going to need commercial investment property loans to fund your project. These loans can be used to purchase a property or refinance an already existing investment and develop new oak constructions, raw land, or spec buildings.
Getting the best terms and rates is essential if you want your investment to be profitable.
Residential vs. Commercial Investment Property Loans
Investment property loans can be categorized into two general types: residential and commercial. Lenders have two sets of significantly different qualifying standards for each style. It’s essential to understand the differences before you start your search for hard money loans for investment property.
Let’s discuss both types of real estate investment funding in greater detail:
Financing for residential investment properties
Residential investment loans are designed for real estate assets that provide housing and have four units or less. They can use them on anything from single-family homes to duplexes to four-door apartments.
Investment property loans for residential real estate are very similar to typical home mortgages, with similar application and approval processes as well as qualifying standards, including the following:
Credit score –The minimum credit score requirement varies depending on the lender, but most of them require a minimum of 700 to approve your application. This score tells lenders how well you manage your money and handle credit.
Debt to income ratio:
Lenders use this ratio (commonly called DTI ratio) to assess your ability to pay your debts based on the amount of income you make in a month.
Let’s illustrate this with an example. Say you make $6,000 every month and have $2,000 in monthly debts reflected on your credit report. This means that your DTI ratio is 33.33%.
Most lenders prefer this ratio to be lower than 36%, and ideally, the percentage of that debt that goes towards paying rent or servicing a mortgage should be less than 28%.
The maximum debt to income ratio varies depending on the lender, but as a general guideline, the highest allowed percentage is around 43%. It will be hard to qualify for an investment property loan if your DTI is higher than that.
Loan to value ratio – This ratio shows lenders how much risk they are taking on a deal based on the amount of equity they have if they ever need to foreclose the property. This number compares the total fair market value of the real estate asset to the total loan amount.
Around 70% to 80% is the average loan to value lenders allow these days. But at the height real estate bubble of 2008, many lenders allowed borrowers to get loans of up to 125% of the property’s value.
Experience being a landlord – Not all lenders require previous landlord experience. Still, it certainly won’t hurt your application to show that you have successfully managed and made money from investment properties before.
It’s also essential that you declare your landlord experience if you are trying to obtain multiple loans for different investment properties. Why? Because getting multiple loans can make your debt-to-income ratio climb fast, even if your tenants essentially pay for that debt. By making it clear that you are a current landlord, your lender may add the income you get from rent to your regular monthly payment to lower your DTI ratio.
However, most banks will only do this if you’ve been a landlord for at least two years. And they won’t apply the entire rental income—usually just 70% to 80%—to decrease their risk.
Also Read: Frequently Asked Questions for Commercial Real Estate Investment
Funding for commercial investment properties
Commercial property investment loans are designed for non-residential real estate assets and larger housing with at least five units.
These loans can be used to purchase or refinance commercial property, including apartment buildings with more than five units, office complexes, shopping malls, storage facilities, industrial facilities, hospitals, hotels, retail spaces, restaurant spaces, and other kinds of commercial real estate investments.
The rates on commercial property investment loans are higher than the rates on residential loans. The lengths are shorter, too, with balloon payments needed after five to seven years.
Commercial investment property loans are different from residential investment loans in many ways. As a borrower, you will be evaluated by the same standards as home loans but from a different angle. Let’s take a closer look at how your application will be assessed:
- Credit score – Commercial lenders, look at a borrower’s credit score because it shows their ability to handle credit and money. Most conventional lenders like banks want to see a score of at least 720.
- Debt to income ratio – Debt and income is no doubt essential factors for a lender to evaluate. However, in commercial property investment mortgages that deal with millions of dollars in loan amounts, a borrower’s income becomes less critical. After all, if things go awry, the job income of a typical borrower won’t be enough to cover the payments, regardless. Because of this, lenders tend to look at commercial property investment loans from a different angle. They mainly look at two factors:
- The property’s ability to provide a steady and reliable cash flow
- The experience of the investor and ability to grow the business
For commercial property lenders, these two characteristics are more important than debt to income. You, therefore, need to portray yourself as someone who knows what you’re doing.
Lenders must perceive you as a serious investor and business owner instead of a mere hobbyist. Make sure you have a solid business plan and that you can answer the questions they will likely ask. Show them that you understand the deal inside and out. Prepare for the meeting like you would prepare for a job interview.
Loan to value ratio
This number is a lot more significant for commercial investment property financing than residential financing. The bank or private lender wants to ensure substantial equity and are not overleveraged in the deal.
Most commercial lenders want to see a minimum of 70% loan to value ratio to have 30% equity should they need to resell or foreclose on the property.
Experience as a landlord – Experience is another major factor that commercial lenders consider. They want to be sure that you can manage the business and pay off the loan. While getting funding for your commercial investment property is possible, even if this is your first time doing a deal, having some landlord experience can help your application.
Debt service coverage ratio
This factor is exclusive to commercial property investments. More commonly referred to as the DSCR, this number shows the lender if a property can make a good income.
It essentially compares the payment on all debts with the property’s total income (excluding mortgage payment).
For example, a property with a net operating income of $100,000 per year and a total debt payment of $100,000 per year has a DSCR of 1. Commercial lenders ideally want to see a 1.2 DSCR at least—which means that there’s 20% cash flow profit after all expenses are paid.
Finding investment property loans
Many people are intimidated by the prospect of finding investment property loans, but the truth is that there not hard to locate. There are many products available. However, finding the right loan for you and your project may be a little more complicated.
Experts agree that the best way to find potential lenders is to ask other investors for a referral. You’d be surprised at how helpful other real estate investors can be. Many of them are willing to give you tips in a sincere manner and would be happy to recommend you to a suitable lender that they have worked with before.
And when it comes to lender types, there are many options to consider. The right lender for another borrower may not be the right for you, so it’s essential to think about your particular situation and requirements. Let’s take a look at several places you can approach to find funding for your investment property:
Banks are the most obvious choice for people who are looking for investment property loans. These conventional lenders are a popular choice for beginner real estate investors, particularly those trying to fund their first few deals.
It’s relatively easy to check and compare multiple residential investment loan products offered by different banks online to find the best loan for your requirements. But commercial investment loan information is not continuously published online. You may have to call the bank for more information.
Do note that banks tend to have strict standards because they sell their loans to Freddie Mac or Fannie Mae. They don’t exactly have the most flexible terms, but they can give you reasonable rates if you meet the requirements.
Credit unions –
Slightly more flexible than banks, credit unions are a bit easier to talk to, but they also sell their loans. Credit unions have to abide by the same regulations as banks when assessing applications and underwriting deals. Most credit unions cap investors between 4 and 10 loans because of regulatory requirements.
Portfolio lenders –
Seasoned real estate investors get more creative in sourcing financing by going to portfolio lenders. These lenders are either credit unions or banks that don’t sell their loans to Freddie Mac or Fannie Mae—they originate mortgages and hold them in their portfolios instead of selling them off to the secondary market.
This strategy allows them to be a bit more creative when it comes to their lending abilities. The money they use is their own, so they can invest it in catering to customized requirements by different real estate investors.
Hard money lenders & private lenders –
Hard money lenders are professional private lenders who provide short-term loans. They are more concerned with their equity in the deal and not so much on the borrower’s financial situation.
Many successful commercial property flippers use commercial hard money loans to buy investment properties that are in bad shape, remodel them, and quickly resell them for a profit or refinance them so that they become buy-and-hold investments.
The rates on hard money loans usually include an interest rate and several points (a point of being equal to 1% of the total loan amount) paid at closing as a fee or added to the loan. Topics range from 1 to 10 depending on the deal’s strength and lender, while interest rates range from 10% to 18%.
There are hard money lenders throughout the US. Some only lend locally in their state, but the bigger ones lend nationally.
Private money lending is similar to hard money lending, but they are not the same (even though these terms are used interchangeably). Personal money loans are generally less formal; professional investor-lenders do not extend them.
Anyone with some money to invest can become a private money lender—from your mom to your cousin to your next-door neighbor or even a co-worker looking for investments that will provide higher returns.
In other words, these lenders are people you might already know. Private money deals are a lot less strict. There are no regulations regarding the points you have to pay, though they typically end up being slightly less than the rates charged by commercial hard money lenders.
Many property investors—especially seasoned ones—routinely use private money for deals that banks decline. If you know many people with significant capital to invest in, this option is certainly worth looking at. It can help you find the funding you need quickly without the hassles of dealing with the stringent rules of banks and other conventional lenders.
Whether you choose hard money or private money, it will evaluate your application based on the strength of your project rather than your credit score or income.
In both lending situations, the lender places a lien on the investment property to protect their interests.
These types of loans usually don’t show up on your credit report. They are considered as non-recourse loans, which means that the lender can do nothing else but foreclose on the investment property if you fail to pay.
Mortgage brokers – Mortgage brokers are individuals or companies that can search through multiple loan products (sometimes in the hundreds) to find the best loan for your project and you as a borrower. They generally work on commission, so be sure to factor this in as a cost of doing business.
Many mortgage brokers are specializing in different property types and different loan types. They’re not all created equal, so it’s essential to do your due diligence to find an effective, efficient, and responsive broker. It’s best to work with someone who understands the market you move in and has helped many other investors find funding for projects that are similar to yours.
It’s no surprise that almost all of the wealthiest people in the world have investment property holdings in their portfolios. Buying real estate assets that make money is a reliable way to increase your passive income and build authentic and lasting wealth.
It’s also a good strategy for building a legacy if you’re interested in creating generational wealth that you can pass on to your children and grandchildren.
Perhaps a good 99% of the most successful property investors had to borrow money in the beginning. Unless you are swimming in liquid funds, you probably have to find an investment property loan, too.
The good news is that it’s easier than ever to search for and compare different loan products in this information age. The key to ensuring that your application is approved is to understand the process.
Try to put yourself in the shoes of the lender and think about what they want to see. Fulfil those requirements as much as you can to increase your chances of getting approved.
We hope that this blog post has given you some direction to help you start your investment journey. If you have any questions, feel free to leave a comment below. Good luck with your investment property project!
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