10 Types of Rental Property Financing

Rental properties are a very popular real estate investment strategy. It gives you the opportunity to grow your earnings in both the short and long term. but, not everyone knows how to finance a rental property business.

In this article, we go over 10 investment property loans that will help you get the funding you need for your rental property financing. By the end, you'll know which ones are aligned with your goals, finances, and strategy.

Recommended: Be sure to read our guide to How to Start a Real Estate Investing Business.

Top Ways to Raise Money for a Rental Property Business

1. Traditional Mortgage Loans

If you don't qualify for a commercial or business loan for your real estate investment, a traditional mortgage would suffice. That is to say, lenders will not require you to live on the property. You also don’t have to use it for personal purposes. Moreover, borrowers who don’t have a sophisticated business structure or lengthy profit and loss records can qualify for a mortgage loan.

If you create a simple structure for your business, such as a limited liability company (LLC), traditional mortgage loans are enough to get you started. This is even more advantageous if you have a strong credit score because you can lock in a lower interest rate and other desirable loan terms.

Those who are willing to invest their time in the mortgage application process can take advantage of their personal credit and income to kick-start their real estate buy and rent project. Beforehand, you should consider creating an LLC for your business.

Click here to learn more about how you can establish an LLC, one of the easiest and simplest business structures that you can create for your real estate investment.

Need a refresher on the basics of what a mortgage is and how to apply for one? Be sure to read our What Is a Mortgage guide to learn more.

2. A Home Equity Loan or Line of Credit

Believe it or not, current homeowners can take out a loan or line of credit against their property's value. While this is a popular way to fund renovations, there aren't many restrictions on how you can use the money. In other words, you can borrow funds against your existing home's value. Next, you may use the home equity loan to finance your buy and rent real estate investment.

Example: Assume that a homeowner purchased their house for $150,000. However, they already paid down $30,000 in monthly installments and their remaining loan balance is $120,000. Meanwhile, its value went up to $180,000 in comparison to when the homeowner bought the house. Therefore, they can take out a home equity loan for $60,000. You can calculate your home equity by subtracting the remaining loan balance from its current value. In our example, they are $120,000 and $180,000, respectively.

A home equity loan or line of credit particularly suits investors who are willing to pay relatively higher interest rates (vs. a traditional mortgage) in exchange for a minimal down payment.

Home Equity Loan vs. Line of Credit

Current homeowners can take out a loan against their property in one of two forms. Here are the differences between them:

Home Equity Loan: You receive the funds in one payment. In our above example, the recipients would get the full $60,000. After that, they pay a fixed interest rate. This makes a home equity loan suitable if you're looking for a predictable and non-fluctuating interest expense, especially when rates are expected to increase in the near future.
Home Equity Line of Credit: This option would be appropriate if you don't plan on using the full amount or are unsure about how much funding you need. Just as with a credit card, the funds are available for you to use, but you only need to pay back what you spend. Investors that expect interest costs to go down will also appreciate the variable rate that comes with a home equity line of credit.

3. Friends and/or Family

Working with your friends and family on a real estate investment has many advantages. For a start, you don't need to worry about finding a trustworthy business partner.

If you are considering this option, here are the steps that you should follow:

Start by making a list of relatives, family members, and friends who may be interested in investing in a buy and rent project.
Ideally, you should target people who regularly invest their money (whether in real estate or other assets).
Another good place to start is by contacting friends/family members that have prior experience in property management and/or real estate. This gives you two benefits: Raising money and working with an experienced business partner(s).

4. Savings

Saving money in order to fund your investment is certainly doable. After all, the most common route to homeownership is by saving money to cover the down payment and closing costs. This method is particularly useful if you plan on applying for a traditional mortgage or any other loan that requires a collateral payment.

If you are considering this option, calculate how much you can set aside each month and come up with an estimated time frame. You should even contact potential lenders before you start saving. This will give you an idea of what your down payment and other closing costs are. In turn, your savings goals and timeline will be even more accurate.

5. Retirement Funds

Investors that have a sizable 401(k), IRA, and/or Roth IRA can withdraw a portion of their funds and put it towards their buy and rent investment. Since some of these accounts have complex rules, it is best to consult with your advisor before making a withdrawal.

Nonetheless, investors that surpassed their 60th birthday can withdraw from their retirement funds for any reason and without incurring any penalties or fees. If you are over the age of 60 and have enough savings to retire comfortably, you may want to consult your advisor and consider using your 401(k)/IRA for your buy and rent real estate project.

6. Private Money

Private money is a pool of funds that comes from several investors. It is very critical to formally outline what each investor's terms and obligations are. This minimizes potential future disagreements. Banks and financial firms will provide you with standardized contracts and loan terms. Yet, when it comes to other investors (such as friends, family, and acquaintances), you and your lenders are responsible for ensuring that the right paperwork and legal agreements are in place. Private money is one way to do so.

This method of raising funds is worth considering if one or more of the following situations apply to you:

You don't have a good credit score.
Your business is new and doesn't have an established revenue stream.
You don't have enough funds or assets to offer as collateral.

To minimize their risk of default (in case the borrower can't pay them back), private money investors will want to be listed as the property's main owners. This is because they are mostly concerned about the value of the property, as opposed to your credit score or finances.

Above all else, private money gives you flexibility in terms of the investment/loan terms and interest rate. You can directly negotiate with other parties based on what you believe the investment opportunity is worth. Your credit score and income will play a minimal role in determining what the financing terms are.

Getting Started With Private Money

Here are a few ways to get started raising private money funds for your real estate investment:

Initially, you should make a list of potentially interested friends, family members, and acquaintances.
You can also try to contact investors that you may not know on a personal level.
You could ask your friends/family for referrals, explore online networking websites, and attend local events (such as the local angel investors’ meeting). This approach is even more effective if you have experience in sales or the willingness to build new relationships with other investors.

7. Hard Money Loans

Private and hard money loans are both suitable for many types of buy and hold investors. Amongst them are new businesses and borrowers that don't have a strong credit score. This is because hard money lenders are mainly interested in the property's potential value appreciation, even more so than your business's track record or your personal finances.

There are, however, a couple of crucial differences:

First of all, hard money loans come from one source, which is usually a financial institution. Private money, on the other hand, is obtained from several individual investors and lenders.
Secondly, the terms of hard money loans, including the interest and down payment, are more defined.

In any case, hard money is advantageous for several reasons:

If you found a property at a great price, hard money lenders may allow you to quickly access the funds and close the deal. At times, your funding request could get approved within 48 hours.
Furthermore, hard money loans might be suitable if you don't have the cash for the down payment. Hard money lenders will accept other assets as collateral, such as a car or stock portfolio.
Above all else, if you plan on repairing a property before renting it out, hard money loans will help you pay for the cost.

Investors that expect to generate a relatively wide profit margin might find these benefits worthwhile, even if the interest rates on hard money loans are higher than with other types of funds.

How to Raise Funds via Hard Money Loans

Investors who are considering this option should examine their local market and contact hard money lenders in their area. This is important because each lender may have their own rules. For example, some banks or financial firms might only issue hard money loans for specific property types, such as apartment complexes. The available funds for repairs and rehabilitation may also vary across different hard money lenders. Therefore, you should start by making a list of financial firms and identifying the ones whose loan terms are aligned with your investment objectives.

8. Grants

Unlike a loan, grants are financial rewards that recipients don't need to pay back. Moreover, you can apply for a grant even if you have a bad credit score or your business has little-to-no financial history.

Investors who live or invest in an economically distressed area are more likely to receive grants from local, state, and federal government entities. Grants are typically awarded to businesses that create economic and housing opportunities. In other words, if your goal is to renovate a home or use your investment to help communities in need, applying for a grant might be worthwhile.

A good place to start would be by researching and contacting government agencies or nonprofits in your area (or the location you want to invest in). After that, examine what their funding requirements are and if your investment is eligible for the grant. Lastly, carefully study the type of information that you should include in your grant proposal. Each government agency and/or nonprofit will look for specific details. Some may prioritize affordable rental housing opportunities, while others might award grants to projects that create a certain number of jobs.

9. Reinvestments into the Business

This method typically works well for investors that are looking to scale-up their business as it grows. For instance, you may have a full-time job and not enough time to commit to a large buy and rent investment. Similarly, some investors prefer to start small before putting in a large amount of money. In those cases, reinvesting into your business as time goes by can reap plenty of short and long-term rewards.

If this method is suitable for you, here is what you need to do:

First of all, determine what your near and distant goals are.
After that, come up with your desired initial investment amount and calculate your anticipated future profits.
From there, you can create a practical timeline that suits your current and future objectives.

10. Commercial Loans

Commercial loans are another way to fund your buy and rent real estate investment. After all, it is a business, and lenders will treat it as such. If your goal is to start a larger scale operation by buying multiple properties, banks are willing to lend you more for a relatively low interest rate. This is more likely when your business has been profitable for several years and has its own established credit history.

You may also take advantage of these commercial loans if you plan on upscaling an existing investment. For example, some investors might want to transition from a sole proprietorship to an LLC. Others would expand their business by acquiring additional properties. Moreover, because lenders will likely ask you to partially live on the property, commercial loans are ideal if you're looking to manage your real estate investment on-site and on a full-time basis.

Learn more about what lender is best for you. Read our Best Mortgage Lenders for LLC Owners guide.

Here is how you can apply for a commercial loan:

Make a list of banks in your area that offer this type of funding.
Subsequently, you can sit down with different loan officers and compare their offers.
Above all else, you should carefully note down the details that your loan application should include. Some lenders may prioritize your past income, while others prefer applications with a strong potential for growth.

Moving Forward

As with any loan or investment proposal, you should initially identify how much money you need. Next, examine the options based on your business goals, personal finances, and professional/social network. From there, you can make a decision that best suits your needs.

After that, you can start looking at potential properties to buy and negotiating with sellers. If you want to learn more about the variety of loans available to business owners, be sure to read our Different Types of Mortgages guide.