Types of Real Investment Estate Loans:
A Comprehensive Guide

Real estate investing can be a lucrative venture, but securing the right financing is crucial to success. With numerous types of real estate loans available, each with its own set of advantages and disadvantages, it's essential for investors to understand their options. Whether you're a first-time investor or a seasoned professional, this comprehensive guide will help you navigate the various types of real estate loans and determine which one best suits your investment strategy.

In this article, we'll explore eight common types of real estate loans:

1. Traditional Mortgages

2. Hard Money Loans

3. FHA Loans

4. Commercial Real Estate Loans

5. Bridge Loans

6. Construction Loans

7. VA Loans for Investment Properties

8. Home Equity Loans

By understanding the features, benefits, and drawbacks of each loan type, you'll be better equipped to make informed decisions and maximize your real estate investment potential. Let's dive in and explore each type of real estate loan in detail.

Traditional Mortgages

Definition and explanation
Traditional mortgages are the most common type of real estate loan, typically issued by banks, credit unions, and other financial institutions. These loans are used to purchase residential properties and are secured by the property itself, meaning that if the borrower defaults on the loan, the lender can foreclose on the property. Traditional mortgages come in various forms, each with its own set of features and requirements.

Conventional mortgages
Conventional mortgages are not backed by a government agency and are instead issued by private lenders. These loans often have stricter qualifying requirements compared to government-backed loans, such as FHA loans. Borrowers typically need higher credit scores, lower debt-to-income ratios, and a down payment of at least 3-20% of the purchase price. Conventional mortgages can be a good option for borrowers with strong credit and financial profiles who want to avoid the
additional fees and requirements associated
with government-backed loans.

Conforming vs. non-conforming loans
Conforming loans adhere to guidelines set by Fannie Mae and Freddie Mac, two government-sponsored enterprises that purchase mortgages from lenders. These guidelines include loan limits, which are updated annually and vary by location. In 2021, the conforming loan limit for single-unit properties in most areas is $548,250. Loans that fall within these limits are easier to qualify for and often have lower interest rates.

Non-conforming loans, such as jumbo loans, exceed the conforming loan limits. These loans may have different qualifying requirements, such as higher credit scores and larger down payments, and may also have higher interest rates. Non-conforming loans can be a good option for borrowers looking to purchase higher-priced properties or those who don't meet the requirements for conforming loans.

Fixed-rate vs. adjustable-rate mortgages
Fixed-rate mortgages maintain the same interest rate throughout the life of the loan, typically 15 or 30 years. This provides borrowers with predictable monthly payments and the security of knowing that their interest rate will not change. Fixed-rate mortgages are a good choice for borrowers who plan to stay in their property for a long time and want to lock in a low interest rate.

Adjustable-rate mortgages (ARMs) have interest rates that can change periodically based on market conditions. ARMs typically start with a lower interest rate compared to fixed-rate mortgages, making them attractive to borrowers who plan to sell or refinance their property within a few years. However, ARMs can be riskier if interest rates rise significantly over time, leading to higher monthly payments. Borrowers should carefully consider their long-term plans and financial stability before opting for an ARM.

Hard Money Loans

Definition and explanation
Hard money loans are short-term, non-traditional loans typically used by real estate investors to quickly acquire and renovate properties. These loans are issued by private lenders, such as individuals or investment companies, rather than traditional financial institutions. Hard money loans are secured by the value of the property being purchased, with the lender focusing more on the property's potential than the borrower's creditworthiness.

Pros and cons of hard money loans

Pros:

1. Fast approval and funding process, often within days or weeks

2. Flexible lending criteria, with less emphasis on the borrower's credit score or income

3. Ideal for short-term projects, such as fix-and-flip investments or bridge financing

Cons:

1. Higher interest rates compared to traditional mortgages, typically ranging from 8-15%

2. Shorter loan terms, usually 6-24 months

3. Higher closing costs and fees, including origination fees and prepayment penalties

4. Larger down payment requirements, often 25-30% of the purchase price

When to consider hard money loans
Hard money loans can be a valuable tool for real estate investors in specific situations, such as:

1. Quickly acquiring a property in a competitive market

2. Financing a fix-and-flip project with a short timeline

3. Securing bridge financing while waiting for long-term funding

4. Purchasing a property that doesn't qualify for traditional financing due to its condition or intended use

However, investors should carefully consider the costs and risks associated with hard money loans and ensure they have a solid plan for repaying the loan within the given timeframe.

Finding hard money lenders
To find hard money lenders, investors can:

1. Network with local real estate investment clubs and organizations

2. Attend real estate investing seminars and conferences

3. Search online for hard money lenders in their area

4. Ask for referrals from real estate agents, attorneys, or other investors

When choosing a hard money lender, investors should compare interest rates, fees, and loan terms from multiple lenders. It's also essential to research the lender's reputation, experience, and track record to ensure a smooth and successful transaction.

This page offers practical advice on where to find hard money lenders and how to evaluate them.

FHA Loans

Definition and explanation
FHA loans are government-backed mortgages insured by the Federal Housing Administration (FHA). These loans are designed to make homeownership more accessible to borrowers with lower credit scores or limited funds for a down payment. While FHA loans are primarily used for primary residences, they can also be used for certain types of investment properties, such as multifamily homes or properties that will be owner-occupied for at least one year.

Advantages of FHA loans

1. Lower credit score requirements, with many lenders accepting scores as low as 580

2. Smaller down payment options, with as little as 3.5% down for borrowers with credit scores of 580 or higher

3. More flexible debt-to-income ratio requirements compared to conventional loans

4. Allows for gift funds to be used towards the down payment and closing costs

5. Streamlined refinancing options for existing FHA loans

Eligibility requirements
To qualify for an FHA loan, borrowers must:

1. Have a steady employment history and proof of income

2. Have a valid Social Security number and be a legal U.S. resident

3. Occupy the property as their primary residence for at least one year (for investment properties)

4. Have a credit score of at least 500 (580 for the lowest down payment option)

5. Have a debt-to-income ratio of 43% or less (some exceptions may apply)

6. Pay for mortgage insurance premiums (MIP) throughout the life of the loan, unless a 10% or greater down payment is made

FHA loan limits
FHA loan limits vary by county and are based on the median home prices in each area. As of 2021, the standard FHA loan limit for single-family homes in low-cost areas is $356,362, while the limit for high-cost areas is $822,375. For multifamily properties, the limits are higher and vary based on the number of units.

Investors should be aware that FHA loans come with certain restrictions and requirements when used for investment properties. For example, the property must be owner-occupied for at least one year, and the borrower must have a valid reason for occupying the property, such as a job relocation or a need for a larger space. Additionally, FHA loans may not be the most cost-effective option for investors due to the required mortgage insurance premiums and the longer occupancy requirement compared to other loan types.

Commercial Real Estate Loans

Definition and explanation
Commercial real estate loans are designed for investors and businesses looking to purchase, renovate, or refinance income-generating properties, such as office buildings, retail spaces, warehouses, or apartment complexes. These loans are typically issued by banks, credit unions, and other financial institutions, and they have different terms, rates, and qualifying requirements compared to residential mortgages.

Types of commercial real estate loans

1. SBA 7(a) loans
   The Small Business Administration (SBA) 7(a) loan program is designed to help small businesses acquire, expand, or renovate commercial properties. These loans are issued by SBA-approved lenders and are partially guaranteed by the government, making them less risky for lenders and more accessible for borrowers. SBA 7(a) loans can provide up to $5 million in funding, with repayment terms of up to 25 years for real estate purchases.

2. SBA 504 loans
   SBA 504 loans are specifically designed for small businesses looking to purchase or renovate fixed assets, such as commercial real estate or equipment. These loans are funded through a partnership between a Certified Development Company (CDC) and a traditional lender, with the CDC providing up to 40% of the project cost, the lender covering 50%, and the borrower contributing 10%. SBA 504 loans can provide up to $5.5 million in funding, with repayment terms of 10 or 20 years.

3. Conventional commercial mortgages
   Conventional commercial mortgages are issued by traditional lenders without government backing. These loans typically have stricter qualifying requirements, such as higher credit scores, larger down payments, and more extensive documentation of the property's income potential. Conventional commercial mortgages can offer more flexibility in loan terms and rates, but they may be more difficult to obtain for some borrowers.

   

Qualifying for a commercial real estate loan
To qualify for a commercial real estate loan, investors typically need to:

1. Have a strong credit score (usually 660 or higher)

2. Provide a down payment of 20-30% of the purchase price

3. Show proof of income and business financial statements

4. Provide a detailed business plan and financial projections for the property

5. Have a low debt-to-income ratio and a strong debt service coverage ratio (DSCR)

6. Provide collateral, such as other properties or assets, to secure the loan

Lenders will also evaluate the property's income potential, location, and condition when determining whether to approve a commercial real estate loan. Investors should be prepared to provide extensive documentation and undergo a rigorous underwriting process to secure financing for their commercial real estate investments.

Bridge Loans

Definition and explanation
Bridge loans are short-term loans that help investors "bridge" the gap between the purchase of a new property and the sale of an existing one or the securing of long-term financing. These loans are typically used by real estate investors who need quick access to funds to take advantage of time-sensitive investment opportunities or to cover the costs of renovations or repairs before refinancing into a permanent loan.

When to use bridge loans
Real estate investors may use bridge loans in situations such as:

1. Buying a new property before selling an existing one

2. Financing the purchase and renovation of a fixer-upper before refinancing into a long-term loan

3. Taking advantage of a time-sensitive investment opportunity, such as a foreclosure or auction sale

4. Covering the costs of property improvements or repairs to increase the value before selling or refinancing

Pros and cons of bridge loans

Pros:

1. Fast approval and funding process, often within days or weeks

2. Flexible underwriting criteria, with less emphasis on the borrower's credit score or income

3. Allows investors to seize time-sensitive opportunities or fund renovations without using their own cash reserves

4. Can be used to purchase non-owner-occupied investment properties

Cons:

1. Higher interest rates compared to traditional mortgages, typically ranging from 6-10%

2. Shorter loan terms, usually 6-12 months

3. Higher closing costs and fees, including origination fees and prepayment penalties

4. May require a larger down payment or more equity in the existing property

Bridge loan rates and terms
Bridge loan rates and terms can vary depending on the lender, the borrower's qualifications, and the specific deal structure. However, some common characteristics of bridge loans include:

1. Interest rates ranging from 6-10% above the prime rate

2. Loan terms of 6-12 months

3. Loan-to-value ratios (LTV) up to 80% of the property's value

4. Origination fees of 1-2% of the loan amount

5. Prepayment penalties for paying off the loan early

Investors should carefully consider the costs and risks associated with bridge loans and ensure they have a solid exit strategy, such as selling the property or refinancing into a permanent loan, before the bridge loan term expires. It's essential to work with experienced lenders and real estate professionals to structure the deal in a way that minimizes risk and maximizes the potential for success.

Construction Loans

Definition and explanation
Construction loans are short-term loans designed to finance the building or renovation of a property. These loans provide funds to cover the costs of land acquisition, materials, labor, and other construction expenses. Construction loans are typically disbursed in stages as the project progresses and are monitored closely by the lender to ensure that the work is being completed according to plan.

Types of construction loans

1. Construction-to-permanent loans
   Construction-to-permanent loans, also known as single-close loans, combine the construction financing and the long-term mortgage into a single loan. This means that the borrower only has to go through one approval process and one closing, which can save time and money. Once the construction is complete, the loan automatically converts to a permanent mortgage with a fixed or adjustable interest rate.

Advantages:

• Simplified application and closing process

• Locked-in interest rate for the permanent mortgage

• Lower closing costs compared to two separate loans

Disadvantages:

• May have higher interest rates compared to stand-alone construction loans

• Less flexibility if the borrower's financial situation changes during construction

2. Stand-alone construction loans
   Stand-alone construction loans, also known as two-close loans, are separate from the long-term mortgage. The borrower obtains a short-term loan to finance the construction and then applies for a separate permanent mortgage once the construction is complete. This allows the borrower to shop around for the best mortgage rates and terms after the construction is finished.

Advantages:

• Potentially lower interest rates during the construction phase

• More flexibility to choose a permanent mortgage lender

• Ability to make changes to the permanent mortgage based on the borrower's updated financial situation

Disadvantages:

• Two separate application and closing processes, which can be time-consuming and costly

• Interest rates for the permanent mortgage are not locked in during construction

• Risk of not qualifying for the permanent mortgage after construction is complete

Qualifying for a construction loan
To qualify for a construction loan, borrowers typically need to:

1. Have a strong credit score (usually 680 or higher)

2. Provide a down payment of 20-30% of the total project cost

3. Show proof of income and assets to cover the loan payments and other expenses

4. Have a low debt-to-income ratio and a strong debt service coverage ratio (DSCR)

5. Provide detailed plans, specifications, and a construction budget for the project

6. Work with a qualified and licensed builder or contractor

7. Obtain necessary permits and approvals for the construction

Lenders will also evaluate the borrower's experience with construction projects, the feasibility of the project, and the value of the property after completion. Borrowers should be prepared to provide extensive documentation and undergo a rigorous underwriting process to secure a construction loan for their real estate investment.

VA Loans for Investment Properties

Definition and explanation
VA loans are mortgage loans guaranteed by the U.S. Department of Veterans Affairs (VA). These loans are designed to help eligible veterans, active-duty service members, and surviving spouses purchase, build, or renovate homes with favorable terms and benefits. While VA loans are primarily intended for primary residences, they can also be used to purchase multifamily properties (up to four units) if the borrower intends to occupy one of the units as their primary residence.

Eligibility requirements
To qualify for a VA loan for an investment property, borrowers must:

1. Be an eligible veteran, active-duty service member, or surviving spouse

2. Have sufficient entitlement available for the loan amount

3. Occupy one of the units in the multifamily property as their primary residence

4. Meet the lender's credit score and income requirements (typically a minimum credit score of 620)

5. Provide proof of stable income and employment

6. Intend to use the property for long-term investment purposes, not flipping

Advantages of VA loans for investment properties

1. No down payment required (up to the conforming loan limit)

2. Competitive interest rates compared to conventional loans

3. No private mortgage insurance (PMI) requirement

4. Flexible credit and income guidelines

5. Potential for rental income to offset mortgage payments

6. Lifetime benefit, meaning eligible borrowers can use their VA loan entitlement multiple times

VA loan limits and guidelines
As of 2021, the VA loan limit for multifamily properties is the same as the conforming loan limit set by the Federal Housing Finance Agency (FHFA). For most counties, the limits are:

• Two-unit properties: $653,550

• Three-unit properties: $789,950

• Four-unit properties: $981,700

In high-cost areas, the loan limits may be higher. If a borrower wants to purchase a property that exceeds these limits, they may need to make a down payment for the difference between the loan limit and the purchase price. Read this for more info about VA loan limits.

When using a VA loan for an investment property, borrowers should be aware of the following guidelines:

1. The borrower must occupy one of the units as their primary residence

2. The property must be in move-in condition and meet the VA's minimum property requirements (MPRs)

3. The borrower must have sufficient residual income to cover the mortgage payments and other expenses

4. Rental income from the non-owner-occupied units can be used to qualify for the loan, but only if the borrower has prior experience as a landlord or property manager

While VA loans can be an attractive option for eligible borrowers looking to invest in multifamily properties, it's essential to carefully consider the responsibilities and risks associated with being a landlord and property manager. Borrowers should also work with experienced lenders and real estate professionals who understand the specific requirements and guidelines for using VA loans for investment purposes.

Home Equity Loans

Definition and explanation
Home equity loans are a type of loan that allows homeowners to borrow against the equity they have built up in their primary residence. Equity is the difference between the home's market value and the outstanding mortgage balance. Home equity loans provide a lump sum of cash that can be used for various purposes, including real estate investing.

Home equity loans vs. home equity lines of credit (HELOCs)

1. Home equity loans:

• Provide a lump sum of cash upfront

• Have fixed interest rates and fixed monthly payments

• Repayment terms typically range from 5-30 years

• Best for borrowers who need a large sum of money for a specific purpose

2. Home equity lines of credit (HELOCs):

• Provide a revolving line of credit that can be drawn upon as needed

• Have variable interest rates and flexible repayment options

• Draw periods typically last 5-10 years, followed by a repayment period of 10-20 years

• Best for borrowers who need ongoing access to funds or have unpredictable expenses

Pros and cons of using home equity for real estate investing

Pros:

1. Lower interest rates compared to other types of loans, such as personal loans or credit cards

2. Potential tax benefits, as the interest paid on home equity loans may be tax-deductible

3. Flexibility to use the funds for various real estate investing purposes, such as down payments, renovations, or cash reserves

4. Longer repayment terms, which can help keep monthly payments manageable

Cons:

1. Putting your primary residence at risk, as the home serves as collateral for the loan

2. Possible closing costs and fees associated with obtaining a home equity loan or HELOC

3. Variable interest rates on HELOCs can increase over time, leading to higher monthly payments

4. Overextending yourself financially, which can be particularly risky if property values decline or rental income is insufficient to cover the loan payments.

   

Qualifying for a home equity loan
To qualify for a home equity loan or HELOC, borrowers typically need to:

1. Have sufficient equity in their primary residence (usually at least 15-20%)

2. Have a strong credit score (usually 680 or higher)

3. Demonstrate a stable income and employment history

4. Have a low debt-to-income ratio (usually 43% or less)

5. Provide proof of homeowners insurance and up-to-date property tax payments

Lenders will also assess the borrower's overall financial situation and the purpose of the loan when determining whether to approve a home equity loan or HELOC for real estate investing.

Before using home equity to finance real estate investments, borrowers should carefully consider the risks and potential consequences of putting their primary residence on the line. It's essential to have a solid investment strategy, a clear understanding of the local real estate market, and a contingency plan in case of unexpected expenses or market downturns. Borrowers should also work with experienced lenders and financial advisors to determine if using home equity is the most appropriate and prudent approach for their specific real estate investing goals.

Conclusion

In this comprehensive guide, we have explored eight common types of real estate loans available to investors. These include traditional mortgages, hard money loans, FHA loans, commercial real estate loans, bridge loans, construction loans, VA loans for investment properties, and home equity loans. Each loan type has its own unique features, advantages, and disadvantages, making it essential for investors to understand their options and choose the best financing solution for their specific needs and goals.

Understanding the various types of real estate loans available to investors is an essential first step in building a profitable and sustainable real estate portfolio.

Whether you are a first-time investor or a seasoned pro, there is a loan option that can help you achieve your goals and maximize your returns.

By carefully evaluating your options, working with trusted professionals, and staying informed about market trends and opportunities, you can unlock the power of real estate investing and build a brighter financial future.