How to Finance Investment Properties

Financing investment properties requires a clear understanding of your loan options and the requirements for building your multi-family unit or home. 

Whether you’re building multi-family units, homes, or townhomes, knowing how to navigate the different loan types and requirements can make the difference between a smooth construction process and costly delays.

In this guide, we’ll explore everything you need to know about financing investment properties, from understanding the loan options available to the steps involved in securing financing. By the end, you’ll have a clearer picture of how to finance your project and make informed decisions that support your investment goals.

Aligning Your Investment Strategy with Financing

Before diving into the financing options, it’s essential to align your investment strategy with the right loan type. 

Different investment strategies often require different types of funding. Let’s look at some of the most common strategies and how they impact your financing decisions:

• Long-term hold: If your goal is to own and rent out properties for many years, you’ll want to focus on loans with favorable long-term interest rates and predictable payments. Conventional loans and portfolio loans are great options for this type of investment, as they provide stability over time.
• Fix-and-flip: For investors who plan to buy properties, renovate them, and sell them quickly, short-term financing options like hard money loans are more appropriate. These loans provide fast funding but typically have higher interest rates and shorter terms.
• BRRRR (Buy, Rehab, Rent, Refinance, Repeat): This popular strategy involves purchasing a property, fixing it up, renting it out, refinancing to get your cash back, and then repeating the process. This strategy works well with DSCR loans (Debt Service Coverage Ratio loans) that are based on the property’s income rather than the investor’s personal income.

Your investment strategy will guide your financing choices, so it’s important to define your goals before choosing a loan. A loan that fits your strategy will help maximize your cash flow, minimize costs, and support long-term growth.

Financing Investment Properties: What Lenders Look For

The first step to secure funding for an investment property is the loan application. Before you begin, make sure you have all the necessary documentation handy. 

Lenders want to ensure that you’re a responsible borrower and that the project you’re financing will be profitable. Here are the key factors lenders consider when reviewing your application for financing investment properties:

• Credit Score: A strong credit score is one of the most important factors in securing a good loan. Lenders typically require a credit score of at least 680 for investment property loans, though higher scores will get you better interest rates and terms. If your credit score is lower, you may still qualify for some loans, but you’ll likely face higher costs.
• Proof of Income: Lenders need to verify that you have steady income, either through employment, business ownership, or other sources. For investors, projected rental income from the property can also be factored into your overall income. This is especially true for multi-family units, where the expected rental income from multiple units can help strengthen your loan application.
• Debt-to-Income Ratio (DTI): Your debt-to-income ratio is another crucial factor. Lenders prefer a DTI below 36%, meaning that your total monthly debt payments (including the new mortgage) should be less than 36% of your gross monthly income. The lower your DTI, the more confident lenders will be in your ability to repay the loan.
• Cash Reserves: Many lenders require borrowers to have several months of mortgage payments in reserve. This ensures that if the property experiences vacancies or unexpected expenses, you’ll still be able to make your mortgage payments. Cash reserves demonstrate to lenders that you’re financially stable and prepared for the potential risks of investing in real estate.
• Business Plan: For larger projects or more complex investments like multi-family units, lenders may request a business plan. This document outlines your investment strategy, projected rental income, expenses, and timeline for construction or renovation. It helps show lenders that you’ve thought through the financial aspects of the project and have a clear plan for profitability.
• Documentation of Assets and Liabilities: Lenders also want to see a comprehensive picture of your financial health. This includes a list of assets (such as other properties, savings, or investments) and liabilities (such as existing mortgages or debts). This documentation helps lenders assess your overall financial stability and your ability to manage the loan.

By preparing these documents ahead of time and keeping your financial health in check, you’ll improve your chances of securing favorable financing terms. A well-prepared application gives lenders confidence in your ability to repay the loan and manage the property effectively.lding cash reserves, you’ll improve your chances of securing favorable financing terms.

Types of Loans for Rental Property and Multi-Family Construction

Once you’ve prepared financially, it’s time to explore the different loan options available for financing investment properties. Each type of loan has its own benefits and requirements, and the right one for you will depend on your project and investment strategy.

Conventional Loans

Conventional loans are one of the most common options for financing investment properties. These loans are offered by traditional banks and typically require a 20-25% down payment. They are well-suited for investors looking to finance single-family homes or small multi-family units.

• Pros: Lower interest rates, stable payments, widely available.
• Cons: Requires good credit and a large down payment.

Portfolio Loans

Portfolio loans are offered by private lenders who hold the loan in their own portfolio rather than selling it on the secondary market. These loans are often more flexible than conventional loans but may come with higher interest rates. They’re a good option for investors with multiple properties or unique financial situations.

• Pros: Flexibility in terms and qualification.
• Cons: Higher interest rates, more limited availability.

FHA Loans

Government-backed FHA loans allow for lower down payments (as low as 3.5%) and have more lenient credit requirements. Though typically used by owner-occupants, FHA loans can finance multi-family properties if the owner lives in one of the units. Over time, the owner can convert the property into a full rental investment.

• Pros: Lower down payment, easier to qualify.
• Cons: Requires owner occupancy initially, limited to 4 units.

DSCR Loans (Debt Service Coverage Ratio Loans)

DSCR loans are designed for investors and base the approval decision on the property’s ability to generate income rather than the borrower’s personal income. This makes them ideal for cash flow-focused investors who are buying rental properties, including multi-family units.

• Pros: Focuses on property income, ideal for rental properties.
• Cons: May have higher interest rates or require a larger down payment.

Hard Money Loans

Hard money loans are short-term loans provided by private lenders. They are often used for fix-and-flip projects or quick purchases. These loans come with higher interest rates and shorter terms, making them best for investors who plan to sell the property quickly or refinance after renovations.

• Pros: Fast approval, flexible terms.
• Cons: High interest rates, short repayment terms.

Each loan type has its strengths and weaknesses, so it’s important to match the right loan with your investment strategy. 

Local Financing Options 

Investors in the greater Memphis area benefit from a variety of local financing options. Local lenders often have a better understanding of the regional real estate market and can offer more personalized service than national lenders. 

Here are some financing options to consider:

• Local Banks and Credit Unions: Many local banks and credit unions in greater Memphis offer competitive rates on loans for investment properties. They can provide more flexible terms and may be more willing to work with investors than larger national institutions.
• Local Investor Programs: Some local governments and organizations offer incentives for real estate investors, including lower interest rates or down payment assistance. These programs are designed to encourage investment in certain areas and can be a valuable resource for new investors. 

Alternative Financing Methods for Investors

In addition to traditional loans, there are several alternative ways to secure financing for investment properties:

• Private Investors and Partnerships: Partnering with other investors can provide additional funding for larger projects. By pooling resources, investors can take on bigger properties or build multi-family units with less personal capital. This method also spreads the risk across multiple investors.
• Crowdfunding for Real Estate: Crowdfunding platforms allow investors to raise money for real estate projects from multiple contributors. This can be a great option for larger developments, such as multi-family units, where many small investors contribute to the project’s financing.
• Builder Financing: Some builders offer in-house financing options for new construction projects. This can simplify the financing process and provide more favorable terms for investors, especially if you have a long-standing relationship with the builder.

By considering alternative financing methods, investors can diversify their funding sources and take on larger projects with more flexibility.

Navigating Legal and Regulatory Requirements in Memphis/Arlington

When you’re financing investment properties in Memphis or Arlington, it’s important to understand the local laws and regulations. These rules help keep your investment safe and avoid costly mistakes. As an investor and future landlord, you’ll need to follow several important guidelines to stay compliant with the law.

Your Legal Responsibilities as a Landlord

Owning rental properties comes with legal responsibilities. You need to make sure you’re following Tennessee laws that protect both you and your tenants. Here are a few key areas to pay attention to:

• Property Maintenance: You must keep the property in good shape and make sure it’s safe for tenants. This means fixing problems like broken plumbing or electrical issues right away.
• Rental Agreements: Always use a clear, written rental agreement. This agreement outlines the rent, due dates, and the responsibilities of both you and your tenant.

Following Local Rules and Regulations

You’ll also need to follow certain regulations when building or renting out properties in Memphis and Arlington. These rules help ensure that your property meets safety standards and legal requirements:

• Zoning and Permits: Make sure your property is in the correct zoning area for rental properties. You’ll also need to get the proper permits before starting any construction or renovations.
• Housing Codes: Your rental property must meet local safety standards, known as housing codes. These codes cover things like building materials, electrical systems, and fire safety.

Lender Requirements and Protecting Your Investment

Lenders will have their own requirements when financing investment properties. You’ll need to meet these requirements to secure the loan and protect your investment:

• Lender Requirements: Lenders may ask for proof that your property meets safety standards, has the right insurance, and is ready to be rented out. Meeting these requirements can help you get better loan terms.
• Property Insurance: Having the right insurance is not just recommended—it’s usually required by lenders. You’ll need coverage for property damage, liability, and lost rental income in case something goes wrong.

Tenant Protection and Legal Rules for Landlords

As a landlord, you also have to follow rules that protect your tenants. Understanding these rules can help you avoid legal issues and keep your tenants happy:

• Security Deposits: Tennessee law has specific rules about how much you can charge for security deposits and when you need to return them. Knowing these rules helps prevent disputes with tenants.
• Evictions: If you need to evict a tenant, you must follow the legal process. This includes giving proper notice and, if needed, getting a court order. Skipping these steps can lead to legal trouble.

Get Help from Experts

Laws and regulations can be complicated, and they may change depending on your location. It’s a good idea to work with a local real estate attorney or property manager who understands the rules. They can help you stay compliant and avoid costly mistakes.

Learn more! Tips for Budgeting Your Commercial Construction Project. 

Next Steps

Financing investment properties in the greater Memphis area requires careful planning and the right loan strategy. By understanding your loan options, preparing financially, and managing costs effectively, you can set yourself up for success in your new multi-family or home investment property build. 

When you’re ready to build or renovate your next investment property, InterVision can help. Our experienced team can guide you through the construction process, ensuring your project is completed on time and within budget. Contact us today to discuss how we can support your next real estate investment.

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