Getting Loans for Rental Property Business

SVP, National Sales Manager-Mortgage Banking

The decision to buy a rental property is often followed by two questions: how do I know which building to choose? and how do I get the necessary financing? While there has been plenty written about the former, the topic of finding the optimal loan to help you set up and scale your rental property business deserves further attention.

While we recommend partnering with a financial expert from Bank of Hope to determine the best loan option for your particular business situation, we compiled important key insights to assist in your journey. 

Loan Options for Rental Properties With 1-4 Residential Units

If you’re considering purchasing a rental property, chances are you’re familiar with the basic concept of mortgages. However, what you may not be familiar with are the key differences between getting a loan for purchasing investment properties versus your primary residence.

Conventional Mortgage Loans for Rental Properties

Conventional home mortgages are loans that originate from financial institutions like Bank of Hope. The process of obtaining a loan for a rental property business is similar to that of a personal home, but there are some differences in upfront requirements.

• Both down payment minimums and interest rates will be higher - This is because historical data shows that landlords almost always choose to prioritize paying their primary residence's mortgage over their rental properties if they have to choose. Additionally, rental properties are more likely to have ongoing expenses due to occupant turnover, property management fees, and greater need for repairs, among other factors. As a result, lenders view rental properties as higher risk compared to primary residences. Thus, a minimum down payment of at least 20% should be expected.
• Credit score requirements will be higher - As mentioned earlier, the ongoing costs of renting out a property are generally higher compared to living in it yourself. Lenders want to ensure that borrowers who obtain a rental property business loan are capable of keeping up with the mortgage and necessary expenses to prevent the property from falling into disrepair. Hence, they use credit scores as a measure of a candidate's financial management skills. Although the specific minimum credit score requirement may differ among lenders, expect to be asked for a score of at least 620.If you’re concerned, check out our article about improving your credit score.
• The acceptable debt-to-income (DTI) ratio requirements will be more stringent - Another metric that banks and lenders use to assess your readiness for the added expenses of a rental property is your debt-to-income ratio (DTI). This is calculated by examining the percentage of your income that goes towards debt, including other mortgages, car payments, and student loans. While the typical maximum DTI for a primary home's mortgage is 43%, many lenders prefer to see a DTI of 36% or less for rental property loans.

Other Considerations When Getting Conventional Loans for Your Rental Property Business

• You cannot use traditional VA or FHA loans towards rental properties unless you live within the building - Both loans grant special benefits intended to help individuals establish roots, so they require you to live within the building and limit it to no more than four units. However, it's important to note that there are nuanced exceptions to these rules for individuals who need to move from their owner-occupied rental building due to specific circumstances.
• Your insurance rate will go up when you make it into a rental property - Just because you want to take good care of your investment doesn’t mean that your tenants will have the same attitude. For this reason, insurance companies tend to see more claims for rental properties, resulting in higher fees.
• You will make less profit than you expect - Let's say you have done your due diligence and spent countless hours reading about what it's like to operate rental properties. However, despite all the upfront research, you may still face occasional surprises, and they are rarely positive. These surprises may come in the form of property tax hikes, utility expenses, emergency repairs, costs related to turnover, missed rent, or legal fees. Keeping this in mind, you should structure your loan terms to have a greater financial cushion to handle the unexpected.
• You may face a limit on how many mortgages a bank grants you - Most banking institutions hesitate to let any one individual have more than four mortgages at once (including their primary residence). However, they may be willing to make exceptions if you provide a particularly strong case based on the above-mentioned criteria.
• It’s advisable to have a substantial amount of cash set aside rather than putting it all towards your rental property loan - Resist the temptation to put the majority of your money towards the down payment in order to lower your monthly payments. Having extra money readily available can help you make necessary renovations, hire any necessary staff, weather months of no income, and address any needed repairs.

CLICK HERE TO LEARN MORE ABOUT HOME MORTGAGES FROM BANK OF HOPE

Blanket Mortgage Loans for Rental Property Businesses

As mentioned above, banking institutions typically cap individuals at four mortgages (making it hard to grow your side hustle into a business). Luckily, blanket loans may help you circumvent this issue.

Blanket loans finance the purchase of multiple properties within the same state. Let’s say you are buying three single-family homes; a blanket mortgage would mean you only have to apply once (rather than three times) and wouldn’t have to juggle three separate payment plans.

Blanket loans inherently carry greater risk for both you and the lender. In turn, the number of institutions willing to do blanket loans will be smaller than if you acquired individual loans. Additionally, the upfront requirements will be even stricter and the down payment minimum will be higher.

Important note: If you currently own multiple rental properties and are enticed by the upsides of a blanket loan, you can always refinance.

Personal Loans for Your Rental Property Business

There are attractive points to getting a personal loan in order to buy rental properties, starting with the fact that you forgo the need for a down payment and application fees are noticeably less. Additionally, there is no collateral tied to the loan, meaning that a series of missed payments won’t enable the lender to take your property away (though it will significantly impair your credit score).

However, personal loans are not without their limitations, starting with the fact that the maximum amount you can receive will be less than if it was a mortgage. You’ll also have less time to pay off the loan. Most importantly, the lack of collateral on the personal loan means that the bank is taking on more risk, which results in higher interest rates.

For these reasons, it’s fairly uncommon to use a personal loan to buy an investment property. More often, they’re helpful to other aspects of your rental business, such as financing renovations.

Scenarios In Which You Can (and Can't) Use SBA Loans Towards Rental Properties

Many rental property owners regard their efforts as a business, leading some to question whether they could qualify for loans from the Small Business Administration (SBA). Please note, in many scenarios, you cannot put SBA loans towards rental properties. However, exceptions do exist.

SBA business loans can only be put towards rental properties which are owner-occupied and used predominantly by the business itself. However, the primary source of income for the business cannot be the rental income, itself. To better illustrate, let’s look at two hypothetical scenarios:

• Potentially qualifying for SBA loans - You buy a mixed-use building with the intention of your business using 55% of the floor space and bringing in an estimated 70% of the total revenue, meaning that the spare residential units you rent out make up less than half of the designated square footage and revenue.

Not qualifying for SBA loans: You buy a mixed-use building with the intention of your business using 45% of the floor space and bringing in an estimated 80% of the total revenue. This would not be permissible by the SBA because the square footage would be primarily used as rental properties rather than dedicated to your business. You can also buy a mixed-use building with the intention of your business using 55% of the floor space and bringing in an estimated 45% of the total revenue. This would not be permissible by the SBA because the majority of projected income would come from rental units rather than the primary business.

To summarize, small business loans from the SBA are not intended to support rental properties. However, if a business focused on other revenue streams decides to leverage extra space as rental units, this wouldn’t immediately prevent them from getting an SBA loan to buy the property. To dive deeper into SBA loans, read SBA Express Loans - FAQs About Requirements and Applying.

What If You Need the Loan to Build Your Rental Properties?

For scenarios in which you require upfront financing to support building new large rental properties or undergoing major renovations, we would point you toward construction loans. However, it’s important to be aware that your lender will require highly detailed blueprints, timelines, and budget projects. Additionally, expect to be asked for a down payment exceeding 20% and for the borrowed money to be released in installments.

To learn more about whether a construction loan is a good fit for building or renovating your rental properties, visit our Commercial Lending page.

Why Work with Bank of Hope to Finance Your Rental Properties

When you choose to take the leap into investment property ownership, Bank of Hope has you covered. We work closely with our customers to determine the right financial path to achieve their personal and professional goals, providing market insights and hands-on guidance every step of the journey. What’s more, we offer other financial services every budding rental property business owner will appreciate, including:

• Business checking accounts
• Business credit cards
• Financial planning
• Treasury management

Visit a loan office near you to discuss how our financial experts can help you acquire the best-suited loan for your rental property business, as well as how we can further support your quest for financial success.