How to Finance Your Rental Property Purchases
Last updated: 2023
One of the best things about rental properties when compared to other investment vehicles is the variety of strategies available to finance your purchases. Think about it – the article “How to Fund Your Stock Investments” would be very short: “Pay cash.” End of article.
But with rental properties, there is an array of funding options available beyond paying cash. And as I’ve written about before, the use of leverage can be rocket fuel for your returns, and can even — somewhat counterintuitively — INCREASE your cash on cash returns. I like to call that, with some satisfaction at my alliterative cleverness, the “Magic of Mortgages.”
It’s clear, then, how important financing is to success in real estate investing. Your financing strategy can make a good investment into a great one – or into a bust.
There may be 50 ways to leave your lover, but in this article, I will review 8 ways to fund your rental property purchases:
Cash
Conventional Mortgage (“Golden Tickets”)
Non-conforming Rental Mortgage
FHA Loan
Hard Money Loan
Private Loan
Rental Portfolio Loan (aka Blanket Loan)
Seller Financing (aka Owner Financing)
Here’s a quick summary of the full discussion, in my trademarked one-pager format (yeah, okay, it’s not really trademarked, but it’s still pretty handy-dandy):
(Curious what the golden ticket and balloon icons mean? We’ll get to that later…)
For each funding strategy, I’ll describe the pros and cons, how you can find and qualify for them, and the types of investing for which they’re most commonly used. At the end, you should have a full view of your financing options, and be able to determine which is best for you given your goals, risk tolerance, and current situation. I’ll also close with a discussion of how I have financed my portfolio, and why.
Quick note before we get started: I’ll be ignoring commercial loans in this discussion, which are used to finance large multifamily properties (5 or more units). Those properties, and that kind of financing, is not the focus of my investing, nor of this blog. Any of the financing options discussed here can work for single-family rental properties, or for small multi-family properties (2-4 units).
One other clarification: this post is NOT about ways to generate cash to invest, or how to save for a down payment. Your investable cash might come from any number of sources: savings (aka making more than you spend); a bonus; a side hustle; liquidating stocks & bonds; selling your primary residence or tapping into its equity through a cash-out refi or HELOC; an inheritance; and so on.
Wherever your cash comes from, this article IS about how you take that cash and buy properties with it – particularly about the various ways you can stretch that money by using mortgages or other loans to finance your purchases.
Let’s get into it!
1 Cash
Overview: Obviously, the simplest and quickest way to buy a property is with cold, hard cash. It takes banks and lenders out of the equation, and therefore simplifies the transaction significantly. Sellers also tend to prefer cash offers over financed offers, because there is less that can go wrong between offer and closing. But it requires a big down payment, and it means missing out on the huge long-term benefits of leverage.
PROS
Faster closing: you can move very quickly without a lender
Lower closing costs: 50-70% of closing costs are eliminated
Sellers prefer cash offers: improve your chances of an accepted offer
Lowest possible risk: no leverage means very low risk even if properties decline in value
CONS
Requires large upfront investment: 100% down payment, which can take a long time to save up
Lower returns: a single $100K property purchased in cash will create less cash flow than four $100K properties purchased with 25% down payments (more on that math in this article)
How it’s used: Cash offers are most common with Buy & Hold investors, and also with BRRRR investors. (For the uninitiated, BRRRR stands for Buy, Rehab, Rent, Refinance, & Repeat. Many BRRRR investors will use cash for the initial purchase, and then refinance into a long-term mortgage (either conventional or nonconforming) after they have fixed up the property and rented it out.)
Keep in mind: BRRRR investors plan to “refi out” of their deals, but even long-term buy & hold investors may purchase in cash, and then decide at a later time to do a cash-out refinance in order to tap into the equity in the home. So even if you buy in cash, using leverage later on is an option that’s always open.
2 Conventional Mortgage (“Golden Tickets”)
Overview: A conventional mortgage is the loan product you know and love. It’s also the best option for new investors who can qualify. In fact, they’re so good for rental property investing that they’re frequently referred to as “golden tickets”. You definitely want to use all your golden tickets before you consider other financing options!
Conventional mortgages for rental properties are widely available from almost all banks and lending institutions. With these loans, you’ll have to meet certain qualification criteria, including a minimum credit score, and provide voluminous paperwork to verify your assets, debts, and income.
PROS
Favorable terms: lowest available rates, reasonable fees, and friendly terms
Widely available: get it at any bank or lending institution, including credit unions
Low Risk: 30-year fixed rate option locks in your costs for the long term
CONS
Tough to qualify: you need good credit & reliable income
Lots of paperwork: the process can be a pain (but it’s worth it)
Down Payment: Mortgages on investment properties will usually require a minimum of 20% down payment. A larger down payment (25%+) may get you a better interest rate.
Interest Rates: Conventional mortgages have the lowest rates of any financing option. Rates will typically be ~1 percentage point higher than the prevailing rate — so if you could get a primary residence loan at 5%, expect to pay ~6% on a rental property loan.
Typical Terms: The 30-year fixed rate is the most common mortgage, and is also great for monthly cash flow and long-term returns. You can also get 20-year or 15-year fixed rate mortgages, which will allow you to pay off the principal faster, but higher monthly payments will significantly reduce your cash flow. Finally, 5/1 and 7/1 ARMs (adjustable rate mortgages) are available, but these carry the risk that your interest rate, and therefore your monthly payment, could increase after the 5-year or 7-year fixed period elapses.
How to find: Locate an agent at any national, regional, or local bank. Smaller banks are sometimes more friendly to investors. Credit unions are also an option. You can also engage a mortgage broker, who typically works with dozens of lenders, to get you numerous quotes, or shop rates yourself across lenders using online aggregators like Bankrate..
How it’s used: Conventional mortgages are extremely popular with Buy & Hold investors. BRRRR investors also use them for the “Refinance” part of their process.
Keep in mind: You can’t finance rental properties indefinitely using conventional mortgages, because banks will only give you up to 10 loans. (This limit is part of the Fannie/Freddie guidelines that banks adhere to so that they can re-sell the loans after they make them.) But if you’re married, you and your spouse can EACH get 10 loans if you can both qualify individually.
Also keep in mind that forming an LLC for your rental properties makes access to conventional mortgages MUCH more difficult. Read more on that topic in this article.
Free Rental Property Analyzer
Quick aside: an Excel rental property calculator is the best way to compare your potential returns with different kinds of financing. For example, you might want to see:
How much do your cash-on-cash returns improve if you use a mortgage vs. paying in cash?
How does your loan interest rate impact your monthly cash flow?
Should you get a 30-year or a 20-year mortgage?
Those questions can be easily answered with side-by-side comparisons in the RIA Property Analyzer. I guarantee this is the best free rental property calculator out there today, and many of my readers have told me the same. It’s both powerful and very simple and intuitive to use. Check it out!
3 Non-conforming Rental Mortgage
Overview: A non-conforming loan is one that does not “conform” to the Fannie/Freddie guidelines. As a result, it can be easier to qualify for these loans than a conventional mortgage. It also means that the lender typically does not re-sell the loan after initiating it – instead, they keep it on their own books.
A note on terminology: non-conforming loans are also commonly called “rental property loans” or “DSCR loans” — these terms are all basically interchangeable, and describe the same kind of loan product. (Confusingly, this type of loan is also sometimes called a “portfolio loan”, because the lender keeps the loan on their books as part of their portfolio. However, the term “portfolio loan” is also used to describe blanket loans covering multiple properties in an OWNER’s portfolio, which is completely different. Those kind of portfolio loans — aka blanket loans — are discussed in #7 below.)
Though it can be easier to qualify, these nonconforming loans are not as widely available, and they come with higher interest rates and fees. But they’re essentially the only other option for 30-year fixed rate mortgages after you’ve exhausted your conventional mortgages.
PROS
Easier to qualify: less stringent requirements and less paperwork than conventional loans
Low Risk: 30-year fixed rate option locks in your costs for the long term
CONS
Less widely available: not all banks offer non-conforming loans
Higher rates & fees: you’ll pay more for these loans in the form of higher interest rates and higher closing costs
Down Payment: The same as conventional mortgages — a minimum of 20% down payment is usually required, and a larger down payment (25%+) can sometimes get you a better interest rate.
Interest Rates: Expect to pay at least 1-2 percentage points higher than the prevailing rate, and sometimes more.
Typical Terms: Again, the same as conventional mortgages — fixed-rate loans (30, 20, and 15-year) are commonly available, as are adjustable-rate loans (5/1 and 7/1).
How to find: Only certain lenders make these nonconforming loans, so they’re much less widely available than conventional mortgages – but you can still find them. Specialty lenders like Angel Oak are well-known for making these loans, as are online lenders like Kiavi. A Google search for “non-conforming loans” or “rental property loans” should should turn up plenty of options.
How it’s used: Like conventional mortgages, nonconforming loans are popular with Buy & Hold investors and BRRRR investors (for the “Refinance” part of their process.)
Keep in mind: In addition to higher interest rates and fees, the terms on these loans are usually less favorable – for example, they often have a pre-payment penalty. Nonetheless, nonconforming loans are the next best option for long-term, low risk investors who don’t have access to conventional mortgages, either because they can’t qualify or because they’ve exhausted their “golden tickets”.
4 FHA Loan
Overview: An FHA (Federal Housing Authority) loan is a mortgage that is insured by the FHA. It’s a program designed to help lower- and middle-income buyers purchase homes – so they require a lower minimum down payment and lower credit scores than conventional loans. In fact, FHA loans are famous for one specific number: 3.5%. That’s the minimum down payment on an FHA loan for borrowers with good credit (580 or higher).
Though it can be easier to qualify, and though the 3.5% down payment is tempting, FHA loans come with two important constraints. First, you must live in the property. And second, you can only hold one FHA loan at a time. These constraints mean that the FHA loan is only useful for investors in a narrow set of circumstances, which I’ll discuss below.
PROS
Easier to qualify: less stringent income and credit requirements
Small down payment: as little as 3.5% for borrowers with good credit
CONS
Owner-occupants only: you must live in the property
Can’t scale: you can only hold one FHA loan at a time
Insurance: you must pay a mortgage insurance premium (MIP), both upfront and over the life of the loan
Down Payment: As low as 3.5%, ranging up to 10%, depending on your credit.
Interest Rates: FHA loans have very favorable rates – sometimes even better than conventional mortgages.
Typical Terms: The same as conventional mortgages — fixed-rate loans (30, 20, and 15-year) are commonly available, as are adjustable-rate loans (5/1 and 7/1).
How to find: Nearly all banks and lenders who offer conventional loans are approved to make FHA loans as well.
How it’s used: Because FHA loans require that you live in the property, and limit you to one loan at a time, they’re used by investors only in very specific situations. The two most common are:
“House hacking”, wherein an investor will purchase a small multi-unit property (i.e. a duplex, triplex, or quad), live in one unit, and rent out the other units.
A “live-in flip”, where an investor will buy a home, fix it up while living in it, and then sell it.
Keep in mind: While an FHA loan has some very noticeable advantages, it has very narrow usefulness for most buy & hold investors, and it doesn’t help at all for scaling a portfolio.
5 Hard Money Loan
Overview: We’re now moving from more traditional and widely available mortgage products into the realm of “creative financing”. In general, these remaining options are more difficult to find, more expensive, and come with greater risks. Let’s start with hard money loans.
A hard money loan is a specific type of asset-based financing – meaning that the loan is secured by the asset itself (the home), not by the borrower. The lender is therefore much less concerned about your income or credit; rather, they’re concerned about the financials of the deal itself, so there is much less paperwork, usually no credit check, and the loan can close very quickly.
However, the most important thing to know about hard money loans is that they are very short-term, typically 6-18 months. At the end of that loan term, you have to pay back the full loan balance, or the lender can seize the house. As a result, these instruments are typically used by house flippers or developers to get their projects off the ground, and are quickly repaid after the property is sold. (That’s why these loans are also widely known as “bridge loans”, because they serve as a bridge to longer-term financing.)
PROS
Quick close: get your money fast, sometimes within a week
Asset-based: usually no credit requirement, and very little paperwork
CONS
Short-term: typically 6-18 months, so not good for buy & hold investors
Expensive: both interest rates and fees are very high
Down Payment: Usually at least 10%.
Interest Rates: Rates will vary widely with hard money lenders, but they’re very high – expect 8-15% or more.
Typical Terms: Hard money loans are short-term – the lenders want their money back fast, with interest, so that they can issue more loans. Therefore, after the loan term, there will be a “balloon” payment due, which means you have to pay back the remaining balance of the loan in full.
How to find: Hard money lenders tend to be individuals or private companies, not banks. There are a growing number or online lenders (i.e. Kiavi) who issue hard money loans; you can also find them in online networking groups for real estate investors (such as those on Facebook or BiggerPockets.)
How it’s used: Hard money loans are used by house flippers to fund their purchases, and are then paid off after the home is rehabbed and sold. They’re also used by BRRRR investors to fund their initial purchases, and are paid off when they refinance into a longer-term loan (either conventional or nonconforming).
Keep in mind: These loans are designed for property rehabs; so if you’re an investor who is looking for passive income from turnkey or rent-ready properties, hard money isn’t the best option. If you do opt for hard money loans, you MUST be sure you have a way to refinance into a longer-term loan – without this, you might not be able to make the balloon payment when it comes due.
BEWARE THE BALLOON!
Allow me a brief aside about balloon payments. As mentioned above, a balloon payment is when the lender requires the full loan balance to be repaid after a certain amount of time. This doesn’t happen with typical mortgages, which allow you to pay off the loan gradually and evenly over time. But with many “creative” financing options, a balloon payment will come due: for hard money loans, it’s after just 6-18 months; for other options discussed below, it might be after 5 years, 7 years, or 10 years.
Either way, balloon payments carry significant risks. If you don’t have cash to make the balloon payment, you’ll need access to another form of financing, such as a conventional or nonconforming loan. There are two big risks to consider:
The risk that you won’t be able to get those other loans later on when you need them, which means you would default on the original loan and lose the property.
The risk that interest rates may be much higher at that future time, which could reduce or eliminate your expected returns on the property.
For these reasons, loans with balloon payments are not part of my investment strategy. I want cash flow for the long term, and I don’t want that kind of risk hanging over my investments. However, other investors are much more aggressive with their use of leverage.
If you do want to use loans with balloon payments, you should proceed with caution and with a clear understanding of the risks. (And yes — this is why I put a scary red balloon icon in my one-pager graphic next to the funding options that typically have balloon payments!)
6 Private Loan
Overview: A private loan is just what it sounds like: it’s a loan you get from another private individual. It could be someone you know, like a friend or family member, or it could be an investor who is looking to deploy capital and earn interest. Either way, it’s a loan issued based on that individual’s trust in your ability to pay it back.
Private lending is extremely flexible, because all of the terms are up for negotiation between the parties, including interest rates, re-payment schedules, length of the loan, and so on.
PROS
Personal negotiation: everything is up for discussion
Trusted partner: it’s simpler to deal with one person rather than a bank or institution
CONS
Usually expensive: private lenders generally want strong returns (high interest rates), and guarantees of re-payment
Risk to relationships: if the deal goes bad, you could ruin a friendship
How to find: Usually, you would find a private lender within your personal network. Some private lenders also publicize on online networking groups.
Keep in mind: While you may have access to funds from people you know, proceed with caution. Doing business with friends and family does not always end well. Be sure to document your agreement in writing, with the help of a lawyer, in case you need to resolve disputes in the future.
7 Rental Portfolio Loan (aka “Blanket Loan”)
Overview: Some lenders will give you one loan to cover multiple properties. (I call this a portfolio loan, but others call it a blanket loan.) This can be useful to scale up a portfolio quickly, or to free up “golden ticket” slots by consolidating a number of existing conventional mortgages into a new blanket loan.
PROS
Scale up fast: one loan for multiple properties
Reclaim golden tickets: open up slots for more conventional mortgages
CONS
Expensive: both rates and fees will be higher than conventional mortgages
Beware the balloon: these loans usually have balloon payments, i.e. after 5 or 10 years
Down Payment: At least 25%. In the case where you’re converting existing properties & mortgages to a portfolio loan, the loan can be a maximum of 75% of the current value of the properties – aka 75% LTV (loan to value).
Interest Rates: Not as low as conventional mortgages.
Typical Terms: Normally, these loans are available with long-term (i.e. 30-year) amortizations, but with balloon payments due after 5 or 10 years. This means that your payments over the first 5 or 10 years will look just like a 30-year fixed mortgage, with the same amount of principal and interest paid, but the full balance of the loan has to be repaid after the 5 or 10 years expires. Some blanket loans also have adjustable rates after a set number of years.
How to find: This is a highly specialized type of loan, servicing a narrow market of real estate investors with large portfolios. Specialty lenders like CoreVest offer these products. Search for other options online.
How it’s used: These loans are common among investors with large portfolios. They can be used to finance multiple purchases over a short timespan, or used to consolidate and pay off a number of existing loans.
Keep in mind: Be sure to run the numbers if you’re considering a blanket loan to understand how much it will impact your overall cash flow vs. individual conventional financing. Also, note that you’ll need an LLC for this type of loan. Finally, the balloon payments here are a real risk; lenders will tell you “well, you’ll just fe-finance before the balloon comes due”, but having access to a re-finance in the future is not a guarantee, as discussed above.
8 Seller Financing (aka Owner Financing)
Overview: Seller financing (also referred to as owner financing) is a setup whereby the seller of the property serves as the bank/lender, and offers loan terms to the buyer. So instead of applying for a conventional mortgage with a bank, you would sign a mortgage agreement directly with the seller.
Obviously, terms of these arrangements are negotiable, but a typical seller financing deal would include a down payment, monthly payments with a 30-year amortization schedule, and a balloon payment due in a short period of time, usually 2-5 years. The seller is a person, not a bank – they don’t want to wait around 30 years to be paid. The theory is that in a few years, the buyer’s financial situation will have improved enough to allow them to get more traditional financing and pay off the seller’s mortgage. So here again, as a borrower you are subject to the future risk of a balloon payment, as discussed earlier.
This arrangement works best if the seller owns the property free and clear (without a mortgage). And most sellers are not willing to offer direct financing in any case. Therefore, finding a property that you can purchase with seller financing can be difficult.
A “lease option” is another type of seller financing. In this arrangement, the seller leases the property to the buyer for a period of time, like a regular rental, after which the buyer has the option to purchase the property at agreed-upon terms (usually including the purchase price). There are a number of variations on this type of arrangement.
Seller financing is a big topic; there are endless flavors of these agreements between sellers and buyers. The topic deserves its own article – and many folks have already written such articles. I encourage you to search them out online if you’re interested in seller financing, so that you can dive deeper into the topic.
PROS
Easier to qualify: all terms are negotiable with the seller
Potentially lower down payment: some sellers will be open to 10% or even lower
CONS
Hard to find: there are few sellers willing to do seller financing
Beware the balloon: these loans will have balloon payments, usually after just 2-5 years
Down Payment: Typically 10-20%.
Interest Rates: Negotiable, but usually higher than prevailing mortgage rates.
Typical Terms: A typical arrangement would include a down payment, monthly payment with a 30-year amortization, and a balloon payment due after 2-5 years.
How to find: Some real estate listings will indicate that the seller is open to this kind of financing. Otherwise, work with a local real estate agent who can help you locate potential seller-financed deals.
How it’s used: Because these tend to be shorter-term loans, they’re commonly used by Buy & Hold investors who expect to be able to convert to more traditional financing at a later time.
Keep in mind: While seller financing can seem attractive because you avoid the hassle of banks, you’ll normally pay a higher interest rate, and you’ll still need to secure other financing once the loan term expires after a few years.
How I Financed My Rental Portfolio
My 25-property portfolio was primarily financed with conventional mortgages. It can’t be stressed enough: this is by far the best way for new investors to fund their purchases. It pays to maximize your golden tickets! In my case, both my spouse and I could both qualify for mortgages, so we have 20 conventional mortgages between us.
After my “golden tickets” were exhausted, I’ve had to move to nonconforming loans. For example, when I acquired Memphis House #17, I used Kiavi to provide me a 30-year fixed rate nonconforming loan. This will be the type of loan I use as I continue to build my portfolio, because it provides an essentially unlimited means to scale my portfolio with 30-year fixed rate loans.
Also, I did purchase a few properties in cash. At the beginning of my journey, I hadn’t yet realized how powerful mortgages could be – that’s why I bought My First Memphis House in cash. Later on, I bought a few more in cash because they were so cheap that the mortgages fell below my lender’s minimum loan of $50K.
At a certain point in my growth, I spent a good deal of time investigating portfolio loans (blanket loans), that would allow me to consolidate all my existing mortgages into a new loan, and open up new slots for conventional mortgages. However, the numbers just didn’t work — the interest rates on the portfolio loans were higher, thus reducing my overall monthly cash flow. Plus, I would have had to form an LLC (which I didn’t otherwise want to do), and I had no good solution for when the balloon payment came due. For these reasons, I ultimately decided against a portfolio loan.
Conclusion
Leveraging debt is a key part of a successful rental property investing strategy. Real estate is the only asset class where you have the opportunity to leverage “other people’s money” so easily and cheaply. But wise investors are strategic with their leverage, and avoid taking on too much risk.
Here are your key takeaways:
Cash is great, but you give up the MANY benefits of mortgages when you buy in cash.
Conventional mortgages are your golden tickets. You get 10 (or potentially 20 with your spouse.) Use them first!
After conventional mortgages, nonconforming loans are the next best option for low-risk, long-term financing of your rental properties.
Other types of “creative financing” can be powerful, but they come with higher costs and greater long-term risk, especially those that have balloon payments.
And here’s that one-pager graphic summary one more time:
About the Author
Hi, I’m Eric! I used cash-flowing rental properties to leave my corporate career at age 39. I started Rental Income Advisors in 2020 to help other people achieve their own goals through real estate investing.
My blog focuses on learning & education for new investors, and I make numerous tools & resources available for free, including my industry-leading Rental Property Analyzer.
I also now serve as a coach to dozens of private clients starting their own journeys investing in rental properties, and have helped my clients buy millions of dollars (and counting) in real estate. To chat with me about coaching, schedule a free initial consultation.
