What Are Investment Real Estate Loans? A Complete Guide for Beginners

Investment real estate loans are a diverse set of tools that help both aspiring and seasoned investors build a successful property portfolio. These specialized loans serve as the backbone of funding for properties intended to generate income, usually through rental yields or resale profits. Unlike traditional home mortgages, investment real estate loans come with distinct features tailored to meet the needs of real estate investors.

At Defy Mortgage, we provide investors with a streamlined pathway to securing these loans, whether you’re a freelancer, entrepreneur, real estate investor, or self-employed individual. Our 75+ non-traditional loan options, including DSCR loans and jumbo loans, can all be fully customized to align with your financial needs, however complex they may be. We also offer foreign national loans for those who don’t have US social security or credit history. 

Drawing from our vast experience in making the lending experience as seamless and stress-free as possible, we’ve crafted this comprehensive beginner’s guide that explores investment real estate mortgages. We’ll discuss each of the major options you have as an investor and give you tips on how to maximize your chances of getting approved with ideal terms for optimal investment outcomes. 

What Are Investment Real Estate Loans?

Investment real estate loans are financing options designed to generate income through property investment. These loans cater specifically to the unique demands of acquiring or improving properties for rental or sale.

Definition and Purpose

Investment real estate loans are simply mortgages that are specifically designed to purchase properties intended to generate rental income or be sold for a profit. Unlike traditional home loans, these loans take into account the income potential of the property to determine eligibility, rates, terms, and the maximum loan amount. 

Some types of investment real estate loans, like DSCR loans, even use income potential as the chief basis for approval, with personal finances only being a secondary consideration. 

Key Characteristics

Investment real estate loans are designed with features that empower investors to achieve their financial goals:

• Flexible Approval Options: Certain investment real estate loans remove the complex barriers for investors by waiving the need for W-2 income or tax returns. These options focus more on investors’ cash flow, rather than their traditional income sources. 
• Rental Income Potential: Many options, like DSCR, allow borrowers to leverage their rental income (both generated and projected) to help qualify for the loan. This helps investors demonstrate that they have sufficient funds to cover the property, allowing them to grow their portfolio more efficiently. 
• Accessible for All Levels: With various loan types available, Investment real estate loans offer a variety of loans that are great for novice and seasoned investors, or anywhere in between. 
• Customizable terms: Most investment property financing is non-QM, enabling more flexibility in interest rates, down payments, and other loan terms. 

Who Are They For?

The diverse loan types that fall under the umbrella of investment real estate loans each offer a unique advantage to real estate investors with their own goals and strategies. Here’s a closer look at some of the ideal candidates for investment real estate loans:

• Aspiring or current landlords: Individuals looking to generate income by renting out properties can use investment real estate loans to help purchase single-family homes, vacation rentals, or even secure funding to construct apartment complexes.
• Property flippers: Investors focused on buying under-valued properties, renovating them, and reselling them for a profit will find investment mortgages such as fix-and-flip loans and construction loans invaluable to their strategies.
• Portfolio builders: Those seeking long-term stability and diversification can benefit from loans like DSCR loans, and primarily utilize their property’s income and scale their portfolio.

How Lenders Calculate a Property’s Income Potential

The methods that lenders use to estimate a property’s income potential often depend on whether the property will be put up for resale or rent – it also depends on the lender themselves. Here are some main ways of how income potential is calculated:

• Debt service coverage ratio (DSCR): DSCR is a metric that evaluates a property’s profitability by dividing its annual net operating income (NOI) by its yearly total debt service (TDS). Most lenders look for a DSCR of 1.25, although at Defy we offer DSCR loans for properties with ratios down to 0.75.
• Market comparisons: Lenders often analyze comparable rental properties in the area to estimate potential rental income.
• Current lease agreements: Properties that are already being leased can be gauged on their average income and income stability by assessing existing rental agreements and tenant payment histories.
• Projected After-Repair Value (ARV): Properties that will be resold following renovation have their income potential calculated based on the future value after the upgrades have been completed. 

Types of Investment Real Estate Loans

There are a variety of investment real estate loan types available to fit almost every possible scenario. Here are the most common ones for you to consider when planning out your investment strategy: 

DSCR Loans

Debt Service Coverage Ratio (DSCR) loans are designed for real estate investors who want to qualify based on the property’s cash flow potential rather than their personal income. DSCR is a financial metric that measures a property’s ability to cover its debt obligations through income.

DSCR loans truly stand out from the rest of the real estate loan options because they are uniquely positioned for investors looking for flexibility, speed, and income-focused financing. Key aspects of DSCR loans include:

• No personal income verification: Unlike conventional loans, DSCR loans focus on the income generated by the property itself, not the borrower’s income.
• DSCR ratio requirement: Most lenders require a DSCR of at least 1.25, meaning the property’s annual income must be 25% greater than the mortgage payments and other fixed periodic expenses over a single year.
• Faster approval: Since these loans don’t rely on verifying the borrower’s personal income, the approval process can be faster compared to traditional loans.
• Loan terms: Similar to conventional mortgages, DSCR loans usually have terms of 30 years, with both fixed-rate and adjustable-rate options available.

DSCR loans are ideal for borrowers with complex or fluctuating personal incomes who prefer to qualify based on the property’s cash flow. Investors who own multiple rental properties or plan to scale up their portfolio can also benefit from the fact that you generally can get unlimited DSCR loans, and each loan relies primarily on the income potential of the property itself rather than external factors. 

Fix and Flip Loans

Fix and flip loans are short-term loans tailored for investors who buy properties, renovate them, and quickly sell them for a profit. 

Key features of fix and flip loans:

• Short-term financing: Loan terms are typically 6 to 18 months, ideal for quick property turnovers.
• Higher loan amounts: Fix and flip loans primarily determine loan terms according to the loan-to-cost ratio (LTC) instead of the loan-to-value (LTV) ratio. LTC accounts for the purchase of the property as well as any renovations that need to be made, resulting in the lender covering more of the cost of getting the property ready for resale. 
• Standard qualification criteria: Fix and flip loans undergo a full underwriting procedure that accounts for the borrower’s financial profile as well as the property’s ARV. 
• Draw schedules: With fix and flip loans, there is an expectation that the borrower will renovate the property to raise its value, unlike with hard money loans where this is not an explicit necessity. Borrowers are often required to submit renovation plans detailing each renovation, with funding released on a per-renovation basis. 

Although fix and flip loans come with tighter underwriting standards than something like a hard money loan, this also allows them to be sold to Freddie Mac and Fannie Mae, providing the advantage of increased funding capacity for heavy renovations. This makes them ideal for real estate investors looking to buy distressed or undervalued properties, make repairs, and sell them at a higher price within a short timeframe.

Construction Loans

Similar to fix and flip loans, construction loans are a type of short-term financing designed to fund property development, with a focus on building or significant renovation of real estate properties. Unlike traditional mortgages, 

Key features of construction loans:

• Short-term: The typical period for a construction loan is 12 months, although some can go up to 18 months. 
• Transitioning to a Standard Mortgage: Depending on the lender, you may be offered an option to convert the construction loan into a standard mortgage once construction is complete.
• Interest-only period: While the construction is underway, borrowers often pay only interest, reducing financial strain while the property is being built. 
• Draw Schedules: Similar to fix-and-flip loans, construction loan funds are also typically disbursed in draws, with each draw based on the completion of specific construction milestones.

While construction loans start out as short-term loans, their ability to be converted into a permanent mortgage makes them ideal for financing a property that you intend to operate or hold long-term. By contrast, with fix and flip loans, there’s an expectation that the property will be put up on the market immediately to be sold as soon as possible. 

Conventional Loans

Conventional investment property loans are traditional mortgage options offered by banks and credit unions. Similar to conventional home loans, they are typically fixed-rate or adjustable-rate mortgages with loan terms ranging from 15 to 30 years. 

Key features of conventional loans:

• Risk-averse: To mitigate risks, lenders only consider the as-is value of a property when determining approval. If a property’s appraised value is too low, it is unlikely to be approved for a conventional loan, regardless of the outcome of any renovations. 
• Good credit required: Borrowers usually need a credit score of 680 or higher. A down payment of at least 20% is often required to offset the risk.
• Proof of financial stability required: Lenders may demand proof of a stable income, low debt-to-income (DTI) ratio, and sufficient cash reserves to cover expenses.

Conventional loans are ideal for investors who have a strong financial profile and intend to hold onto the property long-term.

Hard Money Loans

Also known as bridge loans, hard money loans are asset-based financing options provided by private lenders or investors. Similar to fix and flip loans, hard money loans place more emphasis on the asset’s income potential rather than the borrower’s financial profile. However, unlike fix and flip loans, hard money loans don’t account for the borrower’s financial profile and are not sold on the secondary market. Keep in mind that not all lenders offer hard money loan options. 

Key features include:

• Quick approval and funding: With no income verification necessary, approval can often be given within days, making hard money loans ideal for time-sensitive deals.
• Short repayment terms: Borrowers are expected to be able to offload the property onto the market within a short timeframe, so repayment terms can be as short as 6 months, although some go up to 5 years. 
• After-Repair Value (ARV): Unlike conventional loans that typically only consider as-is value, hard money loans consider the value of the property after all repairs and renovations have been done. 
• Low LTV: As a risk-mitigation measure, hard money lenders generally only allow up to 65% loan-to-value. This means that a purchase of $100,000 will only be financed up to $65,000, with the remaining $35,000 having to be covered by the borrower as the down payment.

Because of their fast-paced nature, hard money loans are commonly used by house flippers or investors looking to renovate and sell properties quickly. The lack of strict underwriting is particularly beneficial for those who want to capitalize on an opportunity as soon as possible.

However, while they are an excellent option for those needing fast cash, their higher cost can make them unsuitable for long-term investments. Additionally, their lower LTV can make them inadequate for higher loan amounts, as the borrower will have to make up a larger difference in the down payment. Hard money loan amounts typically don’t take renovation costs into account as well unless otherwise stated by the lender.

FHA Loans for Multi-Family Properties

Federal Housing Administration (FHA) loans are government-backed loans designed to make homeownership more accessible. Although they focus on helping Americans purchase their first home, savvy investors can work around FHA restrictions by purchasing a multi-family property, living in one of the units to fulfill the primary residence requirement, and renting out the remaining units to tenants. 

To use an FHA loan to purchase a multi-family property as an investment, the following requirements must be met:

• Credit score: A minimum credit score of 580 is required to qualify for the lowest down payment option. Borrowers with FICO scores between 500 and 579 may still qualify, but with less favorable rates. 
• Down payment: You can pay as little as 3.5% down if your credit score is 580 or above. Those with credit scores between 500 and 579 may need to put down up to 10%.
• Self-Sufficiency test: The property must pass the FHA’s self-sufficiency test, which ensures the projected rental income from the units will cover the mortgage payments. This is particularly important for multi-family properties with three or four units.
• Occupancy requirement: The borrower must occupy one of the units as their primary residence for at least 12 months after the closing date.

Backed by the federal government, FHA loans allow first-time investors to get started with less upfront capital while still generating rental income from the other units. However, keep in mind that the FHA places restrictions depending on the type of investment property. Co-ops, properties with more than four units, and properties that don’t fulfill the minimum property standards cannot be financed with an FHA loan.

Portfolio Loans

Portfolio loans are mortgage loans kept by the original lender rather than sold to the secondary market. This allows lenders to tailor the loan terms to the needs of borrowers with unique financial situations. However, since the loan is kept in-house, the lender assumes the entirety of the risk, making this type of loan rarer. Not all lenders offer this type of loans. 

Here’s how portfolio loans work:

• Loan retention: When a lender issues a portfolio loan, they keep it on their balance sheet (portfolio) rather than selling it to investors in the secondary mortgage market. This means the lender continues to collect the monthly payments from the borrower and assumes the risk of the loan’s performance.
• Flexibility in underwriting: Because these loans aren’t being sold, lenders can offer more customized terms. For example, borrowers who are self-employed, have complex income streams, or are purchasing non-traditional investment properties may qualify more easily for a portfolio loan than a conventional loan. Portfolio loans can also have more flexible down payment requirements or credit score standards.
• Higher risk and interest rates: Since lenders are holding onto the loan instead of selling it, they take on more risk. To offset this, interest rates on portfolio loans may be slightly higher than on conventional loans. However, this extra cost is often worth it for borrowers who wouldn’t qualify for standard financing.

Since they’re not bound by secondary market guidelines, portfolio loans are popular among those who need extra flexibility with their investment real estate mortgage. More flexibility allows them to better fit lending scenarios that fall outside standard loan criteria. 

Commercial Real Estate Loans

These loans are tailored for large-scale investments, such as apartment buildings, retail spaces, or mixed-use developments. Commercial real estate loans are highly specialized and can have much higher loan amounts than other types of investment property mortgages. Thus, not all mortgage lenders offer this type of loan and it’s important to do your research.

Key aspects include:

• Larger loan amounts: Compared to residential loans, commercial real estate loans offer higher borrowing limits that make them ideal for expansive or high-value projects.
• Tailored loan terms: Commercial property mortgages typically have shorter loan terms than conventional mortgages, but they can be tailored according to borrowers’ financial plans. Most range between 5 to 20 years.
• Strict underwriting standards: Lenders often require detailed financial projections, business plans, and proof of the property’s income potential to mitigate the risk of a larger investment.
• Lower LTV ratio: Loan-to-value ratios are typically capped at around 65%, requiring a substantial down payment. It can be raised to 75%, however, depending on the borrower’s financial profile.

Commercial property loans are best suited for very large investments that have a high likelihood of turning a profit in the long term. Given their loan amounts, requirements, and LTV, they’re a much bigger commitment than other loan types, with a higher cost of entry. However, borrowers may be able to avail of specialized loans like Small Business Administration (SBA) loans for mixed-use properties.

How to Qualify for Investment Real Estate Loans

Lenders assess several factors when determining eligibility for investment property mortgages. While we can’t provide financial advice, here are our suggestions and some resources to help you maximize your chances for approval.

Improve Credit Score and Financial Health

Your credit score is one of the most significant factors lenders evaluate. It reflects your financial responsibility and ability to repay debts.

• Credit Score Requirements: For most conventional loans, a minimum credit score of 620 is required. However, a higher score (700 or above) can improve your chances of approval and result in better loan terms.
• Debt-to-Income Ratio (DTI): Lenders prefer borrowers with a low DTI, generally below 43%, as this indicates the ability to manage existing obligations along with new loan payments.
• Stable Income: Proof of steady income through tax returns, pay stubs, or bank statements is essential. Entrepreneurs and freelancers may need to provide additional documentation to demonstrate financial consistency.

Prepare Down Payment and Cash Reserves

Investment property loans typically require larger upfront payments and additional reserves to ensure the investor’s financial stability.

• Down Payment: Most lenders require 20-30% of the property’s purchase price as a down payment. Higher down payments reduce lender risk and may lower your interest rate.
• Cash Reserves: Borrowers are expected to have reserves covering six months or more of loan payments. This ensures that unforeseen vacancies or maintenance costs won’t impact repayment ability.

For larger investments, lenders may also require reserves to cover operational expenses like property taxes, insurance, and utilities.

Property Valuation and Income Potential

Unlike personal mortgages, the property’s income-generating potential plays a critical role in loan approval for investment properties.

• Appraisals: Lenders require a professional appraisal to determine the property’s current market value. The appraisal also helps ensure the loan amount aligns with the property’s worth.
• Income Potential: The property’s rental income is a key factor in qualifying for certain loans, such as DSCR (Debt-Service Coverage Ratio) loans. Lenders calculate income potential based on:
  • Local market rental rates.
  • Current lease agreements (if applicable).
  • Future value after renovations or improvements.
• Debt-Service Coverage Ratio (DSCR): Some lenders use DSCR to determine whether the property’s income will cover the loan payments, even if the loan isn’t a DSCR loan. They often look for a DSCR of 1.25, indicating that the property generates at least 25% more income than the total debt service.

Research and Due Diligence

Comprehensive preparation and an understanding of the investment property market can significantly improve your chances of securing a loan with ideal terms. 

• Market analysis: In-depth research on the local real estate market where you plan to invest will help you highlight trends, gauge rental demand, and estimate property appreciation potential. This will enable you to grasp the financial outlook of your target market, which can be a major influence on whether lenders will consider your venture a viable investment. 
• Property evaluation: Beyond selecting attractive markets, it also pays to thoroughly vet each property, accounting for things such as condition, location, and proximity to amenities. These factor into their rental income or resale value.
• Craft a clear investment plan: A detailed investment strategy outlining your goals, expected cash flow, and long-term plans for the property will demonstrate to lenders that you’re responsible and committed to generating a profit. 
• Get pre-approved: Obtaining pre-approval from lenders will give you clarity on your borrowing power and make you a much stronger competitor in bidding wars.

Investment Real Estate Loans FAQ

Can I use an investment real estate loan for flipping properties?

Yes, many investment real estate loans, particularly hard money loans and fix and flip loans, are designed for short-term flipping projects. These loans are secured by the property’s value rather than the borrower’s credit history, making them ideal for investors needing quick funding. 

What is the minimum credit score required for an investment property loan?

Most conventional loans require a minimum credit score of 620, but some lenders may set the minimum higher. Alternative loans, like DSCR loans or portfolio loans, may place less emphasis on credit scores and more on the property’s income potential, making them viable investment property loan options for those with less-than-perfect credit. This isn’t true for every lender so be sure to ask!

How do lenders calculate income potential for rental properties?

Debt service coverage ratio (DSCR) is a chief metric used by most lenders, estimating income potential by taking the ratio between annual income after deducting overhead and the total amount that goes to mortgage payments and other fixed costs per year. Apart from that, lenders can evaluate income potential using market conditions, current lease agreements, and tenant payment histories. 

What is the minimum DSCR required to qualify for a DSCR loan?

Most lenders look for a debt service coverage ratio of at least 1.25, meaning that the property should be making 25% more income per year than its annual debt obligation. Debt obligation includes other fixed periodic costs such as property taxes and homeowners association fees. At Defy, we offer DSCR loans for properties with DSCRs as low as 0.75.

Can DSCR loans be used for short-term rental properties?

Yes, short-term rentals such as vacation homes can also qualify for DSCR loans. As long as the property makes enough money during its occupancy periods to make up for its off-season performance, it can be deemed eligible. 

Can you refinance from a hard money loan into a DSCR loan?

Absolutely. Using a hard money loan to purchase a property and then refinancing into a DSCR loan is a common strategy among those who practice the BRRRR (buy, rehab, rent, refinance, repeat) method of real estate investment. Refinancing your rental property into a DSCR loan is a great way to lower your interest rate, especially if your property has a high net operating income.

Are there tax benefits associated with investment real estate loans?

Yes, investment real estate loans can offer several tax benefits. Depending on eligibility, investors may be able to deduct mortgage interest, property taxes, and operating expenses like maintenance, insurance, and property management fees. Additionally, the property’s value (excluding land) can be depreciated over time to reduce taxable income. Consult a tax professional to gain a full picture of your deductibles.

Can I refinance an investment property to access its equity?

Yes, refinancing is a common strategy for investors. It allows them to access the property’s equity, which can be used to purchase additional investments or cover expenses. Refinancing can also help secure a lower interest rate or transition from a short-term loan to a long-term mortgage. 

Key Takeaway

Investment real estate loans are a powerful tool for building wealth through property investment. With options ranging from conventional loans to specialized hard money, DSCR, and portfolio loans, you can find a lending solution for a wide variety of situations. Just be sure to ask your lender of choice which loan options they offer! And with the level of customization we offer at Defy, you can be sure that whatever you choose will be optimized for your unique needs. 

Each type of investment real estate loan is geared towards specific borrowers and scenarios, so understanding your financial profile and investment strategy is essential to selecting the best option.

Ready to begin your real estate investing journey? Reach out to Defy today and start brainstorming with our mortgage experts. With our streamlined platform and competitive rates, we can fast-track you to financial success.