Editor's note: This story originally appeared in the June issue of DS News, out now.
You’ve decided to become a rental property investor. You’ve done extensive research on the fastest growing markets for rental investment, and perhaps you’ve even decided to purchase your first property or add one or more to an existing portfolio. Now, it’s time for one of the most important pieces of building your rental property business: finding the right financing partner.
Rental property investors have many financing options, each with benefits and drawbacks. Some options may be better suited for investors who are just beginning to build their portfolios, while others appeal to more experienced investors. Let’s take a look at the options.
Cash: Purchasing properties with cash frees investors from the requirements of banks or other financing partners. However, it limits the investor’s purchasing power and ability to invest cash in other vehicles. All-cash purchases have also become more difficult in recent years as home prices continue to rise.
Friends and Family: If you decide to go this route, it’s a good idea to define the terms of your agreement, get consensus on the business plan, and consider placing your properties within an LLC. Consulting a real estate and/or tax attorney may also be worthwhile.
Agency Financing: Fannie Mae and Freddie Mac have both announced programs designed to help rental investors refinance or fund the acquisition of new assets. Fannie and Freddie’s programs allow owners of smaller-sized portfolios to find competitive, fixed interest rates and loan terms as long as 10 years. In commenting on the agencies’ programs, experts have noted these programs may primarily benefit owners of 20 to 100 properties. Credit score, credit history, and income will be components of the application for Agency financing.
Local or Community Bank Financing: Investors may find attractive financing options through a local bank as a result of in-depth local market knowledge. Small banks may also be familiar with business financing and equity partnerships, so if you have a business partner or are hoping to include other investors in your rental investment business plan, exploring a relationship with a smaller bank could make sense. As with agency financing, credit score, credit history, and income will be components of the application.
Hard-Money: Hard-money lenders provide financing primarily based on the property (or properties) you’re using as collateral for the loan. Typically they place more emphasis on the cash flow of the property, as opposed to personal income or debt-to-income ratios (as is the case with Agency or community bank financing).
Hard-money lenders charge higher interest rates and offer shorter terms than the financing partners we’ve previously identified. That said, this type of financing can offer a fair amount of flexibility for investors who need to move quickly on a property acquisition or who expect to turn over the property speedily or replace the hard money loan with longer-term financing from another source.
Direct Lenders: Direct lenders are a bit of a hybrid of community bank financing and hard money. Direct lenders generally use asset-based evaluations of potential borrowers’ properties and portfolios. They will consider the cash flow of the property, the condition, and location of the property, whether or not it has a tenant in place and other factors. Direct lenders will also evaluate your credit score, credit history, and available liquidity, but typically don’t use these measures as the primary determining factor of whether they are willing to lend. Direct lenders’ interest rates tend to be higher than agency or community bank financing, but can also offer longer terms than hard money lenders, with some offering 10-year and 30-year terms. Similar to a community bank, direct lenders may also offer a full suite of products, specifically designed with the rental investor’s need in mind. From single rental loans and portfolio loans to fix-and-flip lines of credit and even new construction financing, a direct lender can grow your relationship alongside you growing your business.
Ten Crucial Interview Questions
After you’ve narrowed down the prospective types of financing partners that you believe would be a good fit for your current rental business and your growth aspirations, you’ll want to begin the interview process. During this time, be prepared to share the details of your current portfolio and long-term business plan with prospective partners. Here are some questions you might consider asking.
- How long have you been in business? This is an important question and will help you evaluate how stable and reliable the partner may be. New companies may not necessarily be unreliable partners, but it’s helpful to know more information about their track record. In that vein, recently launched companies also may not have perfected their customer experience process, so be prepared in the event of a less than perfect experience or a novice account executive or loan officer.
- Are you a direct lender? Unless you’ve decided to work with one of the agencies or a community bank, you’ll want to know if the financing provider considers themselves a direct lender. This question can help you get more insight into the available rates and terms as well as what to expect from the lending process. Many investors consider direct lenders to be in the “sweet spot” of rental property financing partners, so it’s worth knowing at the onset of the process whether this is also the case for you.
- Do you underwrite to your own requirements? The response to this question will help you understand the potential level of flexibility the financing partner may be able to offer, whether they can waive or modify specific loan requirements and what may happen if you approach the lender with a unique need or special situation.
- How quickly can you close? In today’s fastmoving market, time to close is key. Especially if your property purchase is contingent on the financing you’re seeking, long timelines or multiple parts of the lending process can hamper your ability to act quickly if and when a good investment property comes to market.
- What are your fees? Like any lender, lenders who focus on rental properties will often have certain fees built into the origination process. Be sure you know up front what these fees are so that you can factor them into your required upfront costs.
- What documents do you require? Agencies and community banks may require more documentation than hard money or direct lenders, which both tend to require information based on the property’s cash flow rather than a borrower’s personal income. In general, it’s helpful to be prepared with tax and bank statements, a W-2 if, account statements from any accounts you’ll use to demonstrate liquidity, copies of your driver’s license, and state or military identification or passport. If you house your rental properties within an LLC or other legal structure, the lender will likely ask to review those statements as well.
- What happens if I decide to sell a property in my portfolio? Some lenders may have certain requirements around how long properties must remain on the loan or apply steep penalties if you decide to sell a property. If you think you may want to sell part of your portfolio, it’s a good idea to understand how much this may cost or whether it’s possible.
- Can I add new properties to an existing loan? Along the lines of the prior question, lenders may have certain requirements or fees associated with making changes to properties that are collateral for an existing loan.
- What suite of products do you offer? The answer to this question will help you understand whether the lender is likely to be a short or long-term partner. If the lender offers a full suite of products, it’s reasonable to expect that you may be able to build a longer-term relationship as your portfolio grows and matures.
- How can you help me grow my rental property business? This is perhaps the most important question of the bunch and will give you the most insight about how the lender will approach your relationship, whether you’ll have access to new and different products as your needs change and generally whether the lender is in the business of building successful long-term customer relationships.
Regardless of which financing partner you choose, it’s a good idea to ensure that your lender can accommodate your needs as an investor, offers a number of products, and is willing to grow your relationship as your rental business matures.