This rate accounts for the fact that the financial institution is lending more than the property is actually worth and the fact that the borrower is likely to pay off the loan in a shorter period of time. For example, a fix-and-flip loan might have a term of just 12 to 18 months.
Some fix-and-flip loans come with interest-only repayment periods, during which time the investor won’t be required to make payments toward the principal.
It’s important to note that while these loans come with some benefits, including the fact that they’re tailored to house flippers, there are also some risks. If you aren’t able to sell the home as quickly or for as much as you hoped, you could find yourself underwater on a loan with a high interest rate and unaffordable monthly payments.
Financing Based on Home Equity
Another option to finance an investment property is to use the equity you have built up in your primary residence or another property you own. With home equity loans, home equity lines of credit (HELOC), and cash-out refinance, lenders allow you to use this equity for other purposes.
Home Equity Loan
A home equity loan is a fixed lump sum you borrow from a financial institution, with a predefined repayment period and interest rate. You can often borrow up to 85% of your home’s equity for any purpose.
Home Equity Line of Credit
A home equity line of credit (HELOC) is a revolving line of credit homeowners can use to borrow against their home’s equity if and when they need it. HELOCs come with a maximum amount you can borrow, but you can continue to borrow that amount as long as you pay it back. HELOCs often have an initial “draw” period, during which you can borrow against your equity, as well as a repayment period where you make fixed payments. During the draw period, you may only be required to pay the interest on your line of credit at a variable interest rate.
A cash-out refinance is a type of refinance loan where you take out a new mortgage that is larger than the one you’re refinancing. The difference between the original mortgage and the new one is paid to you in cash for you to do whatever you want. A cash-out refinance acts just like any other type of mortgage refinance loan when it comes to repayment-you simply take out a larger loan. Then, you can use the extra cash to finance your investment property.
Pros and Cons of Equity-Based Loans
The advantage of using your home equity to finance an investment property is that you’re able to leverage an asset you already own. But there’s also a major downside to consider. When you use your home equity to finance the purchase of a second property, your original property serves as collateral. If the investment property doesn’t pan out as you expected and you can’t make your loan payments, you could lose your primary residence.
Another risk is that in the case of HELOCs, there’s often a variable interest rate. So a loan payment that seems affordable today could easily become unaffordable if interest rates rise significantly.
Tips for Financing an Investment Property
Getting financing for an investment property has a few hurdles you can clear if you know how to prepare ahead of time.
Plan for a Large Down Payment
Conventional loans for investment properties require anywhere from 15% to 30% down, depending on the number of units in the home and loan type. The more you can save, the more flexibility you’ll have when it comes to shopping for properties.