How to Finance a Rental Property

How to Finance a Rental Property

Census data suggests that as of 2022, there were nearly 20 million rental properties in the United States. These properties comprise an estimated 48.2 million rental units overall. A significant portion of the population relies on landlords who will rent them a place to live. It also means that there are many investment opportunities available to those who are willing to go out on a limb and put their own money at risk to finance a rental property.

Before you change your title to “landlord”, make sure you understand what you need to know about financing a rental properties. The more homework you do on this on the front end, the less you will have to worry about later.

Borrowing Via a Conventional Loan

The vast majority of homes sold are purchased with a conventional loan. The borrower (aka investor) takes out a traditional bank loan to obtain the funds necessary to purchase their rental property. That said, while these loans are the most common way for investors to purchase properties, they are not the easiest loans to get your hands on.

As you begin the application process to finance a rental, you can expect to have your tax returns scrutinized and judged on a broad set of expectations that that likely will not take individual cases into consideration. Most lenders require the borrower to have a credit score of at least 620. Those lenders often require verification of certain income levels. They also want to look at your debt to income ratio to determine how stable your personal financial situation appears to be. After all, no lender wants to shell out money to a borrower that appears to be in financial distress and is unable to repay their loans. 

Investing in Properties with Tenants Already Living There

Those who may find themselves limited when it comes to securing traditional funding do have options.

One option that some choose is to purchase properties that already have tenants actively living in them. The rationale behind this is that it becomes easier to convince a lender to fork over the money if that lender sees that the property is income-producing. This may make the lender slightly less concerned about the risk associated with this particular loan. They might become more flexible on their terms, and it may be possible to obtain lending even when it didn’t seem like it would work out before.

Borrowing a Home Equity Loan

If you are already a homeowner, then another option open to you is the possibility of borrowing a home equity loan against the value of the property you already live in. You can tap the equity you have already built up in your home to have liquid cash on hand to purchase a rental property.

This strategy allows you to avoid many of the burdens of borrowing that you might otherwise have to deal with. However, you should be careful about using this method as it is risky if you aren’t completely certain of your ability to pay the loan back. You certainly don’t want to borrow more than you can reasonably afford. You are putting your home on the line for this type of loan, so be very careful.

As you can see, there is more than one way to get into the business of becoming a landlord. Keeping all options open as far as financing is considered is the best way to approach all of this. Take some time to do your homework on the options available to you. Think carefully about what will work best in your specific situation, and then proceed with that option.