Beginning real estate investors are sometimes surprised to learn that not all lenders know how to work with investors and sometimes may even prefer not to deal with them. Making investment property loans require a certain amount of expertise that not all lenders have.
Let’s discuss how real estate financing works, then explain what makes a lender investor-friendly and how to find investor-friendly lenders to help you keep your real estate business growing.
- The main types of real estate loan categories are mortgages for owner-occupied homes, residential rental real estate, and commercial real estate.
- An investor-friendly lender is one who understands why real estate investors use leverage and can access a variety of loan programs and financing options.
- When vetting investor-friendly lenders, it’s important to ask about the maximum number of loans, minimum down payment amounts, and whether a financed property can be transferred into a limited liability company (LLC).
How real estate financing works
Real estate financing can be divided into 3 broad categories: financing for a primary owner-occupied residence, loans for residential rental real estate, and commercial real estate.
Each category represents a different level of potential risk to a lender, which influences the variety of loan programs available, down payment amounts, interest rates, and loan terms. For example, lenders generally view residential financing as less risky than commercial real estate because homes are typically easier to manage, less expensive to maintain, and easier to rent.
Within the residential asset class, lenders make a distinction between owner-occupied property and rental property. Generally speaking, lenders also view owner-occupied homes as less risky compared to renter-occupied homes because an investor may be more willing to walk away if an investment doesn’t go as planned. Because the perceived level of risk is lower, lenders offer financing programs for a primary residence with lower down payments and slightly lower interest rates.
Residential property types typically classified as investment real estate include single-family rentals (SFRs), condos and townhomes, and small multifamily buildings with up to 4 units. As a rule of thumb, a commercial lender must be used to finance multifamily properties with more than 4 units.
What makes a lender investor-friendly?
Knowing how lenders think about risk makes it easier to understand why some lenders are more friendly to residential real estate investors than others. While it may be possible to get a loan for an investment property from a lender who makes loans for primary residences, that typically isn’t the best choice.
In the same way that many real estate agents don’t know what real estate investors look for when buying a rental property, many lenders who specialize in making loans for owner-occupied properties don’t understand the subtleties of financing SFRs. For example, an investor may find it difficult to obtain more than a few loans, or a lender may balk if an investor wants to transfer a property into an LLC.
Here are some of the things that make a lender investor-friendly.
Know how real estate investing works
Investor-friendly lenders and mortgage brokers understand that real estate investors use leverage to increase cash-on-cash returns and claim tax benefits, such as depreciation to reduce taxable net income.
Over time, real estate investors may purchase multiple properties to increase cash flow and build long-term wealth. While one SFR may generate a pretax cash flow of $1,200 per year, 5 SFRs could generate a net cash flow of $6,000 per year, and 10 rental properties could produce $12,000 in cash flow.
On paper, the maximum number of loans a borrower can hold at any one time is 10. In the real world, however, loan officers who don’t know real estate investing may limit a borrower to just a few loans, even for a borrower with an impeccable credit score and cash-flowing properties.
The advantage of working with an investor-friendly lender is that they know the limitations investors face, understand how and why real estate investors use leverage, and work with investors to keep cash flow growing and property values rising while increasing loan volume.
Understand why investors use LLCs
Real estate investors use LLCs to keep rental properties separate, separate business assets from personal assets, and limit personal liability.
Because an LLC is a legal entity distinct from an investor, a rental property transferred into an LLC must be quitclaimed to the LLC. A lender may technically view the transfer of the property out of an investor’s name into an LLC as a sale and require the loan to be paid in full, even if the investor is the sole member of the LLC.
An investor-friendly lender may be unable to modify the loan documents to allow ownership transfer of a rental property into an LLC. However, they may be willing to work with an investor to facilitate a quitclaim without calling the loan due and payable.
Access to alternative loan options
Many of us know real estate investors who own dozens of SFRs. But how is it possible to finance that many properties if lenders cap the number of loans at 10 or less?
Investor-friendly lenders and mortgage brokers are experts at thinking outside of the box and finding ways to help an investor grow a rental property portfolio with alternative loan programs:
- A blanket mortgage provides financing for multiple rental properties using a single loan, with all of the properties serving as collateral for the loan. Depending on the loan structure, a borrower may be able to sell individual properties without paying off the entire loan.
- A portfolio loan is held by the mortgage originator on its own balance sheet rather than sold on the secondary mortgage market. Keeping a portfolio loan on its books allows a lender to be more creative with loan terms and conditions and structure a loan that benefits both the borrower and the lender.
- A private lending loan is issued by investors who invest in real estate debt instead of equity. Private lenders are individuals or firms that aren’t associated with a bank and instead use their own capital to originate loans and generate interest income. Although interest rates and loan fees are generally higher, private lenders also have much more latitude to customize a loan.
Where to find an investor-friendly lender
Many real estate investors create a network of 3 to 4 lenders to increase the odds of getting approved for a loan. After all, you don’t want to spend a lot of time and effort finding the perfect rental property only to discover you can’t get financing.
Here are some ways to find investor-friendly lenders.
Upon request, Roofstock can recommend a third-party lender with investment loan experience. Investors are never obligated to use a Roofstock recommended lender when transacting on the Roofstock Marketplace, but, if they do, Roofstock may receive a fee or other financial benefit as authorized by law.
Investment property loan providers
- Citibank for SFRs
- LendingOne for rehab loans
- PennyMac for competitive rates and approval times
- PNC for investors who prefer using a conventional bank to get financing
- Quicken Loans for the best overall customer service
Reach out to your network
Another good way to find an investor-friendly lender is to ask fellow real estate investors where they got their rental property loans. Good resources for networking in real estate include online forums like BiggerPockets, REIClub, and the National Real Estate Investors Association.
If you’re just getting started in real estate or want to take your business to the next level, the Roofstock Academy offers exclusive lectures, groups, 1:1 coaching sessions, and a private investor community to get referrals for investor-friendly lenders and much more.
How to vet investor-friendly lenders
Some lenders and mortgage brokers may claim to be investor-friendly simply because they want your business. While working with a motivated lender is good, it’s just as important to make sure the lender can provide the loans you are looking for.
Here are some questions to use when vetting investor-friendly lenders:
- How many loans can I have with your company?
- What type of loan programs do you offer?
- What is the minimum down payment required?
- Do you consider existing rental income when underwriting a loan?
- What are your reserve requirements? (Many lenders require a reserve amount of up to 6 months' worth of mortgage payments and operating expenses per property.)
- Do you sell the loans or do you hold them on your books?
- Is there a loan minimum or maximum aggregate dollar amount loan limit?
- Can I transfer the property into an LLC, and, if so, do I still need to guarantee the loan personally?
One of the best things about investing in SFR property is that there are a wide variety of loan programs available when you know where to look. However, there’s a big difference between regular lenders and lenders specializing in working with real estate investors. An investor-friendly lender can help you grow a real estate portfolio faster, generate more cash flow, and keep your investment goals on track.