Investing in real estate is not just an option for wealthy individuals. In fact, even those with a moderate income can make extra money from an investment property. So if you’re looking for a reliable source of passive income, read on to learn if financing an investment property would be the right choice for you.

What is an investment property?

Put simply, an investment property is a home that you own but do not reside in. As the owner of this property, you enjoy income earned by renting the home out to others.

You may already own a home that is considered your primary residence, and maybe even a second home, or vacation home, that you live in during part of the year. But an investment property differs from these types of properties in a major way: It can be more difficult to qualify for an investment property loan than it is for a primary or secondary residence.

How do I qualify for an investment property loan?

Different types of investment property loans require you to meet different criteria. Still, there are two universal steps you can take to make yourself a more appealing applicant for any type of home loan.

First, it’s critical to maintain good credit. Like with a traditional mortgage, a high credit score increases your odds of qualifying for a loan and keeps your interest rates low if you do qualify. A conventional loan typically requires a credit score of 620 or higher. Making all your monthly bill payments on time and keeping all of your credit cards below 15% of their limit are good habits to follow, and these practices are even more essential if you want to finance an investment property.

The second factor lenders look at is your debt-to-income (DTI) ratio. As a general rule, it’s best to have your DTI be below 43%, and lower is always better. If you don’t meet these criteria, you may need to wait until you have either eliminated more debt or start earning more income. Note that the profit you make from renting an investment property can count towards your income when calculating your DTI, in some cases, but only if you have an established history of renters living there, usually for a period of at least 6 months.

How much money do I need to finance an investment property?

Real estate investing requires you to spend money to make money. Therefore, before purchasing an investment property, a lender will want to see that you have sufficient funds saved up. Your liquid reserves—that is, cash and assets that can easily convert to cash—should be enough to cover at least 3 months of mortgage payments and other property expenses, although some lenders may require 6 months or more. The more money you have saved up before applying for a loan, the better.

What types of loans can I use to finance an investment property?

There are many loan products available to finance an investment property, but the 4 listed below are the most commonly used.

Conventional Loan: A conventional loan, like the one you may have used to finance your primary residence, is not backed by the government, but it must conform to Fannie Mae or Freddie Mac standards. This type of loan has stricter requirements for credit, income, and assets, and down payment requirement, and the income you will make from renting your investment property is not factored into your DTI.

Commercial Loan: Commercial lenders are a bit less strict than banks when considering applicants. They place less weight on income and debts, choosing instead to focus on credit score and the profit you will make from an investment property. The downside is that commercial loans tend to come with higher interest rates and fees, and many lenders may not offer loans to those applicants who do not already own investment properties.

Home Equity Financing: If you already have equity in a property you own, you may be able to finance it using a home equity line of credit (HELOC), home equity loan, or cash-out refinance. These loans tend to have the lowest interest rates and appeal to sellers because they can see that you have adequate funds.

Hard Money Loan: If you’d prefer to flip a home rather than rent it out for the long term, you can finance the property with a hard money loan. These short-term loans, usually backed by individuals or small organizations, are easier to qualify for than conventional loans, since an applicant’s eligibility is primarily determined based on how much the house will be worth after it is flipped. However, be aware that these perks come at the cost of high insurance rates and a short period—traditionally one or two years—to pay the loan back.

Ready to start investing?

If you believe you can benefit from owning an investment property, Cross Timbers Mortgage can help you through every step of the loan process. Contact us today to start an honest, transparent conversation about your options for financing an investment property.