What Are Investment Property Loans?
Investment property loans provide financing for non-owner occupied residential 1-4 investment properties, multi-family (apartment) buildings, mixed-use buildings, and commercial buildings used for “business” purposes. Stated simply, if a borrower purchases a property with the intention of earning a return on the investment, either through rent collected from tenants, the future resale of the property or to operate a business entity, it qualifies for an investment property loan.
What’s Makes Investment Property Loans Different?
Unlike residential loans, the repayment periods for investment property loans typically range from one to 20 years. Often, the amortization period is longer than the term of the loan. For example, a lender might make an investment property loan for a five to seven-year period with an amortization period of 20 years. In this situation, the investor would make payments over five years, followed by one final “balloon” payment of the entire remaining balance of the loan. Balloon loans can be very risky for investors, especially if the credit markets are under stress when the loan matures. (Velocity helps borrowers avoid this risk by offering a Flex-Perm loan that’s amortized over 30 years.)
Loan-to-value (LTV) ratios are also different for investment property loans. For both commercial and residential loans, borrowers with lower LTVs will qualify for more favorable financing rates than those with higher LTVs. The reason: they have more equity (or stake) in the property, which equals less risk in the eyes of the lender. While high LTVs of up to 100 percent are allowed on some residential mortgages, the LTVs offered on investment property loans generally fall into the 65 to 80 percent range.
While the primary guidelines for a residential loan are the borrower’s income, credit score, and debt-to-income ratio, investment property loans are more focused on the value of the property and its revenue-generating potential, often referred to as an “asset-based” underwriting approach. Because of this, an asset-based loan often eliminates the need for borrowers to document their personal income. This feature makes them a viable alternative for self-employed investors and small business owners with a limited credit history and difficulty proving income.
How Do Different Lenders Process Investment Property Loans?
Many banks and wholesale lenders originate investment property loans and then sell them to another party, typically a government-sponsored enterprise (GSE) like Fannie Mae, Freddie Mac or the Federal Housing Authority (FHA). Lenders must follow the strict underwriting guidelines imposed by these enterprises to have their loans purchased or backed by them. In addition, the Federal Reserve imposes lending concentration limits on banks that limit their exposure to investment property loans. Banks respond by limiting their investment property loans to their best customers.
The Advantage of a Non-Bank Direct Portfolio Lender
In contrast, direct portfolio lenders retain, manage and service their own portfolio of investment property loans instead of selling them off in the secondary mortgage market. Portfolio lenders make money off of the interest rate spread or the difference between their interest-earning assets and the interest paid to finance their mortgage portfolios. Because of this, direct portfolio lenders are not required to follow the strict underwriting guidelines imposed by GSEs or banks and are free to establish their own underwriting rules, which often favor individuals who would not qualify for GSE or bank loans.
The Bottom Line for Investment Property Loans
- With investment property loans, it is usually an investor (often a business entity) that purchases the property, leases out space and collects rent from tenants or later sells the investment for a profit. The investment is intended to produce some form of income.
- When evaluating investment property loans, lenders consider the value of the property, its revenue-generating potential and the creditworthiness of the entity, whether a business or individual.
- Wholesale lenders and banks often sell their multi-family property mortgages to GSEs and must follow strict underwriting guidelines that often disqualify self-employed investors and business owners who don’t have a sufficient credit history established or write off their expenses to lower their tax liability.
- Banks limit their exposure to commercial property loans due to lending concentration limits imposed by their regulators and typically focus on loans to existing customers with deposits at the bank.
- Direct portfolio lenders obtain capital from private investors and their alternative, asset-based lending approach allows them to develop underwriting criteria that often favors investors who have credit and income reporting issues.