Wondering what type of loan to take for your property investment? What are conventional loans? Is there a difference between conventional loans and government-backed loans? How do these differences affect the bottom line of your property investment?
Conventional loans are distinct from government-backed options because of their flexibility and customization. While there’s an abundance of conventional loan types to consider, the key is pinpointing the one that aligns seamlessly with your unique financial situation and investment goals.
Choosing the right financing is about leveraging the vast array of loan types to your advantage. Whether you’re comparing a conventional loan vs. a DSCR loan or evaluating the nuances of each loan type, the correct choice will impact your investment’s profitability. If you are in the market for a property investment loan, contact The Mortgage Shop. Here are some common types of conventional loans.
Conventional Loan Types
1. Fixed-rate mortgages (FRM)
Fixed-rate conventional loans are among the most conventional loans chosen by borrowers. With an FRM, your interest rate remains constant throughout the life of the loan, ensuring predictable monthly mortgage payments. Regardless of market fluctuations, you’re shielded from sudden spikes in interest costs.
2. Adjustable-Rate Mortgages (ARM)
Unlike a fixed-rate loan, an adjustable-rate mortgage (ARM) has an interest rate that can change periodically. While they often start with a lower rate than most conventional loans, this rate can adjust over time, impacting your monthly mortgage payment. It’s crucial to understand when and how these adjustments occur to determine if an ARM aligns with your financial strategy.
3. Interest-Only Mortgages
For those seeking flexibility in their early monthly mortgage payments, interest-only loans can be enticing. Initially, you only pay the interest on the loan, without chipping away at the principal. However, keep in mind that this will lead to larger payments down the line once you begin repaying the principal.
5. Jumbo Loans
When your home financing needs exceed the conforming loan limits set by Fannie Mae and Freddie Mac, jumbo loans come into play. As they are non-conforming loans, jumbo loan requirements can be stricter, often necessitating a higher credit score, a larger down payment amount, and a lower debt-to-income ratio.
7. Bridge Loans
Bridge loans, often provided by private lenders rather than traditional mortgage lenders, are short-term financing options designed to bridge the gap between selling a current property and purchasing a new one. Ideal for those who find their dream home before their existing property sells, bridge loans offer quick access to funds. However, they usually come with higher interest rates than a conforming conventional loan and are contingent on good credit and the assurance of future monthly payments from the sale of your existing property.
8. Hard Money Loans
Typically sourced from private lenders, hard money loans are asset-based loans where the borrower receives funds secured by real property. They are especially popular for investment properties that require swift financing. While they offer quicker approvals than most amortized conventional loans, they usually have higher interest rates and are ideal for short-term needs. These loans are less dependent on credit scores and more on the property’s value.
9. Home Equity Loans
Your home equity is the difference between its market value and what you owe on a mortgage. A home equity loan allows you to tap into this value, providing you with a lump-sum amount. This loan functions like a fixed-rate mortgage, meaning you’ll have consistent monthly mortgage payments. Good credit often yields better terms, but some lenders may work with lower credit scores.
10. Cash-Out Refinance Loans
Distinct from a traditional mortgage refinance, a cash-out refinance lets you replace your current home loan with a new one worth more than you owe. The difference is given to you in cash. This can be advantageous if you’ve built significant home equity and need a sizable amount. Like other government-sponsored enterprises, it’s imperative to ensure you can manage the new mortgage payments.
11. Home Equity Line of Credit (HELOC)
A HELOC operates similarly to a credit card. Instead of a lump sum, you’re given a credit limit based on your home’s equity. You can borrow as much or as little as you need, making it flexible. Interest rates are typically variable, so they might start lower than a fixed-rate mortgage but can adjust over time. As with other loan types, good credit often fetches you better terms, though some programs cater to veterans affairs or individuals with lower credit scores.
How is a Conventional Loan Different from a DSCR Loan?
As we have seen, most types of conventional loans are primarily based on the borrower’s creditworthiness, which includes factors such as credit score, income, employment history, and other financial details. Conventional loan approval mainly hinges on the borrower’s ability to repay the loan, as assessed by their debt-to-income ratio (DTI).
DSCR (Debt Service Coverage Ratio) loans, on the other hand, are primarily utilized in the commercial real estate and business lending sectors. Instead of focusing solely on the borrower’s personal financial situation, DSCR evaluates the ability of the property or business’s cash flow to cover its debt obligations. The DSCR is calculated by dividing the net operating income of a property or business by its total debt service (principal and interest payments).
A DSCR greater than 1 indicates that there is sufficient income to cover the debt service, while a ratio below 1 suggests potential difficulties in meeting loan obligations. Lenders typically prefer a DSCR that is comfortably above 1, as it provides a cushion for potential downturns in income or unexpected expenses.
Conventional Loans Vs. Government Backed Loans
Government-backed loans are mortgages that have some level of guarantee or insurance provided by a federal government agency. This means that if the borrower defaults on the loan, the government agency will compensate the lender for a portion of the loss. The main advantage of government-backed loans is that they often require smaller down payments and have more lenient qualifying criteria than conventional loans.
There are several types of government-backed loans, including Federal Housing Administration (FHA) loans, Veterans Affairs (VA) loans, and USDA (United States Department of Agriculture ) loans. Each of these loans serves a specific purpose:
- FHA loans are designed to help low-to-moderate-income borrowers purchase homes.
- VA loans assist veterans, active-duty service members, and some members of the National Guard and Reserve.
- USDA loans are for rural and suburban homebuyers who meet certain income requirements.
3 Tips for Boosting Loan Approval Chances for Short-Term Rental Investments
1. Enhance Your Credit Profile
- Credit Score: One of the primary factors lenders consider is your credit score. A higher credit score often indicates financial responsibility, which lenders favor. Regularly review your credit report for inaccuracies, repay outstanding debts, and maintain timely payments to boost your score.
- DTI (Debt-to-Income Ratio): Private lenders assess your ability to manage monthly payments by reviewing your DTI. The ratio will help lenders compare your monthly debt obligations to your income. A lower DTI signifies that you have a good balance between debt and income, making you a less risky borrower. To improve your DTI, consider paying down significant debts or increasing your income streams.
2. Offer a Significant Down Payment
- Equity Position: A larger down payment often means you have more skin in the game. It reduces the lender’s risk as it increases the equity position in the property right from the outset. A substantial down payment can also potentially lower your interest rate, benefiting your long-term investment.
- Loan-to-Value Ratio (LTV): A lower LTV, resulting from a higher down payment, is more attractive to lenders. It indicates that the loan amount is a smaller percentage of the property’s value, thus reducing potential losses if there’s a default.
3. Present a Robust Business Plan and Documentation
- Rental Projections: For short-term rental investments, lenders are interested in the property’s potential earnings. Presenting a comprehensive business plan with market research, occupancy rate projections, and potential rental income can showcase the profitability of your venture.
- Documentation: Be meticulous with your paperwork. Gather and present all necessary documents, including personal financial statements, tax returns, and property details. Being organized and thorough not only speeds up the loan application process but also demonstrates your seriousness and professionalism to lenders.
Talk to The Mortgage Shop about Conventional Loans for Property Investments
Your investment success is pegged on finding a mortgage lender who can offer you value on your loan. The right mortgage lender will align with your financial capability and your investment vision. To make the right choice, consider factors like your credit score, the down payment you can afford, and your tolerance for interest rate fluctuations.
Read the fine print to understand the nuances of each loan type. This will empower you to select the loan and lender that will optimally support your investment goals. The Mortgage Shop helps investors finance and acquire investment properties. We have 15 years of experience in providing exceptional services to property investors. If you are looking for a conventional mortgage loan for investment, talk to a mortgage broker at The Mortgage Shop today.
Frequently Asked Questions about Conventional Loans
1. What are conventional loans?
Conventional loans are offered by private lenders and conform to guidelines set by government-sponsored entities. However, they are not insured or guaranteed by government agencies. Instead, they’re Conventional loans offer various terms and interest rates, making them a popular choice among borrowers.
2. What are the types of conventional loans?
Conventional loans include:
- Fixed-rate mortgages (FRM)
- Interest-Only Mortgages
- Jumbo Loans
- Bridge Loans
- Hard-money loans
- Home Equity Loans
3. What is an example of a conventional loan?
An example of a conventional loan is a 30-year fixed-rate mortgage offered by a private lender that isn’t insured by the federal government but meets the loan limits and guidelines set by government-sponsored entities. Get a conventional loan for your investment at The Mortage Shop
4. What does conventional type mean?
A “conventional type” typically refers to standard or traditional products or methods, often contrasting with government-backed or alternative options. In the realm of mortgages, the conventional type refers to loans that aren’t insured or guaranteed by federal government agencies.
5. What do conforming and non-conforming loans mean?
Conforming loans meet the guidelines set by the Federal Housing Finance Agency, particularly concerning loan limits. Non-conforming loans, on the other hand, don’t meet these criteria. This can be due to the loan amount, the creditworthiness of the borrower, or the loan’s structure.
6. What is a DSCR Loan Interest Rate?
DSCR loan interest rates refer to the interest rates associated with loans where the DSCR is a primary factor in determining the borrower’s eligibility and loan terms. In commercial lending, particularly in real estate, the DSCR measures the cash flow available to service a loan relative to the loan’s debt service.
Lenders evaluate the DSCR to gauge the risk associated with a loan; a higher DSCR indicates that a property or business can comfortably cover its debt obligations from its operating income. When determining interest rates, lenders might offer more favorable rates to borrowers with higher DSCRs since they represent a lower risk. Conversely, if a borrower has a borderline or lower DSCR, they might face higher interest rates due to the increased lending risk.
7. Can I get an FHA loan for an Investment property?
FHA loans, which are government-backed loans, are primarily designed for primary residences. While it’s generally not possible to get an FHA loan for a standalone investment property, if you live in one unit of a multi-unit property and rent out the others, you might qualify.
8. Why do I need insurance for a mortgage?
Mortgage insurance protects lenders in case a borrower defaults on their loan. Conventional loans that come with a down payment of less than 20% typically require private mortgage insurance. This ensures that lenders can recoup their investment if borrowers fail to meet their obligations.
9. Can I get a VA loan to buy an investment property?
VA loans are backed by the Department of Veterans Affairs and are designed primarily for primary residences. However, similar to FHA loans, if you intend to live in one unit of a multi-unit property and rent out the others, it’s possible to use a VA loan.