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If you own a rental, you might be considering buying more properties. But if you don’t have a lot of cash to make that purchase, should you pursue business financing?
Getting a small business loan to buy rental property can help you grow your business while conserving the cash in your bank account for renovations, repairs, and business operations.
But there are disadvantages to be aware of too. This article will help you explore both sides of getting funding to purchase a rental property.
Key Points
• Small business loans can help you grow your rental property portfolio, allowing you to save cash for renovations, repairs, and business operations.
• A limited liability company (LLC) loan for rental property is likely to require personal guarantees from the LLC owners.
• Interest rates on rental loans and commercial real estate loans are often higher than on conventional home loans.
• Due to the risks involved in real estate investment, securing property-related business loans generally involves a more rigorous process.
• Your credit score, debt, and ability to make a down payment can affect your eligibility for a loan.
Lender Options for Rental Property Business Loans
If you’re looking for a loan for a new rental property, where should you begin? First, familiarize yourself with the most common small business loan terms and requirements. There are many lenders to choose from, each offering its own financial products.
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Loan Types for a Rental Property Business
There are several types of small business loans you may want to consider as you begin shopping for financing for rental property.
Term Business Loan
Banks and real estate lenders offer a variety of options. Some loans are specifically for rental properties, while others are aimed at fix-and-flip investors.
These financing options can include:
• Short-term business loans to cover day-to-day expenses
• Long-term business loans for building renovations and real estate purchases
• Bridge loans to address immediate business needs
Recommended: How to Apply for a Small Business Loan
Business Line of Credit
A home equity line of credit (HELOC) may be useful if you need capital for renovations now and more down the road. With a HELOC, the loan is secured with your home equity and you can take out cash up to a maximum draw. Once you repay it, the money is usually available to borrow again.
If your business owns commercial real estate, you might be able to take out a commercial equity line of credit (CELOC).
With either a HELOC or a CELOC, if you default on paying back your line of credit, you risk losing the property that secures the loan.
Alternative Loans
If you don’t qualify for the above options, you may be glad to know that there are alternatives that can get you access to cash.
Alternative loans can include the following lending products:
• Hard money loans. Typically provided by private firms or individuals, they’re short-term loans secured by the property, so the value of the purchase may be more important than your personal financial situation.
• Seller financing. The seller essentially serves as the lender, and you make payments to them. It’s important to get legal counsel to help draft and review these agreements.
• Crowdfunding. You may be able to use a specialized real estate crowdfunding platform to attract investors to help fund your purchase.
Wondering why a Small Business Administration (SBA) loan for rental property isn’t on this list? The SBA specifically prohibits the use of SBA loans for investment properties, even LLC business loans for rental properties.
Interest Rates for Rental Property Loans
So what’s the going interest rate on a small business loan for a rental property? Rates can vary widely, depending on the lender and your qualifications.
It’s a good idea to shop around with multiple lenders and compare rates to ensure you get the best deal.
The Differences Between Rental Property Loans and Conventional Home Loans
You might be wondering how a business loan to buy rental property compares to a personal home mortgage. There are several factors that differentiate them.
How High Interest Rates Are
Lenders specializing in business loans for rental property may be happy to lend to investors like you, but they may also charge you a higher interest rate than they would for a home mortgage.
In fact, interest rates for commercial real estate loans (typically for spaces with five or more units) can be one-half to one percentage point higher than the 30-year home mortgage prime rate. That may not sound like much, but over time, it can add up.
The reason for the higher rates is that lending to a real estate investor, who may have multiple mortgages at once, is generally considered riskier than lending to someone who wants to live in their home and has only one mortgage.
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How Hard They Are to Obtain
For that same reason — the inherent risk that real estate investment involves — rental property lenders may be stricter about offering commercial real estate loans than about personal mortgages. During the application process, you may be asked to provide your credit report, personal income verification, bank statements, and tax returns to show lenders that you’re financially capable of paying the mortgage each month.
You may also be required to offer a larger down payment on the property or to demonstrate greater cash reserves and income to show that you can afford to pay back the loan.
Finally, lenders may not be as lenient if you fall behind on payments as they might be if you lived in the home that was carrying the loan.
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Requirements and Eligibility for Rental Property Loans
There are often more stringent requirements to qualify for a small business loan for rental property. During the application process, you will typically be asked for business entity documents (if your real estate investment company is a limited liability company or corporation), a voided check, and a scope of work. An investment property loan for an LLC may still require personal guarantees.
Credit Scores
Just as with any business loan (or personal loan, for that matter), your credit score will help determine your eligibility for a rental property loan, as well as what rate you will be asked to pay. The higher your score, the lower the rate you may be offered.
Some lenders require scores of 620 to 680, depending on your down payment, to consider you for a business loan for rental property. Lenders may look at your business score, your personal score, or both. Borrowers who meet a lender’s minimum credit score for business loans may get approved for financing.
Debt-to-Income Ratio
Another important factor in applying for a rental property loan is the debt-to-income ratio of your small business, also known as your DTI ratio. This is the ratio of how much gross monthly debt you have compared against your total monthly income. The higher the ratio, the more risk you present to lenders. Most want to see a DTI ratio of 36% or lower, including any debt you carry on your home.
Your Down Payment
Most lenders will require you to make a business loan down payment with your purchase. Some lenders will let you borrow with little to no money down (expect them to charge higher interest rates).
You may be required to put down a minimum of 15%-20% of the purchase price. A down payment of 25% or more may get you better interest rates.
The Takeaway
Business loans for rental property can be helpful when you’re investing in your next apartment building, but they’re not without drawbacks. Comparing and contrasting the options available to you can help you find what will work best for you.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
Can you get a small business loan for a rental property?
Yes, there are specific loans designed for real estate investors with rental properties. However, they tend to have higher rates of interest.
What type of loan do I need for a rental property?
There are several different loan types available to you for rental property, from standard term loans to lines of credit. After reviewing these options, you can choose one that’s right for you.
Can a limited liability company (LLC) get a loan for an investment property?
Yes, a real estate investment company operating as an LLC (or a corporation) may be eligible for a commercial property mortgage. Getting an investment property loan for an LLC may require personal guarantees from the owners. Contact lenders for further details.
What are the requirements for a rental loan?
Eligibility requirements for a rental loan can vary, but they often include a minimum credit score of 620 to 680 or more, a maximum DTI ratio (including your home mortgage) of 36% or less, a minimum down payment of 15% to 20%, and significant cash reserves.
What is the difference between a rental loan and a commercial mortgage?
A rental loan generally refers to a loan to help you buy a residence of one to four units that you plan to rent out and possibly live in, depending on your loan terms. Eligibility will involve your personal credit score, debt level, and income. A commercial mortgage refers to a loan for a space with five or more units or retail spaces, and eligibility will probably depend in part upon the space’s income-generating potential.
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