Investment property loans and mortgages: how to finance a purchase

If you’re looking to finance an investment property, it’s a good idea to research your options carefully before making a purchase to ensure you get the best value for money. 

This could include taking out a new mortgage, bank loan or accessing equity in an existing mortgage, for example.

Let’s find out more about the best ways to finance an investment property.

What is investment property financing?

Investment property financing involves funding the purchase of real estate with money acquired from a loan, mortgage, partnership, or equity.

The idea is to leverage capital to buy properties to generate returns that exceed the cost of financing.

Can I take out a loan to finance an investment property?

You can take out a loan for investment property financing, but you must do your own research and choose one that suits your financial situation, goals, and market conditions.

Consider the interest rates, loan terms, fees, and your long-term investment strategy.

Look for the cheapest loan to finance your investment property to enjoy maximum profits, but these may have stricter requirements and longer approval times.

A bank loan

A bank loan involves an investor borrowing money from a bank or lending institution to acquire a real estate investment.

Depending on the interest rates and terms, a bank loan or accessing equity via a remortgage may be among the cheapest loan types for real estate investments. 

To get a bank loan, you must provide details about your financial situation and the property you intend to buy. 

If approved, the bank offers a loan with specific repayment terms, and the investor is responsible for making regular payments.

To get a bank loan, you must:

1. Ensure your finances are in order.

2. Research lenders to find the right one for you.

3. Evaluate the investment property carefully.

A buy-to-let mortgage

A buy-to-let mortgage is a loan designed specifically for buying a property to rent out, rather than to live in yourself.

Lenders typically assess these applications on the rental income the property is expected to generate, alongside your own income and finances.

You'll usually need a deposit of at least 20-25% of the property's value, though some specialist lenders may accept less depending on your circumstances.

To get a buy-to-let mortgage, it's worth:

• Comparing rates and terms from several lenders, including specialist buy-to-let providers.

• Checking each lender's minimum deposit and rental income requirements.

• Speaking to a mortgage broker, who can help match you with a suitable lender.

Get a private loan

Private loans are financial agreements in which individuals or private lending institutions provide funds to investors to finance their investment property.

Unlike traditional banks, private loans can be more flexible when negotiating terms, including interest rates, repayment schedules, and collateral requirements. 

Specialist buy-to-let and property investment lenders operate alongside high street banks in the UK market, and often have more flexible criteria for portfolio landlords or complex income.

Here's an outline of how private loans work.

Private lending involves identifying potential lenders, negotiating terms, and conducting due diligence. The parties draft a legal agreement stipulating loan terms.

The lender disburses funds, and the borrower pays it back over the term, which may include principal and interest payments.

To get a personal loan, it’s worth:

1. Networking and making connections.

2. Clearly defining an investment strategy.

3. Seeking legal assistance for drafting the agreement.

4. Paying back the loan as agreed.

A hard money loan

A hard money loan is a short-term funding option that is asset-based.

Private individuals or companies offer hard money loans, typically at higher interest rates than traditional loans. These loans often use the investment property's value as security.

A bridging loan, often used in property financing while an investor is waiting for other funds to come through, is an example of a hard money loan.

Here's an overview of how hard money loans work: 

Hard money loans are generally approved and funded quickly. The loan amount is based on the property's value, and due to increased risk, they often have higher interest rates. 

These loans are short-term and require the newly purchased property as collateral.

To acquire a hard money loan, you should::

• Identify hard money lenders.

• Apply for a loan.

• Wait for the hard money lender to assess the property’s value.

• Negotiate terms.

• Complete any required due diligence.

What are the pros and cons of taking out a loan?

Regardless of your loan type, it's best to understand the advantages and disadvantages.

Below are the pros and cons of taking out a loan.

The pros of getting a loan

• Leverage and potential appreciation: Borrowing money increases your investment leverage, potentially boosting your returns.

• Increased buying power and diversification: Loans provide more buying options, allowing you to increase your portfolio.

• Tax benefits: Property investors may be eligible for tax benefits. It’s worth talking to a financial adviser about these. 

• Cash flow: If the returns from an investment property exceed the loan repayment, it can generate positive cash flow.

The cons of getting a loan

• Loan costs: The interest on a loan increases overall costs and reduces profitability. Other expenses like a deposit also tie up a lot of capital.

• Market fluctuations: Market and interest rate fluctuations can negatively impact an investment property's value and loan instalments.

• Debt obligation: Loan repayments are a fixed obligation, and failure to stick to the repayment agreement could lead to financial difficulties.

• Foreclosure risk: Failure to repay the loan may result in foreclosure and the loss of your investment property.

There's no single best loan for every investor, a buy-to-let mortgage tends to suit long-term rental purchases, a bank loan often works out cheapest if you meet the criteria, and hard money or private loans are usually reserved for short timeframes or properties that don't fit standard lending criteria.

A financial adviser or mortgage broker can help you weigh these against your own goals.

What happens if you can’t pay back the loan? 

If you’re financing an investment property and can't pay back the loan, you may face the following issues:

• Late fees or penalties.

• Damage to your credit score.

• You could lose your investment property.

• Loss of equity.

• Deficiency judgement.

• Legal consequences.

Are there alternatives to a loan?

Equity is an alternative to a loan, which involves using the value of an asset, such as a property, to obtain funds. 

Two ways to leverage equity include home equity in your property or equity in an investment property.

If you already own a property with equity in it, releasing some of that equity can be one way to raise funds for buying an investment property, rather than taking out a new loan.

Equity release 

Equity release allows a property owner to access equity in their home without selling it. Before choosing an equity release provider, compare options to find the best terms and rates and consider using a mortgage broker.

The application process involves a thorough assessment of your property, health, and financial situation, and a solicitor handles the terms and conditions of the equity release.

What do I need to get approval for investment property financing?

When applying for investment property financing, preparing and providing the necessary documentation is essential to streamline the process.

Here are some of the documents you might need:

• Personal documents: Proof of identity and residence, as well as your national insurance number.

• Financial documents: Bank statements, employment verification, credit history, pay slips and proof of assets.

• Property: A purchase agreement, property details, and debt information.

• Additional information: A gift letter (if applicable), divorce decree or separation agreement (if applicable), property history, and business financials.

Lenders will also weigh up how much you're putting down.

For an investment property, expect to need a deposit of at least 20-25% of the purchase price, higher than for a residential mortgage, with the exact figure depending on the lender, the property, and your finances.

Seek expert financial advice

There are different ways to secure finance to buy an investment property. It is advisable to explore various options to find the best way to finance an investment property for your own individual circumstances.

Getting financial advice from a regulated financial adviser can save you time and support your financing goals.

Unbiased can match you with an expert who will guide you through the complexities of finding the funding to grow your investment property portfolio.