Investing in property – whether it's for a purchase or development – is a high stakes arena. The sums involved are usually very high, and there can be an element of risk, which is why most people rely on investment loans to facilitate it.
Investment loans are tailored to help you purchase properties that will generate income or appreciate in value over time – helping you pay back the loan, of course.
From buy-to-let mortgages to bridging loans, understanding the different options and their nuances can make a major difference in your investment journey.
What is an investment loan?
An investment loan is a type of financing option specifically designed for purchasing properties intended for investment purposes, such as rental income, resale, or commercial use. Unlike personal or residential mortgages, investment loans often come with different terms, rates, and criteria that reflect the risks and potential returns of property investment.
Investment loans are a common tool, used by everyone from first-time landlords looking to buy their first rental property to experienced developers needing quick funds to secure an auction property. That’s because, for those looking to make an income from property, it’s helpful to be able to grow and diversify without committing all your liquid resources upfront.
What are the different types of investment loans?
People buy property for various reasons, so it’s not surprising that there are a variety of investment loans to suit their needs. Let’s take a look at the most important ones to be aware of.
- Buy-to-Let mortgages
Buy-to-let mortgages are designed specifically for properties that will be rented out to tenants. Key features include:
- Eligibility: Lenders typically require a minimum deposit of 25% of the property’s value, a good credit score, and evidence that the rental income will cover at least 125-145% of the mortgage repayments.
- Rates and terms: These mortgages often have higher interest rates compared to residential mortgages due to the perceived risk of rental income. They may be offered as fixed-rate or variable-rate loans, with typical terms ranging from 5 to 25 years.
- Benefits: The stability of long-term financing with predictable repayments can make it easier to manage cash flow from your rental income. Additionally, some lenders allow interest-only payments, which can further ease cash flow in the short term, while enabling you to pay the property off when you sell it.
- Commercial property loans
For those investing in non-residential properties, such as office buildings, retail spaces, or warehouses, commercial property loans could be the way to go. These loans are tailored to the needs of businesses and often have more stringent requirements:
- Eligibility: Lenders will look at the financial health of your business, the potential rental income from the property, and the overall business plan. A higher deposit, often around 30-40%, is usually required.
- Rates and Terms: Interest rates are generally higher than those for residential properties, and loan terms can vary from 5 to 30 years. The approval process can be more complex, with extensive documentation needed to demonstrate the property's earning potential.
- Bridging Loans
Bridging loans are short-term financing options used to 'bridge' the gap between buying a new property and selling an existing one or refinancing. These loans are ideal for time-sensitive transactions, such as property auctions or quick flips:
- Eligibility: Bridging loans are secured against the property being purchased and/or other assets. Lenders focus more on the property's value and the exit strategy rather than the borrower’s credit score.
- Rates and terms: These loans come with higher interest rates, often ranging from 0.5% to 1.5% per month, and are typically available for terms of up to 12 months. Fees can be significant, including arrangement fees, exit fees, and valuation fees.
- Benefits: The primary advantage of bridging loans is their speed and flexibility. They allow investors to quickly secure properties and can be used for both purchase and refurbishment costs.
- Hard money loans
Hard money loans are another form of asset-based financing, offering quick access to capital for investors who may not meet the stringent criteria of traditional lenders:
- Eligibility: These loans are primarily based on the value of the property being used as collateral, rather than the borrower's financial history or credit score. They are commonly used by developers needing fast funds.
- Rates and Terms: Hard money loans typically have very high-interest rates, often between 8% and 15% per annum, with terms from 6 months to 3 years. Repayment terms can be flexible but are usually short.
- Benefits: Fast approval and funding are the key benefits. These loans are ideal for projects that need immediate financing, such as property flips or developments that will be refinanced or sold quickly.
- Home Equity Loans
Investors with significant equity in their residential properties can use home equity loans to fund additional investments. These loans allow you to borrow against the value of your home, though they also put your home at risk if you can’t keep up with repayments.
- Eligibility: Home equity loans are based on the amount of equity you have in your property. Lenders will typically allow you to borrow up to 80-90% of your home's equity.
- Rates and terms: These loans generally offer lower interest rates than other forms of investment loans since they are secured against your primary residence. Terms can range from 5 to 30 years, and both fixed and variable rates are available.
- Benefits: They offer flexibility and lower interest rates, making them an attractive option for investors looking to leverage their existing assets.
How to qualify for an investment loan
Qualification criteria for investment loans can vary significantly between lenders and loan types, but there are some common factors that will generally be considered:
- Financials: A strong credit score is crucial for securing the best rates and terms on investment loans. Most lenders prefer applicants with a good to excellent credit score, typically above 700. However, some options like hard money loans place less emphasis on credit scores.
- Income stability and documentation: Lenders will want to see proof of income stability, whether from employment, existing rental properties, or other sources. Commonly required documents include tax returns, bank statements, and profit-and-loss statements. The stronger and more stable your income, the better your chances of approval.
- Property value and investment plan: Lenders will closely assess the potential of the property to generate income or increase in value. A solid investment plan that details how you intend to use the loan, the expected income, and your exit strategy can strengthen your application.
- Deposit requirements: Investment loans typically require higher deposits than residential mortgages. Expect to put down at least 20-25% for buy-to-let mortgages, and up to 40% for commercial loans. Bridging loans and hard money loans may offer more flexibility, but the security provided by a substantial deposit often leads to better terms.
Pros and cons of using loans for property investment
Investing in property through a loan offers several advantages, but it's not without risks.
Benefits:
- Leverage: Investment loans enable you to buy properties with less upfront capital, increasing your potential returns. By ‘leveraging’ borrowed money, you can spread your available capital across multiple investments and grow faster.
- Tax advantages: Many investment loans come with tax-deductible benefits, such as the ability to write off interest payments against rental income. This can significantly reduce your overall tax liability, increasing your net return on investment.
- Increased purchasing power: Loans allow you to purchase properties or projects that might otherwise be out of reach. This increased buying power enables you to take advantage of new opportunities as they arise, whether in hot markets or undervalued areas.
- Cash flow management: Loans can provide the necessary cash flow to maintain or improve properties, cover operational costs, or fund expansions. This is particularly useful when managing rental properties, as it allows you to enhance value and rental income without tying up personal funds.
Risks:
- Market fluctuations: Property values can go up or down, and market conditions can change rapidly. A downturn in the property market can lead to reduced property values, rental vacancies, or difficulty selling, all of which can impact your ability to repay the loan.
- Debt obligations: Loans come with repayment obligations that must be met regardless of the property's performance. Missed payments can lead to penalties, increased interest rates, or even foreclosure.
- Costs of borrowing: Investment loans often have higher interest rates, fees, and charges compared to residential mortgages. These costs can add up, eating into your returns and increasing the overall risk of your investment.
- Potential for negative equity: If property values fall, you could end up owing more than the property is worth. This situation, known as negative equity, can make it difficult to refinance or sell the property without incurring a loss.
How to choose the right loan for your investment
Selecting the best loan for your investment depends on several key factors:
- Investment horizon: Short-term investments, like flips or refurbishments, might be best served by bridging loans or hard money loans due to their quick turnaround times. Long-term investments, such as rental properties, generally benefit from buy-to-let or commercial mortgages with stable terms.
- Cash flow needs: Interest-only loans can improve cash flow by reducing monthly payments, making them suitable for investors prioritising short-term liquidity. However, they require a clear exit strategy to pay off the principal eventually.
- Property type: The type of property you're investing in will also guide your loan choice. Residential properties usually align well with buy-to-let mortgages, while commercial ventures will need more specialised financing like commercial property loans.
- Loan terms and conditions: Always compare the terms and conditions of potential loans, including interest rates, repayment schedules, and any fees or penalties for early repayment. A property investment loan calculator can be a valuable tool for understanding the total cost of borrowing and assessing different offers.
- Lender type: Work with lenders who have experience in property investment and can offer terms that align with your strategy. A reputable lender or broker can provide guidance tailored to your specific needs, helping you navigate the complexities of investment financing.
Alternatives to investment loans
Depending on the value of the property you’re considering, there are a range of alternatives to investment loans that can streamline your funding journey, especially in a period where many banks are cutting back on investment lending.
If you’re looking for simple investment funding, a short-term business loan can provide quick access to capital, without the long application process and need for collateral.
- Apply in minutes: With less documentation required and get approved in 24 hours.
- Accessible finance: Approvals based on your wider business financials, not just your credit score.
- Funding when you need it: Get money in your account the same day of approval, and repay early with no extra fees.
With iwoca, you can borrow from £1000 to £1,000,000 for up to five years. We approve the majority of applications in less than a day, and there are no hidden fees.
Find out how a small business loan from iwoca can help your investments grow.
FAQs about investment loans
- How can I get a loan for an investment property?
Start by assessing your credit score, preparing necessary documentation (like proof of income and an investment plan), and researching lenders that specialise in investment loans. Consulting with a broker can also streamline the process by matching you with the most suitable loan products.
- What type of loan is best for investment property?
The best loan type depends on your investment goals. Buy-to-let mortgages are great for long-term residential investments, while bridging loans are ideal for short-term projects that require quick access to funds. Consider your investment horizon, cash flow needs, and the type of property when choosing a loan.
- Can I get a business loan for a buy-to-let property?
Yes, business loans can be used for buy-to-let investments, especially when purchased through a limited company or an SPV. These loans can offer more flexible terms and are particularly useful for larger portfolios.
- How do interest rates compare between different investment loans?
Interest rates vary widely based on the type of loan and the lender. Buy-to-let mortgages typically offer lower rates compared to bridging or hard money loans, which come with higher costs due to their increased risk and short-term nature. Always compare rates using a loan calculator to ensure you are getting the best deal.
- What are the key considerations when choosing a lender?
Consider the lender's reputation, the terms they offer, the speed of their approval process, and their experience with similar investments. Choosing the right lender can greatly affect your investment's success, so it's worth taking the time to find one that meets your needs.
