Do You Have to Put 20% Down on an Investment Property?

Investing in real estate offers a pathway to building wealth and generating passive income, but financing for investment properties differs significantly from primary residences. Lenders have different expectations for down payments on investment properties. Understanding these distinctions is important for anyone considering real estate.

Standard Down Payment Expectations for Investment Properties

Investment properties typically require a down payment of 15% to 30%, substantially higher than the 3% to 5% seen for primary residences. Lenders consider investment properties higher risk because they are not owner-occupied, increasing the likelihood of default if an investor faces financial difficulties. Investors may be more inclined to walk away from a rental property than their primary home.

Conventional loans require a minimum 15% down payment for single-family investment properties. For multi-family properties (two to four units), this can increase to 25%. Lenders also assess other financial metrics to qualify borrowers.

A credit score of at least 680 to 700 is necessary, though 700 or higher is needed unless a 25% or more down payment is made. Lenders look for a maximum debt-to-income (DTI) ratio of 45%, though some accept up to 50% with automated underwriting. Borrowers are required to have cash reserves equivalent to at least six months of mortgage payments to cover expenses during vacancies or challenges.

Financing Options for Lower Down Payments

While conventional loans require substantial down payments, alternative financing options allow investors to secure properties with less upfront capital. These options come with different terms, risks, and qualification criteria.

Portfolio loans are offered by banks or private lenders who keep the loans on their books. This allows for greater flexibility in underwriting standards compared to conventional loans. While some portfolio loans may demand higher down payments, between 20% to 30%, they can be more adaptable to unique borrower situations, such as those with non-traditional income sources or multiple properties.

Hard money loans are short-term, asset-based loans used for distressed properties or quick renovations, such as fix-and-flip projects. These loans have faster closing times and less stringent approval processes, focusing on the property’s value rather than the borrower’s credit score. Down payment requirements range from 10% to 30% of the purchase price, though some lenders may offer 100% financing if costs fit within a specific percentage of the after-repair value. Hard money loans come with higher interest rates and shorter repayment terms, ranging from six to 24 months.

Private money loans, sourced from individuals or private groups, offer another flexible financing avenue. Similar to hard money loans, these are more adaptable than traditional bank loans, with terms negotiated directly between the borrower and the lender. This flexibility may lead to lower down payment requirements, depending on the relationship and the specific investment opportunity.

Seller financing, where the property seller acts as the lender, eliminates the need for traditional bank financing and may reduce the required down payment. Terms, including down payment, interest rate, and repayment schedule, are directly negotiated between the buyer and seller, offering a highly customizable arrangement.

The “Buy, Rehab, Rent, Refinance, Repeat” (BRRRR) method minimizes initial cash outlay for investors. This approach involves purchasing a distressed property, renovating it, renting it out, and then performing a cash-out refinance based on the property’s increased value. The cash from the refinance can then be used for the down payment on the next investment property, allowing investors to recycle their capital. This method relies on using a short-term loan, like a hard money loan, for the initial purchase and rehab, followed by a long-term conventional refinance.

For multi-unit properties (duplexes, triplexes, or quadplexes), a strategy known as “house hacking” enables lower down payments. If an investor lives in one unit, the loan is considered a primary residence mortgage, qualifying for lower down payments offered by government-backed programs. FHA loans require as little as 3.5% down, and VA loans, available to eligible service members and veterans, offer 0% down. Note that these low-down-payment options are only applicable when the property is owner-occupied, meaning the investor must reside in one of the units, distinguishing it from a purely investment property.

Variables Affecting Down Payment Requirements

Lenders evaluate several factors when determining the down payment for an investment property loan, leading to variations even within similar loan types. The borrower’s creditworthiness plays a significant role; a higher credit score, above 740, leads to more favorable loan terms and lower interest rates, although lower down payment requirements are less common for investment properties.

The debt-to-income (DTI) ratio, which compares a borrower’s monthly debt obligations to their gross monthly income, is another factor. Lenders scrutinize this ratio closely for investment properties, preferring it to be below 36%, though some may accept up to 45% or higher depending on the loan program and automated underwriting. A lower DTI indicates less risk for the lender.

The loan-to-value (LTV) ratio, the inverse of the down payment, also influences requirements. It is calculated by dividing the loan amount by the property’s appraised value. A lower LTV, meaning a higher down payment, signals less risk to the lender and results in better loan terms.

The type and condition of the property itself affect lender assessment. Lenders perceive different levels of risk for single-family homes, multi-family properties, or properties requiring extensive repairs. For example, multi-family properties require a larger down payment than single-family investment properties. Lender-specific policies also create variations; different financial institutions have varying appetites for risk and internal guidelines, which influence their down payment demands. Finally, broader market conditions and economic stability impact lender requirements, with stricter terms imposed during periods of economic uncertainty.

Financial Impact of Down Payment Choices

The size of the down payment directly influences an investor’s financial obligations and the profitability of an investment property. A larger down payment reduces the principal loan amount, leading to lower monthly mortgage payments. This also translates to less total interest paid over the life of the loan, as the borrowed capital is smaller.

Unlike primary residence loans, where private mortgage insurance (PMI) is required for down payments less than 20%, traditional PMI is not a factor for investment property loans with lower down payments. Instead, lenders for investment properties build higher interest rates or other fees into the loan to offset the increased risk associated with less equity.

The down payment choice also affects the property’s cash flow. A higher down payment results in lower mortgage payments, which improves the property’s net income and results in more positive cash flow. This increased cash flow provides financial stability and flexibility for the investor. Conversely, a smaller down payment means higher monthly debt service, which reduces cash flow and makes the property less profitable on a monthly basis.

Considering the return on investment (ROI) and cash-on-cash return, there is a trade-off. A lower down payment means higher leverage, which amplifies returns if the property appreciates significantly. However, it also increases financial risk due to higher debt obligations. A higher down payment, while reducing potential leverage-based returns, offers lower monthly costs and reduced risk, appealing to investors who prioritize stability and lower debt exposure.