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Investment Property Loans: What They Are and How to Find One

Investment property loans help you purchase homes to rent out for extra income or to flip and sell for a profit. These loans typically have higher barriers to entry than traditional mortgages — and higher interest rates. Always shop around to find a lender that offers the most competitive rental property loans.

What is an investment property?

An investment property includes any residence from which you earn rental income or you purchase to flip and sell for a profit. A condo, apartment, manufactured home or house can qualify as a rental property, even if you live in it yourself for part of the year. Investment properties usually refer to one- to four-unit residential homes rather than commercial properties, such as apartment complexes and shopping centers.

What is an investment property loan?

Investment property loans carry higher mortgage rates and stricter lending standards than standard mortgages, including higher down payment amounts. To qualify for investment property financing on a single-family home, you’ll need a down payment of at least 15%-20%. If you have good credit, you may qualify for the lower 15% down amount, depending on the lender. Rental property loans for multifamily homes require a 25% down payment.

An investment property loan is very different from taking out a mortgage on a vacation home. The loan requirements for vacation homes are less stringent than investment property loans. Your down payment on a vacation home may be as low as 10%. The cash reserve requirement on a vacation home can be as little as two months, whereas you’ll need at least six months set aside for an investment property.

Location also factors into a vacation home mortgage. If the property is too close to where you currently live — say, within 50 miles or in the next town over — the lender may view the purchase as an investment property, in which case the stricter lending requirements would apply.

Financing options for rental properties

Conventional investment property financing. A conventional loan is your only option if you want to buy a true investment property — that is, a property you plan to rent or sell, but not live in. Conventional loans require 15%-25% down (depending on the type of property you’re buying), and the credit score minimums will be higher than government programs. However, you’ll also have the flexibility to own the property without a residency requirement.

FHA multiunit financing. Loans backed by the Federal Housing Administration (FHA) are attractive if you’re struggling to save up for a big down payment or if your credit score is under 620. The credit score and down payment requirements for an FHA loan for an investment property are lower than conventional loans, and you can use rental income to qualify. But there is a catch: You must reside at the property for a minimum of 12 months.

VA multiunit financing. Loans guaranteed by the U.S. Department of Veterans Affairs (VA)  don’t have a minimum credit score or down payment requirement. Qualifying active-duty service members, veterans and eligible spouses can use a VA loan to buy a property with up to seven units, including one designated for business. The borrower must live in one of the property units.

Alternative financing. Perhaps you have a substantial down payment and excellent credit, but you want to avoid the cumbersome income documentation process required by institutional lenders. If that’s the case, a debt-service ratio loan through a banker or mortgage broker might make sense for you. This is an alternative loan and will likely carry a higher interest rate than other financing, but you might get a lower monthly payment with an easier loan process. To qualify, you’ll need a high credit score, a down payment of 25%-30% and proof that your monthly rental income is at or above your monthly loan payment.

Where to find investment property loans

You have several options when looking for an investment property mortgage. Investment property lenders include:

  • Banks
  • Credit unions
  • Online lenders
  • Hard money lenders

Traditional rental property lenders — banks, credit unions and even online mortgage lenders — vet your credit report and your overall finances to determine whether you can repay an investment loan.

On the other hand, hard money lenders are private investors who specialize in real estate lending. They may be willing to finance a property without running a credit check, but you’ll pay for that leniency with a higher interest rate. You’ll also have a shorter repayment period than you would with traditional investment property lenders. Hard money lenders also charge a prepayment penalty and other fees, and typically require a higher down payment, perhaps upward of 30%.

In some cases, a hard money lender can finance a house flip, for example. But they can work on shorter timelines, giving you a very small margin of error for completing a fix-and-flip sale, Burgess said. If you fail to repay the loan on time, you’ll default and lose the property to foreclosure.

“It’s a very competitive market, so you have to be really careful when you’re thinking about buying flips,” Burgess said. “What you don’t want to do is buy something for too much [money] and put too much into it and not be able to sell it for what you’ve got into it.”

Investment property loan requirements

Taking out an investment loan is similar to the mortgage you’d take out for your primary residence — just with stricter requirements. Here’s a closer look at lending guidelines for rental property loans.

Down payment

As noted above, you’ll need a 15%-20% down payment to buy a single-family investment property, depending on your credit score. To purchase a multifamily property, you’ll have to put down 25%.

The down payment requirements for a mortgage on a rental property are less stringent if you plan to live in the home. Let’s say you’re buying a townhouse with two separate units, and you’ll reside in one while renting the other. You may be able to put down just 15% since you’ll be living on the property.

And if you’re looking for an even lower investment property down payment, consider an FHA loan or VA loan for multifamily properties. Let’s say you’re looking for investment property loans with 10% down because you’re eager to get started but haven’t saved up more for a down payment. As long as you’re willing to live on the premises and qualify for an FHA or VA loan, your down payment for the rental property can be as low as 3.5% for the former and 0% for the latter.

Qualifying rental income

You may also be able to use potential rental income to qualify for a loan. Lenders will credit $0.75 on the dollar using the current market rate when factoring in rental income as part of your application. So, if the market rate for a rental similar to the one you’ll own is $1,000 a month, the lender will calculate $750 a month into your income information.

Credit score

The stronger your overall financial profile, the more flexibility a lender may offer on down payment requirements and interest rates. A high credit score combined with six months of cash reserves and a low debt-to-income (DTI) ratio are keys to getting approved for investment property financing.

Jill Burgess, a loan officer with Ameris Bank in North Carolina, says that for conventional investment property loans, lenders prefer a minimum credit score of 680 or 700. You’ll need a minimum of 680 if you plan to put down 15%-20%. If you can put down 25 or more, the minimum score is 640, though the reserve requirements may be higher.

Cash reserves

A six-month cash reserve is crucial for making repairs and paying for rental property expenses that inevitably pop up. Owning a rental property means you’re responsible for maintenance, repair and property holding costs.

“You’re going to have time when there may be no tenant in there, so you’ve got to be able to carry this without a problem and have excess funds,” said Dennis Nolte, a certified financial planner with Seacoast Investment Services in Winter Park, Fla. “What if the roof needs repair or the plumbing? You’ve got to have excess funds.”

Reserve requirements vary based on the type of investment property loan, how many other investment properties you own and your financial history.

Guideline  Conventional investment loan  FHA multifamily (2-4 units) VA multifamily (2-4 units)
Down payment 15% (1-2 unit)
25% (3-4 unit)
3.5% 0%
Debt-to-income ratio 36% or 45% 43% 41% (higher DTI may be acceptable, depending on your circumstances)
Minimum credit score 640 500 (with 10% down); 580 (with 3.5% down) No guideline minimum
Cash reserves 6 months 3 months 6 months if rental income is used to qualify
25% vacancy *Yes; use 75% market rents to qualify *Yes; use 75% market rents to qualify *Yes; use 75% market rents to qualify

*Note that not all lenders will calculate rental income into your application, particularly if you haven’t been a landlord before. Speak with several lenders when looking for investment property loans and find out whether this rental income is considered.

FAQs about rental property loans

How high are investment property mortgage rates?
Investment property mortgage rates are typically 0.50 to 0.875 percentage points higher than owner-occupied mortgage rates. They can be more than a full point higher, depending on your credit profile, down payment and reserve requirements.

Can I include rental income to qualify for an investment property loan?
Yes, although this varies from lender to lender. Some won’t allow you to include rental income on an investment property loan application unless you’ve been a landlord before. Others don’t count rental income, period. If your lender does permit you to count rental income, it’s typically capped at 75% of the market rate.

Do the rules for rental property financing also apply to second/vacation homes?
Buying a rental property and a vacation home are not categorized the same way, and rental property lending guidelines are more stringent, which we touched on earlier.

Is it possible to buy a rental property with no money down?
No, especially not with institutional lenders. Investment properties represent higher risks for lenders than owner-occupied homes. Because you aren’t living in the house, you’re more likely to walk away from the property. Although your credit will suffer, you aren’t losing the roof over your head. Since the lender is taking on more risk, they want more money down to minimize potential losses.

 

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