Investment Property Mortgage Rates
Buying an investment property can have many perks. Real estate investments can diversify your portfolio, and a rental property can offer an additional source of monthly income. With that said, there are a few things to consider before leaping into investment property ownership.
Unless you hire a management company, you’ll have to take on the role of landlord, which means collecting rent and possibly fielding late-night calls about broken appliances. There’s also the financing aspect. Obtaining a mortgage for an investment property isn’t the same as securing a mortgage for a one-unit primary residence. Interest rates are generally higher, and the requirements you must meet for financing are typically more stringent.
Buying an investment property — how is it different?
Lenders take on an added level of risk when lending money to investors. The higher risk leads to higher interest rates, higher down payment requirements and stricter eligibility guidelines.
Why are lenders hesitant to lend to property investors? Periods of vacancy can make it difficult for investors to keep up with payments. When times get tough, investment property owners can cut their losses and run.
“Think about it, if someone runs into financial problems, are they going to pay the mortgage on the roof over their head where they live, or are they going to pay the mortgage on the investment property that they can just walk away from?” said Michael Ianno, executive vice president of retail production at Residential Mortgage Services Inc.
Lenders want to make sure that borrowers are creditworthy and capable of keeping up with the financial demands of owning an investment property before money exchanges hands. Here’s what to expect when shopping for a mortgage for an investment property.
Higher interest rates
Depending on your down payment and credit score, interest rates on rental properties can be anywhere from 0.50 to 0.875 percentage points higher than what you’ll find for an owner-occupied residence with the same qualifications, according to Ianno, who is based in South Portland, Maine.
“Today, for example, you might see around 4.625% for a primary residence for a 30-year fixed-rate [mortgage] and 5.25% to 5.50% for an investment property,” Ianno said. This estimate is based on the assumption that you have at least good credit or better.
Average credit may get you approved, but good credit is better
A 620 FICO Score is the bare minimum for an investment property. But it’s important to keep in mind that a FICO Score of 620 to 680 could help you secure approval, but maybe not for the most competitive interest rate. Costs are key when purchasing an investment property. A few percentage points can make an investment worthwhile or a money pit, Ianno said. Having a high credit score (700-plus) and a sizeable down payment could secure you the best deal.
A larger down payment required
The down payment requirement is one of the biggest differences between a home loan and an investment property loan. According to Freddie Mac, the down payment for a one-unit investment property is at least 15%. In comparison, a one-unit primary residence could require just 3% percent down. For multi-unit property investments, 25% down is typically required if you don’t live on site.
Down payments for occupied multi-unit homes
You may be able to catch a break if you buy a multi-unit property and live on the premises. If you live on site, “Up to four units is still considered to be a primary residence and treated like a primary residence loan,” said Vladimir Kouznetsov, a financial adviser and certified financial planner based in Irvine, Calif. Primary residence loan guidelines may give you a bit more leeway, and first-time investors may find this scenario ideal. Here’s why:
- A potentially lower down payment. You may be able to put down just 15% to 20% on a conventional loan for a multi-unit property if it’s also your home.
- Gift funds may be allowed. Gift funds aren’t accepted for an investment property in which you won’t be living. But you may be able to use gift funds for a multi-unit property that will be your primary residence.
Down payment requirements can vary from lender to lender based on your credit and the type of investment property. A lender can ask for a higher down payment at its discretion. Some government-backed products may let you put down less than 15% for owner-occupied homes — duplexes, triplexes and fourplexes. We’ll cover low down payment options below.
Debt-to-income (DTI) requirements are relatively the same
Your DTI ratio is used to determine if you can afford a loan. The calculation compares your monthly debt payments to your monthly income. There isn’t too much difference between what’s required for a primary residence and an investment property. The Fannie Mae eligibility matrix sets the DTI maximum at 36% to 45%. The challenge can lie in determining the income that goes into the equation. Your income needs to be enough to cover the payment for the investment property. We’ll discuss this next.
Lenders qualify your employment and income
Lenders want to make sure that you earn or will earn sufficient income to cover the mortgage, so they like to see that you have a stable job and long working history. If you have rental income from other properties, you will have to turn in tax documents to prove it. Projected rental income for the property you’re buying may be used to qualify you for a mortgage, but there’s a process to follow and documentation you need to provide.
An appraisal may be done to determine the market rent for the property you’re buying. In this case, Form 1007 or Form 1025 may be used. If there’s already a present renter with a lease living in the property, the lender will need to verify the lease agreement that’s being transferred to you.
Cash reserves matter
Lenders look at cash reserves. Cash reserves are liquid assets you have on hand after you pay the down payment and closing costs. Typically, lenders look for six to 12 months’ worth of mortgage payments in cash reserves for investment properties. Since an investment property can be risky, the extra cash cushion shows that you’ll have money to tap into if the rent checks stop coming. A lender may require less cash in the bank on reserve if you have a higher credit score and down payment.
Options for financing an investment property
Conventional loans are the most basic of mortgages. The eligibility guidelines covered above are common of conventional loan products. Conventional loans, often called conforming loans, are not government-backed, but they are eligible to be bought by Fannie Mae and Freddie Mac because they “conform” to certain standards. Fannie Mae and Freddie Mac are two government-sponsored enterprises that stabilize mortgage markets by purchasing mortgages from lenders that meet their guidelines. When it comes to investment properties, the guidelines for conforming loans are a bit more strict because of the risk.
FHA loans and VA loans
FHA loans are home loans backed by the Federal Housing Administration. You’re probably familiar with the FHA loan program because it allows down payments of 3.5% to 10% for qualified borrowers. The FHA loan is only an option if you want to buy a multi-unit dwelling and you’ll be occupying one of the units. The home has to be your primary residence, and properties with up to four units qualify.
VA loans are backed by the U.S. Department of Veterans Affairs and offer low down payment options to veterans and eligible spouses. This loan may even offer 100% financing. Like the FHA loan, you may be able to purchase a multi-unit property with a VA loan as long as it has a maximum of four units and it’ll be your primary residence.
Home equity loans or HELOCs to help with a down payment
If you already own a home, you could tap into your home equity for a home equity line of credit (HELOC) or home equity loan to get the funds you need for a down payment. A HELOC is a line of credit that you use and pay back as needed. Typically, these products have a draw period followed by a repayment period. HELOCs usually have an adjustable interest rate that starts low, which is something to be mindful of when weighing it as an option. You can compare potential HELOC offers here.
Home equity loans are installment loans with a fixed rate for a fixed term. Interest rates for these products can be pretty competitive, and you can compare home equity loan products here. Borrowing from home equity for an investment property is something you should think about carefully. If you’re unable to make payments on the money you borrow, you could lose your primary residence.
Loans from private lenders and investors
You may be able to bypass the rules of traditional lenders if you find a family member, friend, private lender or investor to finance your home. Beware — these options can be pricey. For example, hard money loans are a unique type of financing that may be offered by private investors for distressed properties or in other situations where borrowers aren’t able to secure financing. Usually, hard money lenders will require a 30% down payment to make sure the borrower has skin in the game, Kouznetsov said. These loans are typically designed for a short period and can have high origination fees and interest rates.
Is an investment property right for you?
If you’re considering an investment property, it’s important to know the process won’t be the same as it was for your present home. The dollars and cents matter when purchasing an investment. If you have less-than-stellar credit and not much for a down payment, these are things you should work on before investing.
Lenders are a bit tougher on investment property applications for a good reason. You and the lender are both taking on risk. Having to meet stricter underwriting guidelines may seem like a nuisance, but it’s to ensure you’re taking on a financial responsibility you can handle.