Getting really low investment property mortgage rates can turn a poor yield into an okay one, an okay one into a good one, and a good one into an excellent one. So, if you are thinking of investing in real estate, you will want to discover what you need to do to qualify for ultra-low rates.
But even the best mortgage rates can't rescue someone who makes the sorts of mistakes inexperienced property investors commonly risk. So read on to discover how to avoid some of the worst pitfalls and get some of the best rates possible.
Investment Property Mortgage Rates
With some exceptions (below), mortgage rates and down payments on investment properties are typically higher than they are on homes for owner-occupation. That's because lenders perceive the risks on rental homes to be much higher. You can see why:
- Private mortgage insurance is generally unavailable on rental properties, so a minimum 20 percent down payment is pretty much inevitable. Some lenders want borrowers to put down more.
- Some renters look after homes less carefully than many homeowners, meaning there's a greater chance of rental homes losing value through misuse or even outright vandalism, or of them appreciating more slowly. That is a larger risk to the lender since that property is their security on your loan.
- Nearly all rental homes go unoccupied from time to time. If those periods are long, that might undermine a borrower's ability to make mortgage payments.
- If you want to count the rent you're going to receive toward your debt-to-income ratio (DTI) calculation, you may need to show a successful record as a property investor. Some lenders want you to have at least a two-year history of running one or more rental homes profitably before they'll count expected rent as income.
With most mortgages, the 20 percent down payment is unlikely to go away (though read on to find exceptions even to that). But the extent to which investment property mortgage rates will be higher than equivalent rates for owner-occupied homes will depend on whether:
- You can afford to keep up with mortgage payments, even if rents on the new property don't materialize.
- You're buying an existing rental property with a long history of good tenants, high occupancy, and on-time rent payments.
- You're already a property investor with a proven eye for picking winning homes and tenants, and making good profits.
- Your personal credit score is good or excellent.
- Your non-mortgage debts are easily manageable.
Down Payment Exceptions
Some types of government-backed mortgages let you buy an investment property with a small or zero down payment. However, these programs apply only to a single building containing 1-4 residential units and you must occupy one of those units yourself for at least a year.
These programs have various rules and eligibility criteria, so you need to research whether you and your plans qualify. Federal Housing Administration mortgages (FHA loans) can see you buy a duplex, triplex or 4-unit building with as little as 3.5 percent down. Some borrowers backed by either the Veterans Administration (VA loans) or the United States Department of Agriculture ( USDA loans) can get away with paying nothing for their down payment. Discover below why these can be a great back door into property investment.
Investment Property Loan Products
Unless you opt for one of those government-backed programs, you will go with a "conventional mortgage," which by definition is one not backed by the government. Those fall into two groups: "conforming loans," which comply with Freddie Mac's and Fannie Mae's rules, or non-conforming ones that don't.
Conforming and Non-Conforming Loans
The main reason you are likely to choose a non-conforming loan (also known as a "jumbo loan") is because Fannie and Freddie have caps on the value of loans, and those won't cover more expensive purchases. In 2017, those limits across most of the U.S. are $424,100 for a single-unit home, stepping up to $815,650 for a building comprising four residential units. If you want to buy in an area that's officially designated as one with high home prices, those figures are $636,150 and $1,223,475 respectively. And there are even higher caps for residential properties in Alaska, Guam, Hawaii, and the U.S. Virgin Islands. For more details, see the relevant page on Fannie Mae's website. With non-conforming loans, it's up to you and your lender to reach a mutually beneficial agreement, largely free of government rules.
Compare Apples with Apples
Mortgage rates are likely to vary between types of mortgages as well as different lenders. It is important to look at overall mortgage costs rather than just rates. For example, with an FHA loan, you'll typically pay 1.75 percent of the purchase price on closing as an upfront mortgage insurance premium (UFMIP), followed by mortgage insurance premiums every month for the lifetime of your loan. That can change the math when you're comparing different types of mortgages. Learn more at FHA Mortgage Insurance 2017: What, Why and How Much.
Similarly, VA loans usually have funding fees, though, no continuing insurance premiums. However, some borrowers are exempt from those fees.
Low Mortgage Rates Aren't The Only Things to Analyze
Real estate investors are like all other investors: You're more likely to be a good one if you take a hard-headed, math-based, strategic approach. True, some people do well with little more than gut feelings and luck, but your chances of making serious money are improved if you adopt a more businesslike attitude.
A good place to start is by writing a business plan, perhaps using the generic model suggested by the U.S. Small Business Administration. This might impress lenders further down the line, but, just as importantly, it will force you to think through and research what you're getting into. That's because, to create a good one, you're going to have to understand your local property market, which involves talking with local real estate practitioners and other professionals, including tax advisors.
Writing a business plan will prompt you to ask yourself important questions, including the following 10:
- Am I looking to get just a bit of extra income and some capital appreciation, or is this the start of a substantial business?
- Am I willing to turn out at 11:00 pm to fix leaking pipes and spend Saturday afternoons repairing roofs, or will I use plumbers, contractors, and similar professionals? Because that decision could radically affect my cost base.
- If I'm looking for a business, do I want to own lots of cheap homes or a few upscale ones – or a mix?
- If I'm doing my own maintenance, do I need all the homes I buy to be close to where I live?
- Do I need to pay someone else to vet new tenants (interview them, do credit checks, and follow up on references) and to collect/chase rents? Or will I do that myself?
- Do I recognize all the different costs property investors face? These include periods without rent when the home is unoccupied or the tenant can't pay, insurances, homeowners association fees, some utilities, maintenance, real estate taxes, and so on.
- Do I understand the tax advantages and liabilities that come with property investment?
- Do I know what a "cap rate" is and how to calculate one?
- Am I confident I know how to get the best investment property mortgage rates for someone in my position?
- Do I understand the dynamics of my local property markets – those for both sales (when I want to buy) and rentals? What directions have they taken in recent years?
Does that list excite or horrify you? If you're a natural property investor, it should spur you on to learn more. If it doesn't, you could consider investing in a property company or a real estate investment trust (REIT), where other people do the hard work. Or you might prefer to "flip" homes - buying run-down houses and rehabilitating them before selling them quickly for a profit.
New to Investment Properties? The FHA Approach
Remember the promise earlier to explain why FHA, VA and USDA loans can be a great back door into property investment? Well, here is that explanation.
Mortgage lenders see too many first-time property investors who are full of enthusiasm but terribly naive about what's involved. Often, even applicants whose loans are approved sell the properties within a short time, once reality dawns.
So those lenders reserve their best deals for applicants who have already demonstrated success running property investment ventures. And that creates a Catch-22 situation: You can't get a good loan until you've proved you can succeed, but you can't succeed (at least as well as you might have) without a good loan.
FHA, VA, and USDA loans can help you around that obstacle. As described earlier, providing you qualify, you can easily buy a building containing 1-4 residential units, and live in one while renting out the other(s). You can even do so with a very low – possibly zero – down payment. The main condition is you must live in one of the units for at least a year. You should normally be able to count most of your appraised, likely rental income as part of your income, though, not all because of those inevitable costs you're going to have. Seventy-five percent is not uncommon.
But two years on, you should, if things have gone well, have your proven record of success. And that could be your passport to new and ever better opportunities.
Getting the Best Rate on Your Investment Property
The process for getting the best investment property mortgage rates is very similar to getting the best rate on your own home. That's because, until you acquire the status of a large property investment corporation, you're going to be borrowing the money personally. And you're going to be borrowing more and more often than most people, so you need to obsessively focus on remaining an attractive mortgage applicant.
The things that are likely to get you the best possible mortgage rates are:
- A great credit score – Monitor and actively manage yours continually. LendingTree can help you do that at absolutely no cost.
- Keep your non-mortgage debts to a minimum – The lower your debt-to-income ratio, the better.
- Save – Mortgage lenders are always going to like and reward big down payments. The bigger your reserves, the more likely you are to ride out rough patches, which is another thing that could earn you a lower rate.
The final thing you must always do to get a great deal every time is shop around between lenders. Even if you have built an excellent relationship with a particular mortgage company or broker, there is always a real chance of finding something better elsewhere.
It is depressing that, in a 2013 survey by federal regulator the Consumer Financial Protection Bureau, very nearly half of borrowers consulted only one lender or broker before signing up for a mortgage. That decision will have cost some people thousands in lost savings. But it would be so much worse if someone who wanted to be a professional property investor made the same basic error.