Non-Owner Occupied Mortgage Overview
An owner occupied property is the primary residence in which you live. A property with up to four units is considered owner occupied as long as the owner lives in one of the units. Second homes, such as vacation homes that reside outside of the county in which you live, are also considered owner occupied properties. The occupancy status is determined at the time you apply for a mortgage. For example, if you intend to live in the property after your loan closes, then the mortgage is classified as owner occupied.
A mortgage on property in which you do not live is considered a non-owner occupied mortgage. Investment properties such as a property with up to four units that you buy to generate rental income are considered non-owner occupied properties. If you intend to rent out the property then the mortgage is classified as non-owner occupied.
It is important that you provide accurate information regarding property occupancy when you submit your loan application. If your circumstances change after your mortgage closes you are fine as long as your mortgage application was truthful at the time. For example, you may get a job transfer six months after your mortgage closes and decide to rent out the property. Alternatively, some borrowers may decide to move into a non-owner occupied property, such as an investment property. The borrower must live in the property for at least a year for the property to be re-classified from non-owner occupied to owner occupied.
The table below shows investment property interest rates and fees for leading lenders in your area. We recommend that you shop multiple lenders to find the best loan terms for an investment property mortgage.
Investment property mortgage rates are usually 0.25% - 0.50% higher than the interest rates for a home you live in because of the higher risk and complexity associated with non-owner occupied loans. Closing costs, such as the appraisal report fee, for investment property mortgages are also usually higher because you need a rental property appraisal, which requires additional analysis and work.
Most lenders also require that borrowers contribute a larger down payment when obtaining mortgages for investment properties, especially for larger, jumbo mortgages. Lenders may require the borrower to make a down payment of at least 25% of the purchase price for a two-to-four unit non-owner occupied property, for a loan-to-value (LTV) ratio of 75% or less, although lenders may require a down payment of only 15% for a single unit investment property if you are not taking cash out.
For a cash-out refinance on a non-owner occupied property lenders typically permit a maximum LTV ratio of 70% - 75%, depending on the number of units in the property. The lower the LTV permitted by the lender, the greater the down payment (in the case of a purchase) or equity contribution (in the case of a refinance) the borrower is required to have. By comparison, you can qualify for an owner occupied mortgage with little or no down payment, depending on the loan program you use.
Additionally, lenders require you to have a certain amount of money in reserve when you get a mortgage for an investment property. The reserve requirement for most non-owner occupied mortgages is six months of total monthly housing expense, which includes your loan payment, property tax, hazard insurance and homeowners association (HOA) dues, if applicable. The reserve requirement is twelve months for a non-owner occupied cash out refinance if your debt-to-income ratio is higher than 36% and your credit score is lower than 720. Please note that the reserve requirement for a rental property is significantly higher than for a mortgage on your primary residence, which may not require any reserves.
You may also be required to hold additional reserves if you own other properties financed with a mortgage. As we highlight below, the extra reserve requirement depends on the number and type of properties you own:
- One to four properties: 2% of the combined outstanding mortgage balance
- Five to six properties: 4% of the combined outstanding mortgage balance
- Seven to ten properties: 6% of the combined outstanding mortgage balance
The total outstanding mortgage balance includes any home equity loans and HELOCS on the properties. The total mortgage balance, however, excludes the mortgage on your primary residence and the non-owner occupied property being financed.
For example, if you own a total of four properties comprised of the rental property you are financing, your primary residence and two other rental properties, the extra reserve requirement is 2% of the total outstanding mortgage balance on the other two non-owner occupied properties.
We should also highlight that mortgages on owner occupied and non-owner occupied properties are treated differently for tax purposes. According to the U.S. tax code, mortgage interest expense for owner occupied properties (on mortgage amounts up to $750,000) can be deducted from your gross income, which provides a significant tax benefit. The mortgage tax deduction benefit does not apply to non-owner occupied properties which is an important consideration for borrowers. Interest expense, property tax and other expense items, however, do offset any rental income which reduces the taxes owed on an income property. Be sure to consult a tax professional to understand the tax rules that apply to non-owner occupied mortgages and investment properties.
Finally, most conventional and government-backed low or no down payment mortgage programs such as the FHA, VA and USDA home loan programs as well as the HomeReady program only apply to owner occupied properties. You can use all these programs except the USDA program; however, to purchase properties with up to four units but at least one of the units needs to be owner occupied.
If you are buying a rental property, lenders review the projected cash flow profit or loss from the property to assess your ability to qualify for the loan. To determine the rental income for the property, lenders usually use 75% of projected income according to the rental property appraisal report or 75% of rental income according to signed lease agreements. Lenders use 75% of rental income instead of 100% to account for vacancies as well as property maintenance costs and one-time expenses.
If you are buying a rental property and have at least one year of landlord or property management experience, the lender usually uses the rental property appraisal approach and there is no limit to the income that can be included in your loan application.
If you do not have a one year history of receiving rental income or property management experience, there may be a limit to the income that is added to your mortgage application as rental income can only be used to offset the total monthly housing expense for the property being financed. Additionally, if you do not own or rent your primary residence then no income from the investment property is included in your application. In these scenarios, you may be required to qualify for the mortgage based on your personal income and finances, which is usually more challenging.
If you are refinancing a non-owner occupied property, lenders typically require documentation such as the Schedule E from your tax returns for the prior year to verify the rental income. For a refinance, lenders also review any executed rental agreements to understand projected rental income in the future, although lenders usually use the lower rent figure. In short, for both purchases and refinances, lenders tend to be as conservative as possible when they calculate rental income for non-owner occupied mortgages.
Use our free personalized mortgage quote form to compare no obligation proposals from leading lenders. Our quote form is easy-to-use, requires minimal personal information and does not impact your credit. Comparing loan quotes is the best way to save money on your investment property mortgage.
Lenders use the rental income figure to determine the projected cash flow or loss for the property. Property cash flow is usually defined as rental income minus total monthly housing expense including your mortgage payment, property tax and insurance as well as expected maintenance costs. If the property is projected to generate positive cash flow, then that income can help you qualify for the mortgage. If the investment property is projected to produce a cash flow loss, any losses are included in the monthly debt figure used to calculate your debt-to-income ratio, which can make it more difficult to qualify for a non-owner occupied mortgage.
For example, if you have $500 in total personal monthly debt from credit cards, auto and other loans and the rental property you want to buy loses $200 per month in cash flow, the lender will use $700 ($500 in personal debt + $200 in property cash flow losses )as your monthly debt figure to determine what size mortgage you qualify for. The higher your monthly debt, the lower the mortgage amount you qualify for.
You must generate sufficient personal income from other sources, after factoring in any monthly loss from the investment property, to qualify for a non-owner occupied mortgage. As a general rule, a buyer must typically make a down payment of at least 33% for a rental property to be break-even or profitable on a cash flow basis. This does not mean you need to put down 33% of the purchase price to qualify for the mortgage, but you need to show that you make enough money personally to absorb any potential monthly cash flow loss that may be associated with making a lower down payment and having a higher loan amount and monthly payment.
Use the FREEandCLEAR Lender Directory to find top-rated lenders that offer investment property loans.
Sources
"Standard Eligibility Requirements: Investment Property." Eligibility Matrix. Fannie Mae, October 2 2019. Web.
"Rental Income Matrix." Freddie Mac Learning. Freddie Mac, December 2019. Web.
"B3-3.1-08, Rental Income." Selling Guide: Fannie Mae Single Family. Fannie Mae, February 5 2020. Web.
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