Most lenders require you to make a down payment of at 15% to 25% to qualify for a mortgage for an investment property and some lenders may require a larger down payment for jumbo mortgages. Additionally, you may be required to make a larger down payment if the investment property does not generate a profit. For example, if a property is not profitable the borrower may not qualify for the mortgage if he or she does not have sufficient personal income to absorb the losses. In that case, the lender may require that the borrower make a larger down payment, which reduces the mortgage amount and mortgage payment, making the property more profitable for the buyer.
Use our Down Payment Calculator to understand the total upfront funds required to buy an investment property
As a general rule, although lender guidelines permit a lower down payment, you must typically put down at least 33% of the purchase price for the property to be cash flow break-even or profitable. Be sure to understand a lender’s down payment requirement upfront before you apply for a non-owner occupied mortgage.
Lenders can use several methods to calculate rental income for a property and the actual amount of rental income generated by a property may be different than the income figure used by the lender to determine your ability to qualify for an investment property mortgage.
To include rental income from an investment property to qualify for the mortgage, lenders typically require that you provide the Schedule E from your tax returns for the prior year to verify the income. Schedule E shows your income or loss from an investment property and lenders usually average the income and add back certain non-cash expenses such as depreciation.
This approach is more common when you are refinancing an investment property because your tax returns provide a record of historical rental income. Please note that if the property’s rental income has increased since your most recent tax return, you may not get full credit for the higher rent amount.
If you do not have a tax return that demonstrates the rental income, such as when you buy an investment property, lenders typically use the lower of 75% of the rental income according to an investment property appraisal report or 75% of income according to a signed lease agreement.
To prepare an investment property appraisal report, an appraiser compares the subject property to other investment properties in the area to determine the estimated market rent for the property. The appraised market rent may be higher or lower than the rent you actually receive when you lease the property.
Lenders apply a 25% discount to the rental income from the investment property appraisal report or executed lease agreements to account for vacancy and maintenance costs. To be even more conservative, the lender uses the lower of the two discounted figures to determine your ability to qualify for the loan.
So if 75% of the estimated monthly rent according to the investment property appraisal is $8,000 and 75% of the monthly rent according to signed lease agreements is $10,000, the lender uses the lower $8,000 figure to determine the mortgage you can afford.
It is important to highlight that if you are buying an investment property and have at least one year of experience receiving rental income or managing properties there is no limit to the rental income that can be included in your mortgage application.
If you do not have a one year history of receiving rental income or managing investment properties, there may be a limit to the rental income that is added to your application. In this case, you may be required to qualify for the mortgage based on your personal income and debt payments as well as other factors. This is why it is usually more challenging to qualify for a mortgage on your first rental property.
To summarize, it is important to understand how lenders determine rental income as the figure they use for your mortgage application may be lower than the actual or potential rent generated by the property.
When you apply for a mortgage on an investment property you must personally qualify for the loan. That means that the lender evaluates your credit score as well as your personal income and debt. If the property you are seeking to buy is not profitable after subtracting cost items such as property tax, homeowners insurance and homeowners association (HOA) fees from rental income, the loss from the property is considered personal monthly debt for the borrower. You must generate sufficient personal income from other sources to qualify for the mortgage according to the lender’s debt-to-income ratio requirement, after factoring in the monthly loss from the property.
If the property is profitable according to the lender's rental income guidelines, then this income is added to your personal income, improving your ability to qualify for the mortgage.
Lenders typically charge higher interest rate on investment property mortgages as compared to owner-occupied loans. Interest rates vary by lender, down payment, loan amount, loan program as well as other factors but non-owner occupied mortgage rates are typically 0.25% - 0.50% higher than owner-occupied mortgage rates.
The table below outlines investment property mortgage rates and closing costs for lenders in your state. Because there is a wider spread in rates and fees for investment property loans, borrowers should compare proposals from at least four lenders to make sure they find the best mortgage terms.
Closing costs for an investment property loan are typically higher than closing costs for owner-occupied loans. For example the appraisal report for a rental property is typically $200 - $300 higher than the appraisal for an owner-occupied property. Closing costs vary by lender, loan amount, loan program, property types and other factors but borrowers should budget for higher costs when they apply for the mortgage.
The reserve requirement for an investment property mortgage is six months of total monthly housing expense which is comprised of your loan payment, property tax, homeowners insurance and homeowners association (HOA) dues, if applicable. For example, if total monthly housing expense on the property being financed is $5,000 and the reserve requirement is six months, you are required to hold $30,000 in savings when the mortgage closes.
Please note that for a cash out refinance of an investment property, the reserve requirement is twelve months if your debt-to-income ratio is higher than 36% and your credit score is less than 720.
If you own a second home or additional investment properties, you are required to hold extra reserves to qualify for the mortgage. According to the guidelines below, the more properties you own, the higher the reserve requirement:
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 combined principal mortgage balance includes any loans on the properties such as HELOCs and home equity loans. The total mortgage balance used to calculate the extra reserve requirement, however, excludes the mortgage on your home and the investment property being financed.
For example, if you own two properties including your principal residence and the investment property you are getting the mortgage on, you are only required to hold six months of reserves for the investment property. But if you own three properties including your home, the investment property you are financing and another investment property, you are required to hold additional reserves equal to 2% of the outstanding mortgage balance on the second investment property.
Because guidelines and requirements for investment property mortgages vary by lender it is important to get pre-approved at the beginning of the mortgage process. Be sure you understand the lender’s policies regarding rental income, borrower qualification and what size mortgage you can afford. Establishing a relationship with a lender and getting pre-approved for your investment property mortgage will also allow you to move fast when you find a property you want to buy. Our get pre-approved form is easy-to-use, free and enables you to connect with multiple lenders to review loan terms.
Most conventional and government-backed no or low down payment mortgage programs such as the FHA, VA and USDA programs as well as the HomeReady Program only apply to owner occupied properties so you cannot use them to finance the purchase of an investment property. In most cases, however, you can use these programs to purchase properties with up to four units but at least one of the units needs to lived in by the individual(s) who obtained the mortgage to purchase the property. The USDA home loan program only applies to single-family residences.
"Rental Income Matrix." Freddie Mac Learning. Freddie Mac, December 2019. Web.