»
»
How to Get a Mortgage on an Investment Property

How to Get a Mortgage on an Investment Property

Harry Jensen, Trusted Mortgage Expert with 45+ Years of Experience
, Trusted Mortgage Expert with 45+ Years of Experience
Getting a mortgage for an investment property is different than getting a loan on a property that you live in and requires extra effort and investment by borrowers.  Lenders apply stricter qualification requirements because investment properties involve more risk than a home you occupy as your primary residence.  This is especially the case if you have not owned or managed a rental property before.  Managing tenants, collecting rent and maintaining a property can be challenging, time-consuming and potentially costly.  Plus, most people who buy investment properties are usually also paying the mortgage or rent on the property they actually live in so that is an extra cost to consider.

To account for these factors, lenders apply specific guidelines to make sure that you can qualify for the mortgage and afford the property.  First, to get a mortgage on an investment property you are required to make a larger down payment.  This provides extra protection for the lender and makes the borrower more invested in the property.  The higher you down payment, the more money you could potentially lose if you default on the loan. 

Borrowers are also typically required to paying a higher mortgage rate and closing costs for investment property mortgages plus hold savings in reserve at the time your loan closes.  These are all measures applied by the lender to manage the additional risk associated with financing rental properties.  For example, requiring reserves is intended to help borrowers manage unexpected financial challenges such as a tenant not paying rent or expensive property repairs.       

There are also some aspects of the application process that may not be as simple as you would think, especially if you are applying for your first investment property mortgage.  It is important that you understand how lenders calculate projected rental income as there are multiple methods and the income figure that lenders use may be different or lower than the rental income the property actually generates.  You may expect that a property is cash flow positive but that does not mean the lender comes to the same conclusion.  Additionally, your personal income and debt expenses also impact your ability to qualify for the mortgage.  If you have too much personal debt you may not get approved for the loan even if the rental property is profitable, especially if it is your first property and you have no landlord or property management experience.  Additionally, if the property is breakeven or expected to be cash flow negative, you must earn sufficient personal income to absorb the loss.

Another point to keep in mind is that many mortgage programs cannot be used to finance investment properties.  For example, most no or low down payment programs including the FHA, VA and HomeReady programs do not permit rental properties.  Although you can use these programs to purchase multifamily properties with up to four units, you are required to live in one of the units.  This restriction limits investment property financing options.

As you can see, there are many points to consider if you want to buy a rental property.  Below we outline how to get a mortgage on an investment property.  Understanding how the process works before you apply for a loan should position you to successfully grow your investment property portfolio.
1

You May Need to Make a Bigger Down Payment

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 (loan amount exceeds the conforming loan limit of $484,350 in most U.S. counties). 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.

2

Understand How Lenders Determine Rental Income

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 two years to verify the income.  Schedule E shows your income or loss from property and lenders usually average the income over the prior two years, according to your tax returns.

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 two years of tax returns that demonstrate the rental income, such as when you buy an investment property, lenders typically use the lessor of 75% of the rental income according to an investment property appraisal report or 75% of income according to a signed lease agreements.

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 your first investment property and you have less than two years of landlord or property management experience, lenders may not give you any credit for projected rental income, depending on the type of property and number of units. In this scenario, you are required to qualify for the mortgage based on your personal income and debt expenses and other factors. This is why it is usually significantly more challenging to qualify for the 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.

3

You Must Personally Qualify for the Mortgage

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.

Review Mortgage Qualification Requirements

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.

4

Higher Interest Rate

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.

%
Current Non-Owner Occupied Mortgage Rates as of June 20, 2019
  • Lender
  • APR
  • Loan Type
  • Rate
  • Payment
  • Fees
  • Contact
View All Lenders

%

Data provided by Informa Research Services. Payments do not include amounts for taxes and insurance premiums. Click for more information on rates and product details.

5

Higher Closing Costs

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.

6

Investment Property Reserve Requirement

Most lenders require that you hold savings in reserve when you get an investment property mortgage.  Holding funds in reserve should help you deal with unanticipated financial responsibilities that arise in the future such as a late rent payment or property renovations.  The reserve requirement depends on the number of properties you have financed with a mortgage.  Assuming you have a mortgage on your primary residence, for your first through third mortgaged investment properties (so two-to-four properties in total), you are typically required to have savings in reserve equal to two months of monthly housing expense for each investment property. Monthly housing expense includes the monthly mortgage payment, property tax, homeowners insurance and HOA fees (if applicable).

Understand Mortgage Reserve Requirements for an investment property

For mortgaged investment properties four through nine (so five-to-ten properties in total), you are typically required to have savings in reserve equal to six months of monthly housing expense for each investment property. Because the reserve requirements are for each property, the cost for borrowers can add up quickly. Understanding a lender’s reserve requirement allows you to determine the total amount of money required to purchase an investment property and make sure that you have sufficient funds to close the loan.

7

Get Pre-Approved

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.

GET PRE-APPROVED

$FREEandCLEAR GET PRE-APPROVED

CERTAINTY ● SPEED ● BUYER ADVANTAGE
$
GET PRE-APPROVED NOW

8

Investment Properties Are Not Eligible for Many Mortgage Programs

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.

Learn the Differences Between Owner-Occupied and Non-Owner Occupied Mortgages

Sources

Investment Property Rental Income: http://www.freddiemac.com/learn/pdfs/uw/rental.pdf

About the author

Harry Jensen, Mortgage Expert

Harry is the co-founder of FREEandCLEAR. He is a mortgage expert with over 45 years of industry experience. Over his career, Harry has closed thousands of loans for satisfied borrowers and now offers his advice and insights on FREEandCLEAR. More about Harry

Harry Jensen LinkedInLinkedIn | Email Harry JensenEmail