How to Get a Mortgage on an Investment Property
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.
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. In most cases, lenders use the estimated rental income figure provided in the appraisal report for an investment property. An appraiser compares the subject property to other investment properties in the area to determine the estimated market rent for the subject property. The appraised market rent may be higher or lower than the rent you actually receive when you rent the property.
In other cases, a lender may use the rental income figures provided in the borrower’s 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. Lenders typically review the Schedule E from your tax returns for the prior two years to verify existing rental income. If the property’s rental income has increased since your most recent tax return, you may not get credit for the higher rent amount.
The final approach that lenders use is to take the rental income figure from current lease agreements and apply a 25% discount to account for vacancy and maintenance costs. So if you want to purchase an income property that generates $10,000 per month in rent according to current lease agreements, applying this methodology, the lender uses a rental income figure of $7,500 ($10,000 * 75%) to determine your ability to qualify for the loan.
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 to qualify you for a mortgage may be lower than the actual or potential rent generated by the property.
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.
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.
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.
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.
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.
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.
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.
Investment Property Rental Income: http://www.freddiemac.com/learn/pdfs/uw/rental.pdf