Many investors, especially those who are just starting out, often wonder how to get a mortgage on an investment property. While the process itself isn't much different than applying for a traditional home loan, when it comes to qualifying for the loan, you'll be held to a different standard as an investor.
To that end, below is an explanation of everything you need to know about investment property loans. We've laid out the different types of loans you can use for rental properties and the qualifying standards you need to meet, as well as some tips on how to make the application process go as smoothly as possible.
What kinds of loans can you use to buy an investment property?
In general, government-backed loan options -- like an FHA loan or a VA loan -- aren't available when buying an investment property. Typically these financing options require that the property be used as your primary residence. However, there is an available workaround. If you buy a multifamily property and agree that one of the units will be owner occupied for at least one year, you'll still be able to qualify. This practice is known as house hacking.
For the most part, when we're talking about investment property loans, we're talking about conventional loans. As will be discussed below, however, these loans often have stricter qualifying standards than government-backed loans.
Most of the time, shortly after closing on a home, the lender will sell your loan to an agency like Fannie Mae or Freddie Mac rather than keeping the debt in-house. Occasionally, however, they will keep a loan as part of their portfolio. The loans that they keep are known as portfolio loans.
Since these loans aren't being sold, they don't have to meet the same qualifying requirements as a conventional or government-backed loan. In fact, the lender can set their own qualifying standards for these debts.
If you are unable to meet the qualifying standards for a conventional loan, you may want to consider working with a local bank or lender who offers portfolio loans. This can give you the additional flexibility you need to be able to invest.
Home equity loans
If you already own your primary home, you may be able to borrow against the equity you've built up to finance an investment property. In most cases, lenders will allow you to borrow up to 80% of your home's value.
A home equity loan will also work very similarly to your current mortgage. Here, you'll be given the money in one lump sum. You'll also be expected to make regular monthly payments on both the principal and interest of the loan.
How to get a mortgage on an investment property
Now that you have an idea of the types of loans you can use to buy rental properties, it's time to take a closer look at the specific lending requirements you'll need to meet. According to Fannie Mae guidelines, it's possible to be approved for up to ten home loans at a time. However, be aware that the more loans you have, the stricter the qualifying requirements become.
Tougher credit score requirements
In this case, the credit score you'll need to qualify will be determined by how many loans you currently hold. The minimum score requirements are:
|Number of Properties||Minimum Score Requirement|
|1 to 4||620|
|5 to 10||720|
However, keep in mind that even though you can qualify with these scores, you'll still want to go into applying with the highest possible score. Put simply, your score determines what interest rate you're given, and like with credit cards, those with lower scores are given higher interest rates.
Larger down payment
Since mortgage insurance isn't available for rental property loans, lenders will often require you to make a bigger down payment so you'll have a bigger stake in the property. Similarly to how there are two seperate sets of credit scores above, the amount that you'll need to put down will depend on how many loans you have. The requirements are as follows:
|Number of Properties||Down Payment Requirement|
|1 to 4||20%|
|5 to 10||25% to 30%|
Plenty of cash reserves
Banks use the term "cash reserves" to refer to the money you have left over in the bank after making your down payment and paying your share of the closing costs. They typically express this as the number of mortgage payments you'd be able to make with your leftover funds.
Fannie Mae typically requires six months worth of cash reserves from investors. However, that number can go up to a year, depending on the strength of your lending profile. To get a better idea of how much you need to save, once you've determined your price range, ask your lender to work up an estimated monthly payment for you. You can base your rental income estimates off these numbers as well.
Solid work history
Lastly, everyone who buys a home needs to be able to prove that they have a solid work history, and investors are no exception. Here, you'll need to show two years of W-2s to prove that you've been working at the same job -- or at least in the same industry -- for a while. If you're self-employed, you'll need to provide two years of tax returns instead.
Your lender will also use your W-2s or tax returns to estimate your income. In this case, they will take the average of your income over the last two years. For example, if you made $50,000 one year and $100,000 the next, your average annual income would be $75,000.
Tips to make the qualifying process easier
Find a lender and real estate agent with investment experience
The best thing you can do when you're looking to buy an investment property is to put together a team of qualified professionals. Especially if you're planning on buying more than one rental property, you should focus on finding a lender with investment experience. They'll be able to better help you navigate the specifics of the financing process.
In addition, you'll also want to work with an agent who specializes in rental properties. Not only will you get the benefit of their experience, but they may also offer property management services, which could come in handy once you find the right investment piece.
Prepare your financials before you start house hunting
Since your financial package is such a big part of investing, it's in your best interest to make sure all your paperwork is in order before you start house hunting. Take the time to sit down with a lender to discuss the specifics of your financial situation once you think you're ready to hit the market.
If everything looks good, he or she will provide you with a pre-approval and you'll have a better idea of your price range. On the other hand, if your financials need a bit more work, your lender will be able to provide guidance on what you need to do to be approved.
The bottom line
While qualifying for a mortgage on an investment property is a bit different than doing the same for your primary residence, knowing what to expect before you begin the process can be helpful. Talk to a qualified lender, and use the information above to help you prepare when you're ready to take the plunge.
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