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There’s no better time to invest in rental property than now! Even with current economic uncertainty, the unchanging history of low rental property mortgage rates offers valuable protection to potential homebuyers. Small, local real estate investors in the U.S. owning rental properties already benefit from the inflationary hedge, potentially stable monthly income and appreciation, and tax advantages.
Rental income paves a path of escape from the recent instability, and the demand for residential rentals is bound to keep growing. As a result, every decision you make concerning mortgages for rental property has significant financial implications. If you have experience paying for a primary residence, investing in a rental property mortgage will feel similar. But only at a higher rate with stricter qualification requirements.
Understanding rental property mortgages and other significant differences will help you choose the right real estate investment goals.
A rental property mortgage is a loan for purchasing a property occupied by a tenant instead of the owner. Most people who cannot buy real estate from scratch often accept mortgages to purchase an older property, renovate it to generate rental income, or sell it for profit.
Typically, the property needs to be rent-ready to qualify for the loan. The renting is for short-term use, such as vacation rentals, rather than the regular long-term tenants. The intention is for the loan to finance residential real estate and not to live in the property but to earn rental income. Properties that qualify for rental property loans include:
Applying for a rental property loan is similar to getting a home mortgage, but there are several differentiators. First, anyone lending a rental property loan knows about the risk of offering a mortgage. The lender assumes that if you have to pick between paying for your home and rental property mortgage, there are more chances you can default on your rental property loan. Hence, the application for rental property loans is more comprehensive. Your income, debt, credit, and employment history must be in excellent order to qualify.
Before filling out any comprehensive form, let us identify the essential differences and requirements to qualify for rental property loans.
Loan-to-value Ratios
The impact of LTV ratios on rental property loans is more. The expectation is for a more invested borrower with a lower LTV to qualify for the mortgage. Thus, plan for a down payment of 20-25% or more to get at least 75-80% LTV. But it still depends on the property and your credit score.
Interest Rates
Rental property loans typically attract higher interest rates and fees to compensate the lender for the risk. The range can be from 1% to 4% more points in interest than traditional homes. For example, if an owner-occupied property is 4%, the rental property loan for the same property would be 5% or more.
Reserves Requirements
There can be rainy days when issues arise concerning your rentals, such as higher vacancy rates than expected. Therefore, it is required to have proof of liquid cash or readily convertible assets to pay the mortgage for at least six months. In addition, the sum should cater for the monthly principal, taxes, insurance, interests, and other associated dues for these months.
Credit Scores
Lenders have various terms and conditions on rental property loans. The general rule to qualify for financing is to have at least a 620 credit score. However, a buyer should have a minimum credit score of 740 to get the mortgage for a rental property and pass for better interest rates and terms.
Rent Readiness of the Property
Loans for construction are not rental loans. However, the lender will check the property for significant repairs to ensure it’s rent-ready. Therefore, it’s best to ensure the property is in good condition before applying for the loan.
Proof of Rental Income
Qualifying for regular home loans can require your employment history, personal income, and personal tax returns. The lender may request the same documents, especially when you have other rental properties. For rental loans, the focus shifts to the rental property cash flow. In many cases, there has a be a show of current leases, tax returns showing rental income, and rent roll history as proof of rental income. Adding the estimated rental income from the property you aim to buy gives you a higher chance of qualifying for rental loans.
Getting a mortgage for a rental property leaves you with only a few financing options compared to buying a home. Investors looking to grow their rental properties portfolio must overcome a few more hurdles. The three rental property options to keep in mind include alternative lenders, agency loans, and local banks. Compare these loan options and find the one that offers the best rates and terms.
Alternative lenders, also called non-qualified mortgage lenders, evade the rules of bank regulators or government-sponsored entities. The lenders can offer up to 80% of the equity in your property. With this type of mortgage loan offering more flexibility and appealing terms, investors can grow their rental portfolios via rental loan programs.
The loans prioritize the property’s cash flow over personal income, drastically reducing document requirements and reviews of employment history or tax returns. As good as the alternative mortgage solution may seem, these flexibilities come at a cost. There are prepayment penalties even though the interest rates and fees are higher.
While agency loans are the least expensive, they’re also the most complicated. The lenders give loans based on an intense review of general cash flow, including rental income and your income from stable employment. However, borrowers have to undergo an extensive and uncertain underwriting process.
The down payments and reserve requirements increase based on the number of outstanding loans or mortgaged rental properties you own. In addition, applying for agency loans requires substantial documentation. Finally, with this type of loan, you cannot cash out, refinance or borrow from a legal entity, even if it protects other assets.
Regional banks are behind the financing of several real estate investors. The banks are not keen on underwriting. However, they can allow this flexibility in exchange for higher rates and fees since they plan to keep rather than sell loans. Typically, banks give 5-year or 10-year on paying off 15, 20, or 25 years loans. So, you shouldn’t expect a 30-year loan.
The bank responds to its most recent regulations, and a quick review can unfold several uncertainties. Another drawback is the tendency for local banks to work slowly. Also, it doesn’t operate to generate high volumes of mortgages, which limits investors from financing large portfolios.