Think getting a loan for an investment property will be as easy as your home mortgage? Think again.
Lenders are far more strict in their underwriting of investment properties and require more money down. Why? Simple: Borrowers will always default on their investment property loan before they default on their home mortgage.
With higher risk comes higher pricing, lower LTVs (loan-to-value ratios), and generally more runaround.
Here’s what new real estate investors need to know about how investment loans differ from homeowner mortgages.
Plan on having to put down at least 20% of the purchase price if you’re buying an investment property.
There are exceptions, of course (most notably for house hacking, which we’ll delve into later on). By and large, however, plan on putting down 20-40% of the purchase price.
The good news is that you won’t have to worry about mortgage insurance—but that’s really the only good news.
Some conventional loan programs for investment properties allow for 80% LTV, although you should know going in that it’s a best-case scenario. You can also explore real estate crowdfunding websites, which tend to be more expensive than conventional loans, but may be more flexible.
Depending on the lender and loan program, you might also find that pricing goes down alongside LTV. In other words, if you’re willing to put down more money, you may secure a lower interest rate and lower fees.
As a final note, plan on needing at least three months’ payments as a liquid cash reserve.
It will be higher. The end.
Alright, there’s a little more to know. Plan on both the interest rate being higher and the upfront lender fees being higher.
On paper, conventional lenders often quote that their investment property loans are only 0.25-0.5% more expensive than their homeowner loans. In my experience, it never turns out that way. Expect to add 1-3 percentage points more than an owner-occupied loan rate. That means that if a lender charges 4% interest for homeowner loans, you’ll likely pay 5-7% interest for investment loans.
And don’t forget points. Lenders charge up-front fees for mortgage loans, and one “point” is equal to one percent of the total loan amount. These obviously add up quickly.
It just gets more expensive from there, as you get away from conventional lenders and toward community banks or crowdfunding websites.
Credit matters, of course, although not as decisively as in homeowner lending.
If your credit score isn’t perfect, you’ll still have options; they’ll just cost you more. A score below 740 will spell higher interest rates, higher lender fees, and lower LTVs. The lower your credit score, the more you can expect to cough up at the table and in ongoing payments.
For borrowers with mediocre credit, conventional loans may not be an option.
Still, investment property financing is often based more on the collateral (the property) than you as a borrower. Remember, lenders know that investors are far more likely to default than homeowners, so they’ve already built some extra caution into the loan programs in the form of lower LTVs.
While a retail lender for homeowners asks themselves, “How likely is this borrower to default,” investment lenders also ask themselves, “Can we still recover our money if this borrower defaults?”
Limitations on Mortgages
Your options start dwindling, the more mortgages you have on your credit report.
Once you have four mortgages on your credit, many conventional lenders won’t touch you anymore. There is a program, however, introduced by Fannie Mae in 2009 to help spur investment that allows 5-10 mortgages to be on a borrower’s credit.
The program requires six months’ payments held as a liquid reserve at the time of settlement. It requires at least 25% down for single-family homes and 30% down for 2-4 unit properties. But with any late mortgage payments within the last year or any bankruptcies or foreclosures on your record, you’re persona non-grata.
There’s also a hard limit of a 720+ credit score for borrowers who already have six or more mortgages.
Own More Than 10 Properties?
Your options are limited.
Small community banks are an option because many keep their loans within their own portfolio. These are a good starting place for investors.
Commercial lenders sometimes lend “blanket” loans, secured against multiple properties. But if you go this route, be sure to ask what happens if you want to sell only one of the properties in the blanket or umbrella loan.
Seller financing is always an option if you can convince the seller to take on the headache (and risk). However, most sellers aren’t interested in becoming your bank.
Hard money lenders are great for flips but usually terrible for long-term rentals. They’re simply too expensive.
Look into crowdfunding websites—new ones pop up all the time and are often unafraid of lending to investors with multiple properties.
And, of course, you can great creative. Perhaps you can get a HELOC on your primary residence? Or maybe your friends and family want to invest money toward your next rental?
If all this borrowing talk is starting to get tedious, why not skip investment loans altogether?
You can borrow an owner-occupied mortgage for buildings with up to four units, with cheap interest rates and low (3-5%) down payments. You can even use FHA or VA financing to do it!
The idea is you move into one of the units, with your rents from neighboring units enough to cover your mortgage. In other words, you live for free. Pretty sweet deal, eh?
After living there for a year, you can go out and do it all over again, with another four-unit building!