How to Get a Mortgage for a Rental Property

How to Get a Mortgage for a Rental Property

Rental property loans vs regular home loans

Some of the biggest differences between a rental property loan versus a regular home loan include:

  • Larger down payment, often 20-25% or more, depending on the property and the borrower
  • Higher interest rates and fees to compensate the lender for the additional risk of making a rental property loan
  • Credit score of 620 or more
  • Debt-to-income ratio (DTI) of less than 36%
  • Sufficient cash reserves to pay the mortgage for up to six months if the vacancy rate is higher than anticipated
  • Higher interest rates and fees to compensate the lender for the additional risk of making a rental property loan
  • Qualifying property types must fit into typical categories of single-family, small multifamily, townhome, or condominium
  • Private mortgage insurance (PMI) doesn’t apply when the loan-to-value ratio (LTV) is less than 80%

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How to finance a rental property

For serious investors looking to grow a portfolio of rental properties, there are essentially three rental property loan options: agency loans (Fannie/Freddie), local banks, or an alternative lender such as Visio Lending. Let’s look at all three options:

Alternative Lender (Visio)

Alternative lenders, sometimes referred to as Non-QM lenders, offer rental loan programs specifically designed to help SFR investors grow their rental portfolios. Since alternative lenders are not confined to the rules set by bank regulators or GSEs (government-sponsored entities), they offer a lot more flexibility and appealing terms, such as 30-year terms.

Additionally, most alternative lenders underwrite their loans based on the cash flow of a property rather than personal income. That means they have low document requirements and do not review your employment history or tax returns. There are some drawbacks to alternative lending, yet most seasoned investors are comfortable with them:

  • Higher interest rates and fees – seasoned investors, particularly those in growth mode, are willing to pay higher interest rates and fees for more flexibility to achieve their wealth creation goals
  • Prepayment penalties – prepayment penalties are not allowed for owner-occupied mortgages but are permitted for rental loans. Again, experienced investors are willing to accept one to five-year prepayment penalties if it means they can qualify for a loan that enables them to achieve their investing goals. Visio offers a variety of prepayment penalty options so investors can tailor their loan to their particular circumstances

Agency Loans (Fannie & Freddie)

Agency loans are the least expensive type of loan, yet the most complicated to obtain. Lenders typically underwrite agency loans based on a holistic review of an investor’s cash flow, including personal income from stable employment and net operating income from rental properties. These loans have some drawbacks for investors including:

  • Substantial documentation
  • Lengthy and uncertain underwriting process with substantial reserve requirements that increase with the number of loans outstanding (Basically, the more mortgaged rental properties you own, the more cash reserves you need)
  • Down payment requirements that increase with the number of loans outstanding (the more mortgaged rental properties you own, the more money you must put down for each new property)
  • Restrictions on cash-out refinances
  • Inability to borrow in a legal entity to protect your other assets and identity

Regional Banks

Some real estate investors have success financing their rental properties with local or regional banks. Because banks plan to retain these loans rather than sell them, they can be more flexible on underwriting in exchange for higher rates and fees. Banks, however, cannot portfolio 30-year loans, so they typically write five-year or ten-year loans on 15, 20, or 25-year amortizations. Some of the drawbacks of working with a bank are:

  • Exposure limits typically mean an investor will have to line up multiple local banks to finance a good-sized portfolio
  • Uncertainty in that local banks often change direction quickly in response to their most recent regulatory review. This means they might be in the business of financing rental properties one month and then not the next month
  • Local banks are not set up operationally to originate mortgages in high volumes and tend to work slowly

Rental property loans

Finding money for rental home financing doesn’t have to be an obstacle. There are many avenues to consider, including:

Conventional home loans

Conventional mortgages conform to guidelines set by Fannie Mae or Freddie Mac. They’re not backed by the federal government (like an FHA or VA loan). If you already own a home, you’re probably familiar with them.

When choosing traditional financing (like a conventional mortgage) for an investment property, plan on the interest rate and upfront fees to be higher. Rates are about 0.25-0.75% higher for than rates for an owner-occupied mortgage.

Types of rental properties that may be excluded from traditional financing

  • Timeshares

  • Some manufactured homes

  • Bed and breakfasts

HELOCs or home equity loans (HEL)

With a home equity line of credit (HELOC) or home equity loan (HEL), you can pull equity out of your primary home and use it to buy a rental property. You can have access to lower rates and better terms, but you’re ultimately putting your home on the line. If something goes wrong with your rental property, you could lose your home.

Hard money loans

In need of a short-term loan with a fast turnaround? You may want to consider a hard money loan from a private investor that’s secured by your soon-to-manage rental property. House flippers often use this form of financing, but it can also be used for fund rental properties. Unfortunately, interest rates can be almost double what current mortgage rates are, and the same can be said about origination fees. But you have a higher chance of borrowing more money than you could via traditional financing.

Private funding

Another option to secure rental property financing is through family and friends. That’s right; you can negotiate your terms by merely working with family investors, so long as they have a significant amount of money to invest. Think about trust beneficiaries or relatives with surplus cash who are interested in passive income streams. It’s a reasonable option for short-term financing, and it’s the least time-consuming loan option because there are no set lending requirements.

Seller financing

Though not very common, you may be able to finance your rental property directly through the seller. Instead of sending monthly payments to the bank or lender, you send payments directly to the previous owner. This option makes the most sense if there is not a mortgage on the property. If there is, you’re at risk of paying the mortgage in full by the “due on sale clause.”

Looking to purchase a home in another state? Check out our 6 tips for out of state home buying success! 

8. Hard money loan

House flippers are known for using hard money lenders to help them house hack into a real estate deal.

Hard money loans are non-conforming loans that are generally provided by private lenders, individual investors, or groups who offer money upfront for short-term borrowing.

It’s private money lent with high interest rates and short terms, and this loan option allows investors to secure financing based on the property’s current or even future value.

Hard money lenders may pull your credit score, but the underwriting process is typically less strict than with a traditional mortgage loan.

If you find a deal on a fixer upper, and you qualify for a hard money lender’s loan-to-value guidelines, you may be able purchase with little or no money down.

“If you are buying an investment property, you will need collateral, such as a separate property, going this route,” says Meyer.

Rental Properties as an Investment Asset

One of the main advantages of owning a rental property is the steady stream of revenue that it can generate. But investment properties are just that – investments, and they can do more to generate wealth than simply provide a month-to-month income for the landlord.

Real estate, in any form, has always been one of the more consistent wealth builders for savvy investors, and rental properties are no different. It’s true that the real estate market fluctuates, ebbing and flowing with the economic fortunes of the country. But over the long haul, real estate almost always appreciates in value, making ownership of any property a truly valuable asset, including or perhaps most especially a rental.

Recent research into the risk vs. return of the most popular investment products has shown that rental real estate consistently out performs both stocks and bonds when it comes to return on investment.

A report was generated using historical data going back over 145 years, comparing many different types of investment options. In the report’s final analysis, rental properties proved to deliver the highest return and the lowest risk compared to other popular investment products.

When it comes to investment stability, trusting in something that has been so historically dependable as owning a rental property simply makes good business sense.

What to Consider before Investing in a Rental Property

Before committing to the purchase of any rental pr

Before committing to the purchase of any rental property potential investors should consider some key metrics. While it’s true that rental properties can generate steady income for their owners, and can be a valuable asset overall, it’s crucial to invest in the right property.

There are three key real estate investment ratios to consider before making any purchase of a potential rental property. They include:

Rent Ratio

The rent ratio is determined by dividing the monthly rent generated by the total cost of the property (purchase price + financing costs + rehab costs). The higher the ratio the better. Most investors look to see, at minimum, a ratio of 1% – 2%.

Cap Rate

The cap rate, or capitalization rate, is the ratio of net operating income to property asset value. To calculate the cap rate of a rental property determine the gross annual income of the property, subtract any and all operating expenses from the gross to arrive at your net income, and then divide the net by the property’s purchase price. Ideally, the cap rate should be 6% or better. 8% – 10% is generally considered the sweet spot.

Cash-on-Cash Return

The final metric to consider is the cash-on-cash return. This is calculated by dividing the owner’s pre-tax cash flow by the equity invested in the property. Most investors are looking for a minimum cash-on-cash ratio between 8% and 12%.

Options for a Rental Property Loan

It’s much easier and less expensive to find a loan option for a residential rental property like a house or a duplex compared to a large apartment building or commercial property. If you’re shopping around for a rental property loan online, you can get a free rate quote from an experienced mortgage professional on Stessa

Here are some of the options to look at when you need a loan for buying a rental property or refinancing an existing mortgage:

1. Conventional

Conventional or conforming loans are mortgages that most people are familiar with. They are offered by traditional lenders like banks or credit unions, and also by mortgage brokers who work with a variety of lenders and can help you find the best deal. 

Interest rates are usually lower than other options provided you have a good credit score, and down payments may be less than 25%. Conforming loans must meet Fannie Mae or Freddie Mac guidelines. While Fannie and Freddie allow up to 10 mortgages by the same borrower, banks often set a lower limit of around four loans total.

2. FHA

Federal Housing Administration (FHA) loans are also offered by traditional lenders and mortgage brokers. Credit score requirements and down payments are usually lower than a conventional loan, and income from an existing rental property can be used to help qualify. 

FHA loans are a good option for multifamily property investors looking for a rental property loan for a new purchase, new construction, or renovating an existing property. To help qualify for an FHA multifamily loan, the investor will need to use one unit as a primary residence for at least one year.

3. VA

Veterans Affairs (VA) multifamily loans are a third option for rental property loans offered by banks, credit unions, and mortgage brokers. Mortgages backed by the U.S. Department of Veterans Affairs are available to active-duty service members, veterans, and eligible spouses. 

There are several benefits to using a VA loan for a rental property if you qualify. There is no minimum down payment or minimum credit score, and you may be able to purchase up to seven units. However, one of the units must be your primary residence.

4. Portfolio

Portfolio loans are mortgages on individual single-family or small multifamily properties by the same lender. Although each property has its own loan, the mortgage brokers and private lenders who offer portfolio loans may offer the borrower a ‘group discount’ for multiple loans. 

Loan terms such as interest rate, down payment, credit score, and loan length can be customized to fit the specific needs of the borrower. However, because portfolio loans can be easier to qualify for when an investor has multiple properties, there may also be higher fees and prepayment penalties.

5. Blanket

A blanket loan is a good option for real estate investors who want to purchase several rental properties and finance all of them using a single loan or refinance a portfolio of existing rental homes. Mortgage brokers and private lenders are two sources for finding a blanket mortgage loan for any type of income-producing property. 

Interest rate, length of loan, down payment, and credit score vary from lender to lender, and loan terms can often be customized to meet the needs of the borrower and lender. 

Rental properties in a blanket loan are usually cross-collateralized, which means that each individual property acts as collateral for the other properties. However, you can ask for a release clause that allows you to sell one or more of the group of properties under the blanket loan without having to refinance the remaining properties.

6. Private

Private loans are offered by experienced real estate investors and business people pool their capital and offer debt financing to rental property owners. Because these private investors know how the real estate business works, they often offer loan terms and fees customized to match the deal potential and the experience of the borrower. 

Some private lenders may even take a small equity position in the project and accept future potential profits in exchange for lower fees or interest rates. If the investment performs according to plan, private lenders can also be an excellent source of funding for future rental property investments.

7. Seller Financing

Sellers who own a property free and clear (or with very little mortgage debt) are sometimes willing to act as a lender. By offering owner financing or a seller carryback, property owners who finance a sale to the buyer can generate interest income and earn a regular monthly mortgage payment instead of receiving the sales proceeds in one lump sum. 

Seller financing can be a good option for owners who want to spread out capital gains tax payments over the life of the loan as an alternative to conducting a 1031 tax-deferred exchange. However, because the seller is offering the mortgage, borrowers should expect similar underwriting requirements such as credit checks and minimum down payment.

8. HELOC

A home equity line of credit (HELOC) and a home equity loan are two options for pulling money out of an existing property to use as a down payment for another rental property loan. This strategy is an example of the waterfall technique where investors use the cash flow and equity build-up from existing rental properties to fund future purchases. 

A HELOC acts as a line of credit secured by the equity in an existing property that an investor can tap into at any time, and repay the loan with monthly payments similar to the way a credit card works. On the other hand, a home equity loan is a second mortgage that provides funds to the borrower in one lump sum. 

With both a HELOC and a home equity loan lenders generally set a borrowing limit of between 75% – 80% of the property equity. Interest rates and fees may also be higher compared to doing a cash-out refinancing using a conventional loan.

What Makes An Investment Property Loan More Difficult Than Other Loans?

Qualifying for an investment property loan is more challenging because lenders view investment properties as a greater risk. Some of the reasons why it’s more difficult to qualify include:

Higher Credit Score Requirements

Unless you get a home equity loan against your own home or you go get private money involved, you will have to have a relatively high credit score. Your credit score shows lenders how financially responsible and capable you are (it takes into account things like debts, late payments, bankruptcies, foreclosures, collections, and more). 

Better Debt-To-Income Ratio

Lenders will not only want to make sure that you earn enough money (and that your income is stable) to afford monthly mortgage payments on your investment property, but they will want to know that you don’t have too much debt as well. Because you may already be paying down another mortgage at the same time (such as that on your personal home), it will be more difficult to maintain a low debt-to-income ratio as it is. Even then, lenders require a lower debt-to-income ratio than with conventional loans (typically around 43 percent). 

Down Payment Of At Least 20%

A large down payment helps to offset the risk of having to foreclose on the investment property and sell it to make back the balance owed. The sale may not recover the total of the loan, so a large down payment helps mitigate this risk. In comparison, most conventional loans require a down payment of around 5 to 15 percent. 

Hitting Mortgage Ceilings

If you’ve invested in several properties already, it will become more and more difficult to obtain additional investment property loans. You’ll need to go through Fannie Mae’s special program if you have four or more mortgages on your credit–and even if you qualify for their program, some lenders may still not be willing to provide you with the loan you need.

Perceived to Be a Higher Risk

Some lenders may not be willing to take on the risk at all if you’re trying to secure an investment property loan. This can occur if they’ve lost money in the past on investment property loans and are unwilling to take the risk again. Their rationale is that if the borrower’s investment fails, they may prioritize other debts over the investment property’s mortgage (such as their car payments or the mortgage on their primary residence).

The Bottom Line

Investing in a rental property or tackling a house-flipping project are risky ventures, but they offer the potential for a big payoff. Finding the money to take advantage of an investment opportunity doesn’t have to be an obstacle if you know where to look. As you compare different borrowing options, keep in mind the short- and long-term costs and how each one can affect the investment’s bottom line.

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