For many Americans, acquiring the financing (or refinancing) for a rental property is a critical professional goal.
After all, the right rental property can let you rake in rental income for years, supplementing your primary income or serving as an essential source of passive income in retirement.
But how do you get a mortgage for a rental property or investment property, and what should you consider before applying to a lender?
Read on for the answers to these questions and more.
Differences Between Rental Property Mortgages and Traditional Mortgages
Although rental property loans and traditional mortgages have a lot of the same requirements, there are some considerations that lenders need to factor in when approving and underwriting a mortgage application for a primary home purchase versus an investment property purchase.
Most traditional mortgage products like an FHA loan or VA loan are mainly used for primary home purchases. Lenders assume an inherently higher risk when underwriting rental property mortgages than traditional ones.
Hypothetically, if a rental property owner ran into financial difficulties, they would be more likely to pay their primary or residential mortgage before paying their rental property mortgage.
As a result, rental property mortgages usually come with stricter requirements and are saddled with higher interest rates than loans for owner-occupied properties. These requirements generally include:
Higher credit score requirement
Proof of liquid capital
Higher down payment requirement
Lower debt-to-income ratio
Rental income verification
Keep in mind that requirements will vary by lender and by loan program, which is why it's recommended to shop around and speak with different types of lenders to find a mortgage solution that fits your investment goals.
In this article we will take a look at some of the necessary steps you need to take to secure financing for your rental property investment.
Investigate a Target Market
There are many rental property markets to choose from, especially in Florida; the most profitable are those around major metropolitan areas, coastal areas, and vacation destinations like Naples, Miami, Sarasota and Orlando. It's important to do a bit of homework and investigate the target markets where you want to purchase a rental property to make sure the area caters to your budget, the ideal tenant you want to attract, and overall rental portfolio goals.
This is the stage where seeking expert guidance from a realtor would come into play. You want to make sure you partner with a realtor that has local expertise in your target market so they can provide you with the best insights to put you in the right direction towards rental property success.
Providing your realtor with the following information will help them refine your property search and give them a better sense of your needs:
Estimated budget: Don't worry if you don't have an exact budget in mind. This will be better carved once you get pre-approved for your mortgage. However, providing a ballpark estimate and assuming you would need 20-35% down payment is a good starting point for your realtor to start their search.
Desired neighborhoods and/or neighborhood amenities: Consider what areas you like or if you're not familiar with the neighborhoods yet, offer your realtor some key neighborhood attributes you want to see. For example, if you are planning to buy a home that would be best suited for a family to occupy as a long-term tenant, you may want to make sure there are good schools nearby, local parks, and low crime rates.
Must-have home features: Communicate to your realtor the top features you want to see within the home. For example, if you want to purchase a property in a popular vacation destination like Siesta Key, having a pool or multiple bedrooms to accommodate multiple families vacationing together would be ideal.
Get Pre-Approved For a Rental Property Mortgage
Once you've identified your target market and have teamed up with a realtor, your next step is to find the right mortgage lender and get pre-approved so you can start making offers.
A conventional loan, also referred to as a conforming loan or qualified mortgage is a loan that follows the guidelines set forth by Fannie Mae and Freddie Mac. These loans are typically offered by traditional banks, credit unions and mortgage brokers.
Securing a mortgage with a conventional lender will likely get you the best rates and terms available, but a conventional loan can be the most difficult to qualify for and works best for investorswith excellent credit history and stable full-time employment.
A conventional loan will require:
Credit score at or above 620
Larger down payment compared to a primary home purchase
Lower DTI needed compared to a primary home purchase
Income documents such as W-2s, tax returns, paystubs and bank statements
Some property types may not qualify (condotels, non-warrantable condos, 5+ unit multifamily properties)
If you find yourself unable to qualify for a conventional loan because of your credit score, being self employed, or your loan amount exceeds conforming loan limits, then a non-qualified mortgage (Non-QM) loan may be the next best thing.
Instead of meeting the requirements of Fannie and Freddie to sell on the secondary market, Non-QM lenders keep the loans on their books. This allows non-QM lenders to set their own lending requirements and offer more flexibility for borrowers whose needs fall outside of the conventional loan box.
Rates for non-QM loans are usually higher than conventional loans, but they are easier to qualify for and are a popular option for rental property investors looking for a permanent financing solution that cater to more financial profiles.
Wanting to use cash flow of property instead of personal income to qualify
The good news is that if you've already attempted to qualify for a conventional mortgage, you may already have what you need to determine your eligibility for a non-QM loan, which will help speed up the process.
Private Money Loans
Real estate investing has become a very competitive space where cash buyers often come out on top. That said, there are some investment scenarios that require expedient access to capital in order to get the deal done. Private money loans are a popular solution for investors that want to compete with cash offers and close in a matter of days, not weeks.
While a conventional loan and non-QM loan can offer better rates and terms, they can take months to close and in some cases, can fall through at the very last minute. If you are an investor that is facing a contractual obligation or have a property that is too good to pass up on, a private money loan can help bridge the gap in capital until permanent financing can be secured.
A private money loan is an excellent short-term financing solution in cases when:
You need more time to qualify for permanent financing
You have contractual obligations and/or at risk of losing your deposits
You are pending sale of an existing asset
You want to tap into the equity of your portfolio to fund your next investment
You are a developer and want to purchase or improve land while you qualify for a construction loan
Your current loan is reaching maturity and you need to refinance quickly
You are a foreign national with no credit history in the U.S.
Private money loans do not require income verification and are not credit score based. This allows private lenders to be very flexible and streamline their loan process to fund loans quickly.
Keep in mind that private loans come with much more risk to the lender, and therefore have higher rates and fees than a conventional or non-QM loan. They also have lower loan-to-values maximums and require at least 35% down payment.
Luckily there is little to no documentation required to get approved for a private money loan, which makes it easy to get a quick decision from a private lender on whether or not they can finance your investment.
Tips to Qualify for Rental Property Mortgages
As you prep your application package a rental property mortgage, keep these tips in mind to make your application much more attractive:
Maintain a good credit score: While there are some rental mortgage products that do not require a minimum credit score, it's always best practice to make sure all of your current debts are in good standing and avoid opening new lines of credit until the mortgage process is complete.
Save for a larger down payment: Mortgages for rental properties typically require higher down payments. Making sure you have at least 20-35% for a down payment will improve your approval odds.
As you can see, getting a mortgage for a rental property is a little more complex — and often a little more complicated — than getting a loan for a traditional mortgage.
Your best bet is to team up with a local lender who understands your market and can help you compare all of your options at once. The knowledgeable residential loan specialists at Vaster are dedicated to helpingborrowers accomplish financial success and security through modern mortgage solutions that are personalized to their needs.