What You Need to Know Before Taking Out a Mortgage on an Investment Property
Obtaining financing for a rental property isn’t too different from what you’ll go through when taking out a mortgage for your primary residence. The actual process is very similar – get pre-approved, have your offer accepted, do the inspection/appraisal, sign your name 50 times at closing, etc. However, there are some key differences you must understand, as well as some tips you should follow for making the process quicker and smoother.
The biggest difference you’ll likely notice is that interest rates for an investment property mortgage are higher than what you’ll see with a primary residence. Banks consider investment properties to be higher risk, because they generally are. Because the property owner isn’t personally living in the home, they may be more likely to walk away from it, and thus, the loan, during times of financial hardship. To deal with this increased risk, banks charge higher interest rates for these loans in order to protect themselves.
Another way lenders guard themselves from investment risk is by requiring a larger down payment. While most standard mortgages ask for 20%, and FHA loans require a mere 3%, your down payment on an investment property is going to be higher. Most lenders are looking for a minimum of 25% down, which can be a serious chunk of change, depending on the price of the property. Bottom line: Be prepared to pay more up front when securing a loan on an investment property.
Another thing to keep in mind when using financing on a rental property is that there are limits to how many loans you’re allowed to have out at one time. A lot of investors like to use leverage to acquire more properties and build their portfolio. However, most of the big banks won’t allow more than 4 mortgages, and 10 loans is the maximum for the majority of lenders across the board. (Note: For investors who require financing on more than 10 properties, they typically group properties together in a trust or holding company.)
Some of the lending requirements for an investment property mortgage are different than what you’ll find with a regular mortgage, too. For starters, if you want to invest in multiple properties, and you plan to finance them all, certain stipulations will apply. You’ll need a higher credit score to get a loan approved on more than 4 properties, and you’ll also pay higher interest rates and need to put down an even bigger down payment. For any investment property, you’ll be asked to show proof of income and cash reserves, as well as data showing that the property will be cashflowing.
Choosing the Right Lender
When taking out a mortgage on an investment property, you don’t want just any lender. You want an investor-friendly one who understands your needs. If you have to spend time explaining your objective and strategy to lender after lender as you shop around for a loan, you’re going to waste valuable time and possibly miss out on some deals. That’s why you need someone who knows and understands exactly what you’re doing and what your goals are. It can also be helpful if you work with a direct lender, rather than with a broker. A broker is someone who shops around for a loan for you, which can also result in wasted time and energy. Finding a direct lender cuts out that middleman, allowing you to work more efficiently and effectively as you move through the lending process on a new deal.
Securing a mortgage for an investment property is a bit different than the process you may have gone through for a primary residence. Understanding the primary differences will help prepare you for the process, and connecting with an investor-friendly lender can help prevent some of the issues you may encounter along the way.