Financing a Rental Property
Buying rental property is a great way to invest your money. However investing in real estate is just like any kind of investment; it's wise to assess both the benefits and the risks involved. Rental property allows you to enjoy the potential for market appreciation while building equity each month.
Tell your mortgage broker that you’re interested in buying a rental property. Financing them comes with different rules than a primary residence.
Conventional Bank Loans
For a rental property, you can use an agency loan. This means that the mortgage is backed by Fannie Mae or Freddie Mac. This is considered conventional financing. With conventional financing, the typical expectation for a down payment is 20% of the home's purchase. In some cases, a total of 25% down can score the buyer a better interest rate.
Conventional loans are available either with a fix-rate mortgage or an adjustable rate mortgage (ARM). Both of these options have specific requirements when it comes to the down payment and credit score. Most mortgage lenders review your income, assets, and credit. Borrowers must afford their existing mortgage as well as the monthly loan payments on a rental property. Up to 75% of the rent you expect is taken into account when calculating the debt-to-income ratio. Some lenders will require six months of the payment set aside as reserves. This reserve covers the total mortgage obligation in the event that you go through unexpected financial issues.
For a fixed-rate mortgage, the minimum credit score requirement on a single-unit rental property is 620. The requirements for a rental property are somewhat similar to that of a mortgage for a primary residence. You should keep in mind the 2/2/2 rule: the borrower has to provide two years of tax returns, two years of W-2s and two months of bank statements to your mortgage lender.
Fix and flip loans are also known as hard money rehab loans, rental property rehab loans or house flipping loans. They are short-term financing tools to help cover the purchase and renovation of a property. The homes can either be put up for sale or rented. Fix-and-flip loans are hard money loans, meaning the loan is secured by the property. Hard money lenders specialize in these kinds of loans, however, you may also obtain from certain real estate crowdfunding platforms.
The major advantage of using a hard money loan is that it may be easier to qualify compared to a conventional loan. For fix and flip loans lenders still, consider things such as credit and income however their primary focus is on the property's profitability.
The major disadvantage of using a hard money loan is that it will be more expensive. Interest rates for a fix-and-flip loan can go as high as 18% and will require a shorter time-frame for paying it back.
Tapping Home Equity
Consider taking advantage of a home equity loan, HELOC or a cash-out refinance to secure rental property. The amount you can borrow is based on the combined loan-to-value (CLTV) ratio of 80% to 90% of the property’s appraised value. Using equity to finance a real estate investment has its upsides and drawbacks.
There are a few benefits of tapping into your equity on your primary house in order to buy an investment property:
- The interest rates on rental homes are higher than primary or secondary homes
- Home equity loans can have more favorable terms than rental property loans
- The closing costs are usually lower for home equity loans. If you plan to buy a rental property, take into account the possibility of tapping into the equity of your home to pay for it. This allows you to make profit without stressing out about taking a second mortgage besides the home equity loan
There are many things to consider when purchasing your first rental property. When you’re ready to dive head first into the real estate game, start by getting preapproved for a mortgage.
Casey Moseman can help answer your questions about
buying your first rental property.