Purchasing rental properties can prove to be more difficult than purchasing an owner-occupied home. Lenders take a serious risk when they give you money for a home that you aren’t using as your own. Typically, homeowners pay their primary residence mortgage before they pay an investment property if they get into financial trouble.
Luckily, there are a few options for you to explore when you want to finance an investment property.
Let’s start with the most common loan – conventional loans. These loans are the same loans you could get for an owner-occupied property with the exception of harder requirements and slightly higher fees. As is the case with a primary residence, you need great credit for this program. Because you are trying to finance an investment property, you’ll likely need a credit score even higher than they would require for an owner-occupied property. It’s not unusual to see credit score requirements over 700.
You’ll also see:
- Down payment minimums of at least 20%
- Debt ratio maximum of 28% and 36% respectively
- Minimum liquid reserves of 6 months (checking, savings, stock market, IRA)
Conventional loans typically allow up to 4 mortgages for one borrower, assuming you qualify. If you already have investment properties and have established yourself as a viable landlord, you may be able to use your rental income to help keep your debt ratio low.
There is one way you can use a government-backed loan for your rental property. If you buy a multi-unit property and live in one of the units, lenders consider it owner-occupied. This means you can rent out the other units.
The benefit of doing it this way is the lenient guidelines. FHA loans don’t have ‘other guidelines’ for investment properties because they don’t allow investment property loans. With this exception though, you’ll need to meet the following requirements:
- 580 minimum credit score
- 31% and 43% respective maximum debt ratios
- 5% down payment (this can be an approved gift)
Home Equity Line of Credit on Your Home
If you have equity in your primary residence, you may be able to tap into the equity with a HELOC and use the cash to buy rental properties. Of course, the amount you can take out depends on the amount of equity in your home. Most lenders allow up to an 80% LTV, so this may work better for homeowners that own their home free and clear. You can tap into the equity in your home, invest it in another home, and grow your investment by renting and/or flipping the home.
HELOCs don’t have specific guidelines because each lender makes their own rules. Typically, you’ll see credit score requirements of at least 680 and maximum debt ratio allowances of 40%. Again, this will vary by lender and your situation. Keep in mind, though, taking out a HELOC puts your primary residence at risk of foreclosure should you stop making payments rather than putting your investment property at risk.
Don’t forget about the subprime market. While it may have seemed to go by the wayside with the housing crisis, it’s back. While you won’t find no income, no asset loans any longer, you will find lenders with more flexible guidelines. Subprime lenders don’t sell their loans to the secondary market. This means they can make their own rules.
Each lender will have a niche offering, some of which are for rental properties. Make sure you watch the interest rate and fees on these loans, since they aren’t Qualified Mortgages, they may not be as closely monitored. Lenders have to follow the Ability to Repay Rules, though, which means the lender does their due diligence in making sure you can afford the loan. The chance of you getting a loan that puts you in over your head is minimal.
Sometimes sellers are willing to provide the financing on a home. This is most common with sellers that own the home free and clear. The seller will be the ‘bank’. You make a down payment, as you would with any loan and then you make predetermined payments to the seller.
How sellers qualify you for the loan depends on their ability to accept risk. They will likely run your credit and ask about your other debts. The seller needs to know what type of borrower you are, so they will want to get as much information on your financial life as possible.
This is usually a good option for borrowers that have a hefty down payment and just need to finance the rest of the purchase. Sellers usually don’t offer financing for more than 10 years, though, so this is a better option for investors that plan to buy and flip rather than those keeping the home for the long term.
As with any loan, the best thing to do is shop around. See what type of loan you may get from each of the options above, with the exception of the FHA loan unless it’s a multi-unit property. Then you can compare the terms, costs, and interest rates. Look at the big picture. Decide how long you might own the home and then calculate its total cost. This is the best way to figure out which loan program works for you.