Investing in properties is rightly promoted as one of the safest ways to invest money in the long-term. Properties are more resilient than stocks, mutual funds, or foreign currencies. Also, real estate values always trend upwards in the long run because the investment is built on a finite resource, land. Even if home values decline within a given period, overtime property prices will increase.
Using leverage when buying properties is another thing that makes real estate a great investment option. No other investment offers the range of financing options that is available with properties. By paying only 25% of the sales price of a property, investors can buy a home and start earning income on it.
So why don’t more people invest in properties, given the advantages of real estate investing?
It is because qualifying for an investment property loan is not always easy, and most would-be investors are unable to scale the process. The requirements for obtaining an investment property loan differ significantly from the requirements for getting a primary mortgage.
Even if an investor lives in their own home, it is no guarantee that they will be able to get the rental property loan. Banks view rental property mortgage as a secondary mortgage – an addition to the investor’s first mortgage. By taking a second loan, the investor takes on additional financial burdens that make the possibility of defaulting on both loans much higher.
Consequently, lenders view rental property mortgages as being riskier. That risk is increased if the landlord doesn’t live on the property, which increases the possibility of damage.
Lenders exact stringent conditions as a way to protect themselves against the possibility of losing their money. The requirements ensure that only borrowers with the best credentials can qualify for a rental property loan.
What do lenders require from people who apply for an investment property mortgage? Upkeep Media explains everything in detail below.
1. Excellent Credit Score
Lenders not only demand a very high credit score, but they also look for a relative absence of late payments. The standard credit score required from people borrowing for their primary residence is 580. But for an investment property loan, the minimum credit score is 740.
This is a 160-point gap from what is required for a primary mortgage. Even though an investor can get the rental property loan with a lower credit score, the bank will make them pay higher fees and interest.
2. Bigger Down Payment
The down payment on a primary mortgage is usually between 13% and 20% of the home’s total price. And if the FHA underwrites the loan, the down payment may fall as low as 3% -3.5%. But for investment property loans, the minimum down payment is between 20% and 40%, depending on the type of property.
Single-family homes require 25% down, and properties with 2-4 living units require 30% down. In some cases, lenders will accept 20% down, but it will cost the investor in other ways.
3. Low Debt-to-Income Ratio
The debt-to-income (DTI) ratio is one of the measures lenders use to evaluate the financial resilience of prospective borrowers. It measures the borrower’s total monthly debt payments against their monthly income.
The goal of the assessment is to determine how much of their income goes to paying off debts. The ideal DTI to qualify for a rental property loan is 35%. This means no more than 35% of the investor’s income is committed to repaying loans.
4. Proof of Income
Lenders require proof of income for all types of mortgage. But for a primary mortgage, a copy of the most recent W-2, as well as recent paycheck stubs, will suffice. For rental property loans, the bank will require the applicant to show at least two years of W-2 income.
Or if they are self-employed, two years of tax returns are required. Besides, lenders prefer investors who have been employed in the same industry for a minimum of two years.
5. Cash Reserve
In addition to proof of income, the borrower must have substantial cash reserves. This usually means enough cash to cover six months of mortgage payments for their primary residence and the rental property.
This money must be in cash or assets that are easily converted to cash. The cash reserve assures the lender that even if the borrower loses their source of income, they can still make the mortgage payments.
6. Lower LTV and Higher Interest Rates
The loan-to-value (LTV) is the percentage of the mortgage amount divided by the appraised value of the home. The higher the LTV, the more interest the borrower will be made to pay. A lower LTV is typically required for a rental property loan. Additionally, property investors can expect to pay interest at 1%-3% points higher than is paid on a standard home loan.
To round it up, getting a loan to buy an investment property is difficult but not impossible. It only requires forethought and preparation. Investors who arm themselves with this knowledge and prepare accordingly will be less likely to have their applications denied. Good luck!
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