Investment Property Loans: Know Before You Owe
All loans are not created equal. Expect to pay more for investment loans for rental property than you would for a home. Qualifying for a loan to buy rental property is generally a more difficult proposition. Adapt the investor's hang-onto-your-hat-and-enjoy-the-ride philosophy that helps make your first investment in commercial real estate fun. But you can also profit from these solid tips on how to get financing.
Down Payments Are Essential
Just like a big down payment helps land a home mortgage, it also makes borrowing to buy rental property easier and cheaper. "You'll need at least 20 percent cash down, and 25 percent is better," advises San Francisco real estate investor Richard Sylvain. Mortgage insurance doesn't cover rental properties, according to Sylvain, so traditional lenders require a big slice up front.
The larger the down payment you bring to the table, the better loan deal you're likely to get. For example, a 25-percent down payment will likely get you a lower interest rate. But don't forget closing costs when figuring how much down payment you can afford. You'll need money to pay origination fees, appraisal fees and other loan costs in many cases.
Money in the Bank
Don't spend every dime you have on a down payment. You'll need some cash in the bank to qualify for an investment loan. Most banks want to see that you have at least six months of mortgage payments in cash reserves for every property you own before giving you an investment loan, notes financial expert Mark Ferguson, founder of Invest Four More.
For example, if you pay $2,000 per month for the mortgage on your home, plus you want to take out a commercial loan with a $1,000 monthly mortgage payment, you will need to have six months worth of $3,000 payments, or $18,000. This is in addition to the down payment and closing costs on your commercial property.
Your Credit Report Counts
You've probably heard about the importance of your credit score in obtaining mortgages; this remains true when you seek an investment loan for rental property. It's a good idea to review your credit report regularly for mistakes, and before you apply for an investment loan. If you see problems on your report, consult a credit specialist before closing or opening any accounts. Such actions can negatively affect your credit score.
Bankrate expert Todd Huettner says that you'll pay more interest if your credit score is under 740. If the lender grants you the loan, it will likely charge fees in the form of points — one-quarter of a point to 2 points, or .0025 to .02 percent of the loan amount, to keep the same interest rate.
Keep Other Debt Low
Lenders also look at debt-to-income ratios when calculating loans. Since your home mortgage is included in the calculation, it pays not to buy an expensive home when you're planning to also buy rental property. If you max out your qualification on your home loan, it raises your debt-to-income ratio, and you may find it harder to qualify for a loan on an investment property.
Thinking Out of the Box
If your credit score and cash reserves don't qualify you for an investment loan, consider these out-of-the-box tips from author and lecturer Leonard Baron, MBA, to get you started:
- Buy as an owner-occupant to get good rates, then move out down the road and turn the property into a rental.
- Check with government-controlled loan companies like Fannie Mae and Freddie Mac to look for low-interest investment properties.
- Buy a rental property with a renter already in place — the bank may use estimated net rental income to balance out your debt-to-income ratio.