Rental Property Loans
The mortgage process for the investment properties are the same as the primary residence where the lenders check the debt to income ratio, assets, credit check. The requirements are checked through a process of underwriting before the loan is sanctioned. Lenders usually follow stricter standards for the loans on Investment Property when compared to the Residential loans as they view the rental property investment to be a greater risk as the owner does not live in the property. The interest rate and the loan fees may also be higher than the residential loans to compensate their higher risk. There are scenarios where some investors just choose to walk away if the rental property does not generate positive cash flow.
Lender usually qualifies the rental property loan by qualifying both the property and the owner. These qualifications vary depending on various factors such as the lender, location of the property, percentage of down payment.
Most of the lenders expect 25% down payment for the rental property.
Some lenders might also need proof of reserves of at least 6 months for mortgage payments, property tax etc.
Credit score of at least 620 may be mandatory.
Single family, multi family (units 1-4), condos, town homes qualify for Residential loans.
In addition to the monthly mortgage payments, there are also other costs that need to be considered by the investors while investing in rental properties.
Property management Fees
Maintenance and Repair Fees
Leasing and lease renewal Fees
Capital reserves for emergency purposes
Business and License Fees
Loan Options for Rental Investment Property
Conventional 30 year Fixed mortgage
30 Year fixed mortgage is defined as the mortgage which has the fixed interest rate and the monthly mortgage payments stay same for the entire term of 30 years. The monthly payment is low and the repayment period is longer. This loan is usually the preferred loan by many people.
The loan has smaller monthly mortgage payments which makes it easier to qualify and easier to pay. There is a flexibility to pay off the loan faster by making extra payments to your regular monthly mortgage payments. There is a chance to qualify for more expensive home. As the monthly mortgage payments are smaller, you may have extra money to invest in other areas of your interest.
During the initial years of the loan, majority of your monthly mortgage payment is towards the interest payment. The total interest paid is higher than short term loans thus making the equity growth slower. The lender's risk of not getting paid is spread over 30 years, thus the lenders charge higher interest rate. You may be qualified for much expensive home, but due to a bigger home, your property tax, insurance and maintenance costs may be higher which may not be suitable for many.
Adjustable rate mortgage
Adjustable rate mortgage is a type of loan where the initial rate is fixed for a certain time, then varies periodically based on the terms of the loan chosen by the borrower and the benchmark interest rate chosen by the lender. For example, 5/1 ARM has an initial interest set for first 5 years, then the interest changes annually.
The interest rates are usually lower than the interest rate on the fixed rate mortgages. In 5/1 ARM, the interest rate is locked down for the first 5 years to a lower rate. If you are buying a home for a short period of time and then planning to sell or move, then ARM loan may be the best suit for you. The mortgage payments may decrease if the interest rate falls and drives down the index.
Some ARM loans include a prepayment penalty, this is a fee that may be charged while selling or refinancing your rental home within a specific time period. It is very important to be aware of all the rules, penalties and structures of the loan and may cause a risk if not properly understood.
Jumbo loan is a type of mortgage which is used to finance properties which are too expensive for the conventional conforming loan (exceeds loan limit) standards set by Federal Housing Finance Agency.
Jumbo loans makes the buying of expensive home possible as the loan limits are higher than the conventional loan limit. Jumbo loan helps in financing the property under a single mortgage instead of multiple loans to finance a mortgage. Jumbo loans with a down payment of 20-25% usually gives a better interest rate.
As the Jumbo loans pose a credit risk to the lenders not only because of the high loan amount but also it cannot be packaged as a mortgage backed security and thus they charge a higher interest rate. Not all the properties get qualified for the loan, needs a very good credit score to be qualified for the loan and may also have high closing costs. Gift funds may not be eligible for down payment.
It is a type of loan when the loan is insured by the Federal Housing Administration. FHA loans are possible with a lower down payment than conventional loans and credit scores of as low as 580. The debt to income ratios are also higher than conventional loans. The property (home, multifamily, condo, town home, manufactured home) that the borrower is planning to invest must meet the standards outlined by the FHA. There is an upfront mortgage insurance premium that has to be paid initially or can be rolled into the loan. The loan amount cannot exceed the conformed limit on that area.
VA loans are the type of loans guaranteed by Department of veteran affairs and are funded by private lenders. These loans are available to the military service person or veterans who meet certain requirements. VA guarantees to pay the loan amount if the borrower defaults to repay. There is no down payment or mortgage insurance required as defined in the FHA loans. VA loan requires a one time Funding fee required. Some VA loans allow to purchase multiple investment properties but one of them must be a primary residence. The property must meet the building standards and building codes.
Seller financing is a type of transaction where the seller helps in financing the buyer on their loan instead of a lender while purchasing the home. Instead of giving cash to buyer, seller may also give some credit towards the purchase or remove any down payment while doing a purchase. A contractual agreement is signed with all the terms outlined between the buyer and the seller. This may be seen more common in Land contracts than in residential transactions. Usually, the sellers have an agreement in comparatively shorter term than the traditional mortgage loan. It also protects the sellers to refrain from exposure of risks by extending credit for longer term than necessary. The seller usually holds the promissory note until all the agreed upon terms have been satisfied by the buyer. the financing is done either partially or fully. This is also called as Purchase money mortgage or Owner financing.
Portfolio loan is a type of loan that the lender originates and retains the loan instead of selling on the secondary market. The investor has certain advantages such as getting qualified on low credit scores, liberal debt to income ratio, may not be obligated to meet conforming loan limits, Private mortgage insurance may not be required even while paying low down payment and there is an option where the investors can roll up all their mortgage loans into one and make a single mortgage payment. Some of the disadvantages of Portfolio loans are they might have higher interest rates and higher fees associated and they might also have a prepayment penalty. This is a fee charged by the lender for being liberal with the credit score, debt to income ratio and conforming loan limits.
Home Equity Loan
Home equity loan is a type of loan granted by the lender based on the equity present on their current home. They are also called as Second mortgage. Usually the borrowers apply for a certain amount of loan and if approved by the lender, they get a lump amount of the money requested. It is one of the way to secure a down payment for the investment property with low interest rate and fixed terms as the borrower doesn't have to go through the whole mortgage process again. Most lenders have a loan to value ratio of 85%, meaning the combined value of the current mortgage and the equity loan cannot exceed 85% of the current home value.
Home Equity Line of Credit (HELOC)
HELOC is similar to home equity loan where the loan granted by the lender is based on the equity present on their current home. But, HELOC works as an open line of credit where the borrower can borrow money, make the payment and again borrow multiple times according to their needs up to a certain loan to value ratio. They usually have variable interest rates according to the fluctuation of the market.
Blanket mortgage Loan
Blanket mortgage loan allows a borrower to finance multiple properties at once under a single loan. Properties are usually cross collateralized where one property serves as the collateral for another. The down payment, credit score requirements and the terms on the loan vary according to the lender. There is a clause called release clause which enables to sell one or more properties within the blanket loan. This is mainly used by the investors owning large portfolio of investment properties.