Buying a rental property isn’t always an easy process. To become a landlord, there are a lot of responsibilities you’ll need to check off your to-do list. First, you need the right investment property. Then you need to qualify for an affordable investment property loan to make the purchase, which isn’t the same thing as a typical small business loan for business. But once you complete these initial steps, owning an investment property can potentially give you access to a lot of benefits.
Perhaps the biggest benefit of owning rental properties is the fact that they can potentially increase your monthly cash flow when you generate rental income. The right investment property could also be an asset that appreciates over time. Add in the numerous tax benefits, and it’s easy to see why becoming a landlord is such a popular investment option.
Key Differences in Getting a Rental Property Loan vs. Owner-Occupied Loan
Securing a rental property loan is different than taking out a mortgage for a primary residence. Below are some key differences to be aware of so you’ll know what to expect in advance.
Higher Mortgage Rates
As a rule of thumb, better credit scores lead to lower interest rates. That fact is generally true when it comes to rental property mortgages as well. Still, don’t expect to qualify for an interest rate as low as what you might find for an owner-occupied mortgage.
Higher Minimum Credit Score Required
Investment property loans have different approval criteria than you may be used to with traditional mortgages. For example, if you want to secure the best interest rates available, you should aim for a credit score of 720–760 (depending on the lender). Minimum credit score requirements can vary, but you’ll generally need a credit score of at least 620 or higher to qualify.
Larger Down Payment Requirements
When you buy an owner-occupied home, you may get by with putting 10%, 3%, or even 0% down, depending on the type of mortgage you use to finance the purchase. With investment property loans, on the other hand, a 20% down payment is typical.
Employment and Income Criteria
Your credit score shows lenders how likely you are to pay as agreed when you take out a loan. Examining your income and employment history helps lenders predict your capacity to pay (aka whether you can afford it).
When you apply for an investment property loan, a lender will want you to show a steady employment history. You’ll also need to show enough income to cover your existing debts plus the new mortgage. The lender may let you count your projected rental income for the property you’re purchasing. But, depending on the type of loan, you may have to show previous landlord experience on your tax returns before you can include projected rent as income.
Similar Debt-to-Income Requirements
Your debt-to-income ratio, or DTI, is a measurement of the money you bring in (gross income) versus the money you owe toward monthly debt payments. A lower DTI is better, both from a financial standpoint and from a lender’s point of view. For investment property loans and traditional mortgages, a DTI of 36% or lower is best.
More Cash Reserves
As a real estate investor, it’s crucial to demonstrate to lenders that you have back up reserves you can draw on if you need them. After all, there are times when rental properties will sit vacant in between tenants. Lenders expect you to keep up with your payments during these periods regardless of whether you have rental income for the property or not.
In general, you should show at least six months’ worth of reserves in the bank. These funds should be sufficient to cover both personal and rental expenses.
What Is the Interest Rate for an Investment Property Loan?
Like any other type of financing, interest rates on rental property loans can vary widely. Numerous factors may influence your interest rate and loan terms, such as:
- Credit Score
- Debt-to-Income Ratio (DTI)
- Down Payment Size
- Loan-to-Value Ratio (LTV)
- Loan Type (Long-Term vs. Short-Term Loans, Fixed-Rate Loan vs. Adjustable-Rate Mortgage, etc.)
Although it’s difficult to predict precisely what interest rate you may be offered on a real estate investment loan, one fact is certain. You should expect to pay higher interest rates when you’re financing a non-owner occupied home.
Depending on the factors above (e.g., down payment, credit score, etc.), the interest rate on an investment property loan can be anywhere from 0.50 to 0.875 percentage points higher than a loan for an owner-occupied residence.
Why Are Rental Property Mortgage Rates Higher?
The rates you pay when you borrow money directly correspond to the amount of risk a lender perceives. The entire point of a lender checking your credit scores when you apply for a loan is to help assess the risk of doing business with you. Personal FICO Scores, for example, can help them predict the likelihood that you’ll become 90 days late or worse on any credit obligation within the next 24 months.
Higher credit scores indicate that you’re a more trustworthy borrower. So, if you have good credit scores, you’ll usually be offered lower interest rates from lenders. Yet even people with excellent credit should expect to pay higher interest rates on a rental property loan than they would pay on a loan for their primary residence. This treatment is due to the nature of investment property loans themselves.
Lenders know that when you think of an investment property as a business, you’re less attached to it. As a result, the debt may fall lower on your priority list than, say, your primary mortgage if financial challenges arise.
The math doesn’t lie. Investors are one-third more likely to walk away from their mortgages than owner-occupiers. When a rental property sits vacant, it can become difficult for investors to keep up with their payments. If times get tough, investment property owners sometimes decide to move on instead of weathering the storm.
How to Shop for the Best Rental Property Mortgage Rates
When you’re shopping for the best mortgage rates on investment property loans, it’s essential to take your time and do your homework. A little preparation on the front end could potentially save you a lot of money over the life of your loan.
Before you apply for a rental property mortgage, it’s a good idea to take the following steps:
- Check your credit reports and scores (business and personal). When you apply for investment property financing, a lender is going to check your credit reports and scores. With a mortgage loan, it’s common for lenders to check all three of your personal credit reports and scores from Equifax, TransUnion, and Experian. Other lenders may want to check your business credit as well, depending on the type of loan you’re seeking. It’s always wise to review your credit reports in detail before any major financing application.
- Talk to multiple lenders. Before you decide on a loan for your investment property, take the time to speak with several lenders. You should compare various options to see who will give you the best terms and the best price on financing. According to Freddie Mac, buyers who get five loan quotes save an average of $3,000.
- Consider business loan financing. Conventional mortgages often feature lower interest rates on loans for non-owner occupied homes. But some people have a hard time qualifying for conventional financing. Whether you need an alternative financing option for an investment property or you just want to compare rates, business loans may offer you another potential solution. You can compare available business loan options. You may also want to investigate your business credit card options to pay for regular maintenance and repair.
What Are Today’s Rental Property Rates?
Rental property mortgage loans can fluctuate from day to day and from lender to lender. Not only that, but every applicant is different. So, the rates you’re offered from a lender might not be the same as the rates that are available to the next person who applies.
The best way to find out today’s investment property mortgage rates is to talk to lenders. In addition to the interest rate, be sure to consider the full cost of the loan. Pay attention to the annual percentage rate, down payment size, mortgage insurance requirements, closing costs, and the size of your monthly payments. It’s also wise to consider whether the lender is offering a variable or fixed rate on your loan and if that option is a good fit for your situation.
Final Word: Investment Property Mortgage Rates
If you’re thinking about becoming a landlord, approach the process with eyes wide open. Yes, there’s an opportunity to make money, but there’s risk involved as well. (Not every investment property story has a happy ending for the investor.)
Also, taking out an investment property mortgage can be more stringent and more expensive than the loan process you experienced with your existing home. Nonetheless, there are plenty of successful real estate investors who make the process work and earn a profit despite the challenges involved.
If you want to check your personal and business credit scores before you start looking for an investment property to purchase, we can help.