Investment properties are real estate that homeowners purchase to generate income through rental income and/or appreciation. As a result, they require different types of mortgages when compared with primary residence home loans. In addition, investment property mortgages are often harder to get and have higher mortgage interest rates than typical home loans.
It is important to understand the differences between these mortgages to successfully invest in real estate.
Investment Property Mortgage Rates
The cost of financing investment property is higher than owner-occupant home loans. Investors should expect to pay higher upfront costs on their property loans and higher interest rates.
Mortgage interest rates are higher for income properties because of the higher risk.
Interest rates also depend on several factors:
- The type of property.
- The type of loan.
- The size of the down payment.
Federally backed mortgage companies like Fannie Mae and Freddie Mac add surcharges to investment property mortgages. For example, an income property with 20% down has extra fees equal to almost 4% of the loan amount. On a $200,000 mortgage, this means additional closing costs of nearly $8000.
Investment property buyers can defer these extra upfront charges by paying interest rates about 0.75% higher for loans with 20% down or 0.50% higher for loans with 25% down.
Different Types of Mortgages for Investment Properties
Borrowers can choose between four common types of rental property mortgages. Each comes with its advantages and disadvantages.
#1 Government-Backed Loans
To finance an investment property with one of these home loans, investors buy multi-unit properties, live in one, and rent out the others.
- No previous property management experience is required.
- Low minimum down payments: 3.5% for FHA, 0% for VA loans.
- These programs are only for owner-occupied homes.
#2 Conforming Loans
Conforming loans, such as Fannie Mae and Freddie Mac, are a good choice for experienced buyers with higher down payments. In addition, those with a good income and excellent credit can access these loans at competitive interest rates. However, to qualify for these programs, borrowers need previous experience in property management or as a landlord.
- These loans work for experienced buyers who have good-sized down payments.
- Conforming loans are available at competitive interest rates for those with good credit and a solid income.
- Previous property management or landlord experience is required to qualify.
#3 Portfolio Lenders
A portfolio lender is a bank or other financial institution that originates and maintains a mortgage loan portfolio rather than selling the loan in the secondary market.
Portfolio lenders’ loans tend to be more varied and easier to secure. However, they often come with higher costs.
- Easier to get loan approval.
- More flexible than traditional loans.
- No limit on the number of properties.
- Great for real estate entrepreneurs.
- Higher Fees.
- Higher Interest rates.
#4 Commercial Residential Rental Property Loans
Commercial residential rental property loans allow property buyers to borrow based only on the rental property’s income. These loans are good options for expensive properties, like apartment complexes. However, they also come with more considerable fees.
- Higher financing limits.
- Allow for more than four-unit properties or whole apartment complexes.
- Expensive and often complex to set up.
Higher Down Payment, Cash Reserves Needed
Because mortgage insurance is typically unavailable for investment properties, income property loans often have strict guidelines for 20-25% minimum down payments.
To qualify for these loans, borrowers will also have to prove they have cash reserves in the event of vacant units. For example, if the borrower’s monthly mortgage payment is $2000, they may need to prove that they have up to six months (or $12000) in reserves.
Some borrowers can take advantage of government-backed loans with lower interest rates and smaller down payments if they buy multi-unit homes and reside in one of the units. However, these programs limit the number of properties that a borrower can purchase.
Finally, another option is to buy a home and live in it for one year before converting it to a rental. This process allows borrowers to get a better interest rate and acquire the landlord experiences needed to purchase subsequent investment properties.
Investment Property Credit Score Requirements
Investment property loans require higher minimum credit scores.
Borrowers with less than 25% down payment and a debt-to-income ratio above 36% often need a credit score of 700 or higher. In comparison, borrowers with a down payment of 25% or higher and a debt-to-income ratio below 36% may be able to secure a loan with a credit score of 640.
Marimark Mortgage is based in Tampa, Florida, and serves the mortgage needs of homebuyers, homeowners, and investors in Florida, Virginia, and Pennsylvania.
We specialize in mortgages for first-time homebuyers, conventional home mortgages, refinance loans, reverse mortgages, and FHA, VA, and USDA mortgage options. In addition, we’ve worked extensively with cash-out refinancing and help clients to lower their monthly mortgage payments.