Understanding Investment Property Mortgage Rates
Investment property mortgage rates can range from 50 to 87.5 basis points higher than rates on a primary home. As an example, if mortgage rates for a 30-year, fixed-rate mortgage on an owner-occupied home are averaging about 3.25%, you might expect a 30-year investment property loan to have a 3.75% to 4.125% interest rate.
Why? Because lenders are exposed to more risk when lending money to real estate investors. Higher risk means higher interest rates and stricter borrowing requirements.
Investors typically rent out their investment properties to collect rental income. Periods of vacancy can increase the likelihood of mortgage default if an investor isnt financially prepared after all, theyd want to cover the mortgage payments on their main home first. When times get tough, investment property owners can cut their losses and run.
Shop For The Best Mortgage Rates
The mortgage lending industry is highly competitive, so do your due diligence and shop around for the best mortgage rates. Even a few tenths of a percentage point can save you tens of thousands of dollars over the life of your mortgage loan.
Debt Service Coverage Ratio
The DSCR is calculated as the Net Operating Income from the property divided by the annual mortgage payments , where NOI is total income of the property less operating expenses. The DSCR ratio should ideally be over 1, meaning that the property is generating enough income to fulfill its debt obligations. The higher this ratio is, the easier it is to obtain a loan.
|Net Operating Income||= Rental Income â â Operating Expenses|
|DSCR||= NOI /|
When looking at the NOI, lenders will make sure the stated income and expense data are accurate, supported and reasonable. For instance, if the allowance for vacancies and collections is atypically low, a lender may substitute in higher âmarketâ vacancy and collection rates.
Typical operating expenses subtracted from rental income include taxes, insurance, repairs and maintenance, utilities and property management fees.
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What Are Current Investment Property Mortgage Rates
Investment property rates are usually at least 0.5% to 0.75% higher than standard rates.
So at todays average rate of 3.125% for a primary residence, buyers can expect interest rates to start around 3.625% to 3.875% for a single-unit investment property.
Note, todays average rates are based on a prime borrower profile, with a credit score of 740 and 30 percent down payment.
If you have lower credit or a smaller down payment, your interest rate will likely be higher than what you see advertised.
Thats why average rates shouldbe used as a benchmark only.
Your own investment property rate willbe different, so be sure to compare quotes from a few lenders and find the bestdeal for you.
Why Does A 15
Another huge factor when considering whether to use a 15 or 30-year loan, is qualifying for more properties. When banks qualify an investor, they will look at debt to income ratios. A 15-year loan will have a higher payment and increase your monthly debt payments. The higher your loan payments are, the less cash flow you will have, and it will be harder to qualify for new loans. Many banks will only count 75 percent of your rental income when qualifying an investor for a loan. Even if you are cash flowing with a 15-year loan, if you can only count 75 percent of the rental income, you may show a loss each month. If you have many rental properties showing a loss, it will be very hard to qualify for new loans.
A 30-year loan with its lower payments will make it easier to qualify for more properties.
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Whats A Disadvantage Of Getting A 15
The only downside to a 15-year mortgage compared to a 30-year mortgage is that it comes with a higher monthly paymentbut really, thats a good thing!
With the higher monthly payment of a 15-year mortgage, more of your money will go toward paying off the principal amount of your loaninstead of getting thrown away on interest.
Thats how the 15-year mortgage allows you to pay off your loan in half the time compared to a 30-year mortgageand avoid a mountain of interest payments.
We Are Not In Normal Times
However, we are in a most interesting time. We are currently experiencing a mortgage market anomaly where the average 15-year mortgage is much lower than the average 5/1 adjustable rate mortgage. And whenever there is a mortgage market anomaly, you should take full advantage to save the most amount of money.
Take a look at the latest Freddie Mac mortgage market survey below. It shows the average 15-year mortgage is 2.2% versus 2.52% for a 5/1 ARM. However, its worth noting the average fees/points is slightly higher for a 15-year mortgage than for a 5/1 ARM.
Starting around early 2019, the average 15-year mortgage rate average began to consistently fall below the average 5/1 ARM rate . The reason? A focus on risk-adjusted profits and supply and demand.
Lenders decided they couldnt make enough margin on a 5/1 ARM with a 30-year amortizing period to warrant the increased risk of defaults. Therefore, the average 5/1 ARM rate didnt decline as much.
Instead, lenders began focusing on 15-year mortgages to tighten lending standards and increase their chances of getting paid back in full. With a higher monthly payment and a 50% shorter amortizing period, lenders felt more comfortable lending 15-year mortgages at lower rates.
At the same time, borrowers have decided they wanted to be more conservative and take out a shorter amortizing loan instead. With interest rates so low, why not lock in a loan for 15 years instead of only five years.
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What Can I Do With An Investment Property
There are several uses for a residential investment property, including:
- House flipping, which can be done after making home improvements that increase the propertys value
- House hacking a multiunit home, which allows you to live in one unit and rent out the other unit to cover your mortgage payments and create a passive income stream
- Providing short-term rentals through a platform like Airbnb
- Providing long-term rentals in six- to 12-month increments
The Advantages Of A 30
The 30-year mortgage is the most popular option for homeowners in the US for many reasons. But one of its main advantages is that the payments are stretched out over a period thats twice as long as a 15-year mortgage, which means 30-year mortgages have lower monthly payments. Those lower payments make it easier to afford a home, or to buy a larger home and still stay within your budget.
According to Juan Carlos Cruz, founder of Britewater Financial Group in Brooklyn, New York, a 30-year mortgage is ideal when the loan amount is large and amortizing it over 15 years makes the payments too much to handle, or the buyer wants more purchasing power on a greater home that they can pay off over the 30-year mortgage.
With a lower monthly payment, youll have more money to spend on other household expenses, or you can even use the extra cash to turn around and make more money.
If your money can make a 10-year annual average of 8% in the market with a diversified portfolio minus fees of investment advisors and hidden mutual fund fees why would you hurry and pay your 3% mortgage loan? asks Carolyn Mescher, a CPA, and principal at Magnolia 313 Accounting Services in San Luis Obispo, California.
Invest the additional cash youre saving with a 30-year mortgage versus a 15-year term, and the 5% difference between the 8% youre earning and the 3% interest youre paying would then compound over 30 years, explains Mescher.
More flexibility in payback terms
Larger tax deduction
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Which Is Best For You
It depends. In the interest of full disclosure and to give a personal example, I’ve bought three homes in my lifetime. Two of them were purchased with 30-year fixed-rate mortgages, and the other was purchased with a 15-year, so I’ve taken advantage of the benefits of both under different circumstances. The home purchased with a 15-year mortgage was my “starter home,” and I bought a relatively inexpensive house in order to be able to put 20% down and avoid PMI. My current home is larger and was in a considerably higher price range, so a 30-year mortgage keeps my payment affordable, giving me more financial flexibility to invest and avoid credit card and other higher-interest debts.
As I mentioned, the 30-year fixed-rate mortgage is the industry standard in the United States, and is chosen by the vast majority of homebuyers. However, if you can afford a higher monthly payment, or are planning to buy a home well within your maximum budget, a 15-year mortgage and the savings potential it offers is definitely worth a look.
The Main Downsides Of A 30
The most obvious disadvantage of a 30-year mortgage is that itll take twice as long for you to own your home outright, which means a longer duration until you have financial freedom from your housing payment.
But Nicole Rueth, producing branch manager at Fairway Mortgage in Denver, also points out that the lower monthly payment of a 30-year mortgage comes at an additional cost, with 30-year mortgages carrying higher interest rates. Combined with the longer term, that results in paying much more in total interest over the life of your mortgage.
According to a recent Bankrate mortgage survey, average interest rates on a 30-year fixed-rate mortgage are currently 3.05%, which is near a record low. But in the same survey, the average rate on 15-year mortgages was just 2.45%.
That means youre paying 0.6% more for a 30-year mortgage, which may not sound like a lot. But on a $200,000 home with a 20% down payment, youll pay a total of $31,358 in interest over the entire length of a 15-year mortgage at 2.45%, while the same home with a 30-year mortgage at 3.05% ends up costing a much higher $84,399 in total interest.
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Why Is A Short Term Loan Better
The biggest advantage of a 15-year mortgage is the interest rate is less than a 30-year loan. The difference in rates changes daily and varies with different banks, but a 15-year loan is usually about .5 percent less than a 30 year fixed mortgage. With a lower interest rate, you are paying more towards the principal and less towards interest.
Some people think the biggest advantage of 15-year loans is the shorter length of the loan. I dont agree because you can pay a 30-year loan off early if you want too. You will have a higher interest rate, but .5 a percent is not a huge rate difference, especially when you consider how much you can make buying more properties.
Buying A Second Home To Rent
Buying a second home that will be used as a rental property comes with a number of advantages, most notable of which are the tax deductions. But on the flip side, it also means that a buyer will become a landlord and have certain responsibilities that will require time and energy. It is one thing having a second home that you only visit for yearly vacations, and it is an entirely different thing to have a second home that will be rented out.
As far as tax deductions are concerned, there are two conditions under which a property will be considered a second home. They are:
An example of these conditions being met is a second home that you rent out for 200 days in a year and live in for at least 20 days in the year. Meeting these conditions ensures that the house qualifies for a second home mortgage.
Considering that second home mortgages are usually easier to qualify for than investment property mortgages and come with lower interest, it is important for you to carefully evaluate all the criteria involved in meeting them.
Ready to buy a second home? Or maybe you want to purchase an investment property. You need to know the difference between the two, because getting a mortgage loan for one is usually a more complicated and costly process.
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The Bottom Line: Shorter Or Longer You Have Many Choices
When it comes to mortgage terms, 15-year mortgages are perfect for those with the income to make the higher monthly payments. But just because youre not ready to commit to a 15-year mortgage now doesnt mean you cant enjoy the benefits that come with paying your mortgage off earlier.
Ready to apply? Get started with Rocket Mortgage today.
Take the first step toward the right mortgage.
Apply online for expert recommendations with real interest rates and payments.
Opt For A Larger Down Payment Where Possible
Whenever possible, reduce the interest rate in exchange for a larger down payment. In some cases, it might also make sense to pay upfront fees to lower the rate. If you apply for a big loan, and plan to hold the property for a long time, paying upfront fees and/or a higher down payment could trim thousands of dollars from your repayment total.
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Surgically Invest In Real Estate
Real estate is my favorite way to achieve financial freedom because it is a tangible asset that is less volatile, provides utility, and generates income. By the time I was 30, I had bought two properties in San Francisco and one property in Lake Tahoe. These properties now generate over $150,000 a year in passive income.
In 2016, I started diversifying into heartland real estate to take advantage of lower valuations and higher cap rates. I did so by investing $810,000 with real estate crowdfunding platforms. With interest rates down, the value of cash flow is up. Further, the pandemic has made working from home more common.
Take a look at Fundrise, my favorite real estate investing platform for both accredited and unaccredited investors alike. Fundrise has been around since 2012. The platform has consistently generated steady historical returns, even during down years in the stock market.
For most people, investing in a diversified real estate fund is a great way to gain real estate exposure.
For those of you who are accredited, also take a look at CrowdStreet. CrowdStreet focuses primarily on real estate opportunities in 18-hour cities. 18-hour cities have lower valuations, higher cap rates, and generally have higher growth rates due to positive demographic trends.
You can build your own select fund with CrowdStreet.
Readers, any of you take out a 15-year mortgage? Why do you think people are still taking out 30-year fixed mortgages in todays environment?
The Complete Guide To Investment Property Mortgages In 2021
If the road to real estate riches were an easy one, everyone would be a millionaire landlord or house-flipper.
Making big money from investment property is rarely as simple as buy low, sell high. It requires careful research, planning, hard work and a dollop of good luck.
But as long as you make real estate investing decisions with your eyes wide open, the financial rewards could surprise and delight you.
In 2019, the average gross return of house flipping purchasing, renovating and quickly reselling homes was 39.9%.
In other words, the average house flipper earned $39,900 for every $100,000 invested.
The average return on rental properties in 2019 was 15%. This means the average buyer of a $500,000 apartment building earned $75,000 in a single year!
By contrast, the average stock market return over the past 50 years was about 8% while the average investors return on mutual funds was between 4-5% over the last 30 years.
In this article:
Before examining the benefits of buying investment property, lets bust two persistent myths:
Myth 1: Buying a primary residence is the same as purchasing an investment property.
Fact: Although many people think of their homes as investments, a home is not an investment property unless you buy it for the express purpose of generating rental income or a profit upon resale.
Myth 2: Home values have always risen, so a primary residence will end up being an investment property if you own it long enough.
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Home Equity Lines Of Credit
HELOCs are revolving credit lines that usually come with variable rates. Your monthly payment depends on the current rate and loan balance.
HELOCS are similar to credit cards. You can withdraw any amount, any time, up to your limit. Youre allowed to pay the loan down or off at will.
HELOCs have two phases. During the draw period, you use the line of credit all you want, and your minimum payment may cover just the interest due. But eventually , the HELOC draw period ends, and your loan enters the repayment phase. At this point, you can no longer draw funds and the loan becomes fully amortized for its remaining years.
Compared with conventional mortgages, HELOCs offer more flexibility and lower monthly payments during the draw period. You can borrow as much or as little as you need when you need it.
The potential drawbacks are the variable interest rates and the possibility that the monthly payments could skyrocket once the repayment phase begins.
In some house flipping situations, a HELOC could be a lower-cost alternative to a hard money loan.
But unlike a hard money loan, a HELOC could have more risk attached: if you dont already own an investment property, youll secure the HELOC with your primary residence. If you default on the loan, the lender will foreclose on yourhome, not the investment property.
If you already own an investment property, you can overcome this problem by applying for a HELOC on one or more of those properties. The only trick is finding a lender.