How Are Investment Properties Different From Second Homes
Its important to distinguish between investment properties and second homes because mortgage rules and interest rates are different for each type of property. The biggest difference between the two is that you must occupy a second home for at least part of the year, while you the owner dont live in an investment property.
A second home or vacation home might count as an investment property if you intend to rent it out even for short periods. However, lender policies vary over this.
For example, Fannie Mae lets you rent out a second home provided you occupy it yourself for a period each year, retain exclusive control of the home, and dont rely on your anticipated rental income when you apply. Lenders will also expect a second home to be in a tourist area for a vacation home or a certain distance from your main house if you plan to use it as an occasional residence.
There are three main loan types used to finance investment properties:
- Conforming loans: By far the most common option
- Jumbo loans: Used when the loan exceeds conforming loan limits
- Government-backed loans: Used only when you occupy one unit yourself and rent out the others
Most of those seeking investment property loans will require conventional mortgages. The majority of these are conforming mortgages, meaning they conform to lending rules set by Fannie Mae and Freddie Mac.
The Bottom Line: Prospective Airbnb Hosts Will Need To Be Flexible To Buy Airbnb
While COVID-19 has created issues for the travel industry, particularly Airbnb and its hosts everywhere, financing a rental property is still very possible. Getting approved for conventional investment loans may be difficult, but it is doable and there are FHA and VA options if you choose to live onsite, with some homes.
For current Airbnb hosts, there are plenty of financing options as well to help you invest in new properties or recover after some of the losses that came with the pandemic.
If youre interested in financing a second home or multi-unit property to get started as an Airbnb host, apply for a mortgage online today.
Get approved to refinance.
Option : Tapping Home Equity
Drawing on your home equity, through a home equity loan, home equity line of credit , or cash-out refinance, is a fourth way to secure an investment property. In most cases, itâs possible to borrow up to 80% of the homeâs equity value to use toward the purchase, rehabilitation, and repair of an investment property.
Using equity to finance a real estate investment has its pros and cons, depending on which type of loan you choose. With a HELOC, for instance, you can borrow against the equity the same as you would with a credit card, and the monthly payments are often interest-only. The rate is usually variable, however, which means it can increase if the prime rate changes.
A cash-out refinance would come with a fixed rate, but it may extend the life of your existing mortgage. A longer loan term could mean paying more in interest for the primary residence. That would have to be weighed against the anticipated returns that an investment property would bring in.
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Proactively Improve Your Credit Rating
For the most part, youll need good credit to obtain an investment property loan. Work on improving your credit to make qualifying easier by paying off outstanding debts and by making sure you pay all your bills on time. If you have credit card debt, try to get your debt-to-credit ratio down to 30 percent.
Whats The Difference Between A Construction Loan And A Home Loan
A construction loan and a home loan are different in terms of what they can be used for, and as such, the approval requirements will be slightly different for each. A construction loan is used to build new structures or renovate existing ones, while a home loan is just a traditional mortgage. Both types of financing will require a credit check and other financial information, but a construction loan will also require the project plans to be approved before the loan is issued.
Additionally, construction loans can only be used for the duration of the project. On the other hand, home loans are issued for a set period until they are paid off. Borrowers who rely on construction loans will typically refinance their property after the project is completed and enter a more traditional loan. To do so, homeowners will go through a property inspection and appraisal.
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Why Use An Investment Property Loan
The first and most important reason to seek financing is because you dont have enough cash for the full purchase price however, there can be other benefits to taking out a loan.
Borrowingor leverage, as the financial experts call itallows you to make a bigger investment with a smaller initial outlay. That means that any returns would be magnified, whether they come from rental income or rising real estate prices. A 10% increase in your propertys value becomes a 20% increase if youve only put half down. Thats the power of leverage.
Borrowing also increases risk, though. A drop in the value of your property will hit you harder if youve borrowed to buy it. If the economy slows down and vacancies rise, youll still be on the hook for loan payments and interest, as well as operating expenses, even though less money is coming in.
What Is A Rental Property Loan
A rental property loan is a first lien mortgage loan secured by an SFR that is occupied by a tenant rather than an owner-occupier. To qualify, the property must be rent-ready. Typically the tenant is long-term, but rental property loans also can be used for short-term rentals, such as vacation rentals.
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How Rental Property Loans Work
As a rule of thumb, loans for a residential rental property come with slightly higher interest rates and require larger down payments. Rental property loans are still fully amortized over 30 years so that the payment amount is the same every month, which makes putting together an accurate pro forma for cash flow easier.
Interest rates are higher and down payments are bigger because lenders view investment property loans as being more risky compared to a mortgage for an owner-occupied home. Thats because banks know from experience that if the investment doesnt go as planned, an investor-borrower is more likely to walk away and give the keys back to the bank.
However, the slightly more restrictive terms on a rental property loan can work in favor of the real estate investor. Interest payments can be completely expensed as a tax deduction by investors. A bigger down payment creates a lower loan-to-value ratio, with a lower mortgage debt service payment amount and potentially increased cash flow.
Although every lender is different, these are some of the typical requirements to expect when applying for a residential rental property loan:
Know The Tips And Options For Investment Property Financing
Real estate has consistently been one of Americans favorite ways to invest. According to an annual Gallup poll, more Americans named real estate the best long-term investment than stocks and gold.
But its no secret that real estate can be expensive, and many people cant afford to buy investment properties out of pocket. Luckily, there are plenty of ways to finance an investment property, including utilizing traditional lending and assets you already own.
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Investment Property Mortgages: Everything You Need To Know
Buying investment property can mean many things. Sometimes people even use this phrase to describe buying a home they live in because, after all, that property is a big investment for them.
But investment property most commonly means buying a home that you dont live in, but instead rent out. Lets take a look at the key things you need to know about buying and financing investment property.
Investment Property Loan Rates
Lenders know that investment property loans are riskier than loans for owner-occupied homes. Thats because if a borrower gets into financial trouble, theyll prioritize paying their main mortgage over their investment property mortgage.
As a result, lenders charge a higher interest rate for investment property loans than for ordinary mortgages as well as setting higher barriers to qualifying.
As weve already mentioned, these rates are often 0.50 to 0.75% higher. That will vary by lender as well as your down payment, credit score, cash reserves, and DTI. Youll get the best interest rate on an investment property with a down payment of at least 25%.
To find out more, read: Investment and rental property mortgage rates.
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Rental Property Loans Vs Regular Home Loans
Some of the biggest differences between a rental property loan versus a regular home loan include:
- Larger down payment, often 20-25% or more, depending on the property and the borrower
- Higher interest rates and fees to compensate the lender for the additional risk of making a rental property loan
- Debt-to-income ratio of less than 36%
- Sufficient cash reserves to pay the mortgage for up to six months if the vacancy rate is higher than anticipated
- Higher interest rates and fees to compensate the lender for the additional risk of making a rental property loan
- Qualifying property types must fit into typical categories of single-family, small multifamily, townhome, or condominium
- Private mortgage insurance doesnt apply when the loan-to-value ratio is less than 80%
Benefits Of Interest Only Repayments:
- Lower monthly repayments
- The interest payable on investment home loans is tax deductible
- May be good if you anticipate selling the property before the end of the interest only period. This relies on the assumption that the property will increase in value and build equity that will give a decent return on investment
- Can use the money you would otherwise be paying on principal for other investments
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Down Payments And Other Requirements
If you have a mortgage for your primary residence, you probably know that most mortgage lenders no longer require a 20% down payment to get a loan. Lenders are stingier with loans for investment properties, however, because the risks of foreclosure and default are higher.
Most fixed-rate mortgages require at least a 15% down payment with a 680 qualifying credit score for a one-unit investment property. Your credit score should be at or above 620 if youre applying through Rocket Mortgage®. Lenders want you to put down 25% with a 620 or higher interest rate on two- to four-unit investment properties.
Best For Easy Administration: Lima One Capital
Lima One Capital
Lima One Capital offers investment property loans for fix-and-flips, single-family rentals, multi-family rentals, and new construction. A BBB-accredited business with an A+ rating, Lima One Capital is headquartered in Greenville, South Carolina and has been in business since 2010.
You can apply for financing and manage your loans online, and you even may be able to get non-recourse loans for portfolios of five or more investment properties, potentially reducing some of the application and loan management burdens. This is why we chose Lima One Capital as the investment property lender best for easy administration.
Most of the companys loan products require quotes, but rates are very competitive for a hard money lender. A national lender, Lima One Capital offers financing in 45 states, and funding normally takes around the standard 30 days.
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Make A Sizable Down Payment
Since mortgage insurance wont cover investment properties, youll generally need to put at least 20 percent down to secure traditional financing from a lender. If you can put down 25 percent, you may qualify for an even better interest rate, according to mortgage broker Todd Huettner, president of Huettner Capital in Denver.
A larger down payment gives you more skin in the game and therefore more to lose if the investment doesnt work out. That can be a powerful incentive, and a larger down payment also provides the bank greater security against losing its investment. If the investment goes poorly, youll lose your whole stake before the bank begins to lose any money in the property.
If you dont have the down payment money, you can try to get a second mortgage on the property, but its likely to be an uphill struggle.
Find Your Ideal Loan Product
Not all property loans are the same. They vary in terms and conditions, like interest and loan terms. They also vary in their purposes, such as construction, renovations, or buy and hold investments.
I once obtained finance for a construction loan to build a unit. My Plan A was to develop it, and then sell it for a profit. Construction began just before the GFC, and I could not find a buyer until after construction was finished. Because of the terms of the loan, I could not rent the property until I refinanced, which I did with another bank. In hindsight, my first loan was not the ideal loan product because it did not afford me the freedom to revert to my plan B.
Make sure your loan suits the purpose of your investment, and that it also offers some flexibility, in case market conditions force you to change plans mid-course. Ask the following questions to determine whether the loan product fits your purposes:
- What is the LVR requirement of this loan?
- What is the interest rate, and how do they calculate it?
- Am I repaying principal and interest, or interest only?
- When must I repay the loan in full?
- Are there any early pay-off fees?
- Are there any additional fees, like application, valuation, LMI or account-keeping?
- Do they offer equity lines of credit or offset accounts?
- Can I rent out commercial premises with this loan?
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When A Home Equity Loan Is A Bad Idea
In general, a home equity loan is a bad idea when it is used for anything other than something that will directly increase your homes value. A home equity loan is a particularly bad idea when used frivolously. Dont use a home equity loan to fund a lifestyle that your income cant sustain. If you cant afford luxury dinners, cars, and vacations on your income, dont erode your homes equity to temporarily live that lifestyle.
Should You Take Out A Home Equity Loan To Get A Tax Deduction
No, you should not take out a home equity loan just for the tax deduction. If you already have a home equity loan, you may be able to get a tax deduction for the interest portion of the loan as long as you use the loan proceeds to buy, build, or substantially improve the home that secures the loan. Keep in mind that this only benefits you if you itemize your tax deductions. If you take the standard deduction, youll see no benefit to having a home equity loan for tax purposes.
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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.
Types Of Rental Property Loans And How Each Works
Using other peoples money by getting a loan on a rental property can be a good way to increase potential returns as long as you conservatively balance risk with reward.
In this article, well look at the options for getting a rental property loan and discuss how to analyze cash flow and property value to help you make the best investment decision.
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The Investment Property Loan Process
If you plan to finance your investment property with a mainstream home loan , the process will look very similar to any other home purchase. You will:
As when buying a home for yourself, its a good idea to get preapproved for a mortgage before you begin house hunting. That way, youll know how much home you can afford. And, more importantly, the seller and sellers real estate agent will know youre making a serious offer.
Before you settle on a lender, make sure to comparison shop for the very best mortgage rate you can find. Investment property mortgage rates are often 0.50 to 0.75% higher than those for standard mortgages. And the lower your rate, the higher your profit margin on the property will be.
How Much Do Investment Property Loans Cost
If you get a conventional investment property loan for a long-term rental property, the costs will often be slightly higher than primary residence mortgage rates. This is because there is more risk associated with rental properties since the loan repayment is based on the income generated from the property rather than your personal income. In addition to an APR, you might also pay an origination fee and be required to pay a prepayment penalty.
Investment property loans cost even more if you use a hard money lender since loan repayment is heavily dependent on the property. In the current low-interest-rate environment, starting rates above 4% to 5% for a 30-year conventional loan and 7% to 8% for a hard money loan are starting to get expensive. The Federal Reserve Bank of St. Louis keeps track of the average 30-year fixed-rate mortgage cost, which is a great place to go to see if your rate is competitive. Remember, the rate will depend on your qualifications and the propertys characteristics. This means borrowers with the best qualifications and most desirable properties will pay the lowest rates.
John Kilpatrick, Ph.D. and MAI with Greenfield Advisors, shared this additional information with us about the short-term cost of investment property loans:
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