Tips For Buying Your First Rental Property
Thinking about purchasing an investment property? Real estate has produced many of the worlds wealthiest people, so there are plenty of reasons to think that it is a sound investment. Experts agree, however, that as with any investment, its better to be well-versed before diving in with hundreds of thousands of dollars. Here are the factors and challenges you should consider before buying your first rental property.
by Guest Author | Last updated Nov 1, 2019 | Personal Finance, Real Estate Investing, Spark Blog |
This is a guest post by Bethany Ramos, a writer and real estate financing expert with Cornerstone Home Lending.
Buying an investment property sounds like a far-off fantasy when you buy your first house. But it may comfort you to know that investment home sales are holding steady.
In 2016, the National Association of Realtors confirmed that 30 percent of all home sales were for vacation properties, purchased either by investors or individual buyers. Vacation home sales for homeowners dropped for the third year in a row, but investor sales remained stable.
Interested in Buying an Investment Property? 3 Subtle Differences
If the time is right, and you want to put your savings toward a property and consider branching out as a landlord, prepare for several differences in investment property loans compared to a standard owner-occupied mortgage.
After all, as a landlord would you default on your home mortgage first, or your investment property loan?
How To Get A Lower Investment Property Mortgage Rate
- Have a good credit score. Youll need a minimum 640 credit score to qualify for an investment property mortgage but a lower score wont get you the most competitive interest rate or reduce your minimum down payment requirement. Aim for a score of 700 or higher.
- Make a larger down payment. Contributing more than the minimum down payment means youll borrow less money and reduce your lenders risk. Consider putting down more than 20%.
- Reduce your existing debt. Your debt-to-income ratio compares your monthly debt payments to your monthly gross income and shouldnt exceed 43%, in most cases. Youll need plenty of room in your budget to cover the mortgage payment for an investment property, though 75% your projected rental income may be factored into the equation. Dont forget the other expenses of a rental property, too these include maintenance, repairs, homeowners insurance, property taxes and fees to screen tenants.
- Boost your cash reserves.Cash reserves are liquid assets you have on hand after youve covered your down payment and closing costs. Typically, lenders look for at least six months worth of mortgage payments in cash reserves for investment properties, but it wouldnt hurt to have a years worth or more. Since an investment property can be risky, the extra cash cushion shows youll have money to make payments when your property is between renters.
Gather The Right Documents
Before initiating the refinance process, it is important to gather the right documents that the lender will request. Youll need things to establish proof of income like pay stubs, W-2 forms, tax returns, business tax returns, proof of disability or pension income if you are otherwise unemployed, and detailed information about rental income from investment properties. You will likely need information from the last two years, along with a Schedule E from your personal tax return. The Schedule E form will assist the lender in determining the investment propertys net income over time.
Lenders will also look for proof of assets and proof of individual ownership of the investment property. You should also be prepared to provide paperwork that establishes the extent of your current debts and obligations outside your investment property, including other loans and credit card balances, as well as a current mortgage statement.
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Turning Your Second Home Into An Investment Property After Closing
Its not uncommon for someone to decide to convert a second home to an investment property at some point. Its best to read your mortgage paperwork to verify there arent any restrictions on how long the home has to be used as a second home to avoid an investigation for occupancy fraud.
Dont forget to report rental income to the IRS when you file taxes. If you decide to refinance, youll be subject to investment property guidelines and interest rates on the new mortgage. That means youll need more equity to refinance and will likely pay a higher rate than you did when the home was classified as a second home.
Interest Rates On Investment Properties
A rough estimation is that borrowers can expect to pay between .5 and 1 percent higher interest rates for loans on investment or rental properties. Interest rates depend largely on the borrowers financial and credit situation however, youll generally pay more in interest for investment properties than you would for a home loan because lenders are assuming a slightly higher level of risk.
The thinking is that borrowers are more likely to default on loan payments for investment properties than their primary residences in tough economic times, which makes these types of loans riskier for lenders. They charge higher interest rates for that elevated risk, and borrowers must meet some strict qualifications in order to qualify, such as a larger minimum down payment.
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Next Step: Contact Homefinity
At Homefinity, were ready to bring clarity to the situation and help you make the best decision for your family.
Our experienced staff are waiting to walk you through the process, step-by-step, and help you buy the property you want for the reasons you want it.
If youre looking for a rate quote or answers to questions, get in touch.
Just fill out this brief online application, and well set up an appointment that works for you. Lets talk about the options you have available today.
Some references sourced within this article have not been prepared by Fairway and are distributed for educational purposes only. The information is not guaranteed to be accurate and may not entirely represent the opinions of Fairway. Fairway is not affiliated with any government agencies.
Ready To Find Your Second Home
Purchasing a second home is a huge accomplishment and a great way to invest your money. If youre ready to start this process, wed be happy to help along the way and be your partner in helping you achieve this dream. Our loan officers can provide personal service and answer all your questions to help you feel comfortable with such a major decision. Contact a loan officer to learn more about second home financing options. Dont forget about closing fees too! We have a nifty to help you figure out how much you might owe.
The above information is for educational purposes only. All information, loan programs and interest rates are subject to change without notice. All loans subject to underwriter approval. Terms and conditions apply. Always consult an accountant or tax advisor for full eligibility requirements on tax deduction. *By refinancing an existing loan, total finance charges may be higher over the life of the loan. *Information is for general illustrative purposes only. The information is believed to be reliable, but Guild Mortgage does not warrant its completeness, timeliness or accuracy. Guild Mortgage assumes no responsibility for errors or omissions in the information provided. *Typically, a non-purchase second mortgage. **Please consult your financial advisor on the consolidation of short term debt into long term debt.
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What Are Mortgage Rates For A Second Home
Generally, second homes have lower mortgage rates than investment properties but higher rates than primary residences. Many lenders websites show todays rates, but that can be misleading, so we choose not to show those rates on our site. Just because you see a rate listed on a site, doesnt mean youll be able to lock that in. Those are often the lowest rates available, and your application may need to be near-perfect to get that rate. While its important to stay competitive, customer service is our number one priority at Guild. Building strong connections and long-lasting relationships is why weve been in business since 1960. Well work with you to get a loan to fit your life, with a competitive rate. If youre ready to find out what your mortgage rate for a second home might be, .
What Is The Second Home
It is a property that you purchase added to your current residence to live in for part of the year. You dont occupy the house full-time but whose primary purpose isnt as a rental property. A Second Home is a home thats not your primary residence, but you dont use it as an investment property. Dont be confused with second home. There can be multiple properties treated as second homes.
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Factors That Affect Interest Rates On Primary Residences And Investment Properties
Loans arent cookie-cutter Borrower A might get totally different loan terms than Borrower B even if they apply for the same amount at the same place on the same day.
Both types of lending are based on the following criteria:
- Debt-to-income ratio
- Loan-to-value ratio
After the subprime mortgage meltdown that led to the Great Recession, borrowers must demonstrate solid numbers in each of these categories to qualify for a home loan and the requirements are even stricter for investment property loans.
Second Home Mortgage Requirements
Another essential thing to note is that your property cannot be listed as a primary and a secondary property at the same time. There are criteria that differentiate a primary residence from a secondary home. You shouldnt be living in the secondary home for an extended time, whereas, with a primary residence, the expectation is that youll live there for most of the days of the year.
In addition, unlike with the primary residence, it is not necessary that the residence is close to your workplace. The perfect example of a second home is a vacation home where you are not asked to stay for the whole year but remain there for a short time. Moreover, this property is not included in your investment property but is considered your second home.
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Qualify For A Lower Interest Rate
Interest rates on mortgages for investment properties tend to be higher compared with primary residences. Lenders favor primary homeowners because they want more people to take out home loans. Investment properties aren’t available to everyone, which means they are more exclusive.
The better your credit score, credit history, and debt-to-income ratio, the more likely you are to secure the lowest interest rate offered by a lender. If you own multiple properties with debt, you have a higher barrier to showcase you can comfortably afford to make payments on a new loan. Because of this, you might not get the lowest interest rate offered.
Understanding Mortgage Rates For Investment Properties
Interest rates charged by lenders for asset property loans are known as investment property mortgage rates. A borrower’s financial portfolio, including their credit score and down payment size, determines the rates received. On average, the better your economic standing, the better your rate.
Rental property lenders want to ensure borrowers have good credit and can maintain their financial obligations. The lending process is not the same as buying a primary residence, as there are stricter requirements , and it is more expensive .
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Home Equity Lines Of Credit
Home equity lines of credit known as 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.
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How Are Mortgage Rates Set
At a high level, mortgage rates are determined by economic forces that influence the bond market. You cant do anything about that, but its worth knowing: Bad economic or global political worries can move mortgage rates lower. Good news can push rates higher.
What you can control are the amount of your down payment and your credit score. Lenders fine-tune their base interest rate on the risk they perceive to be taking with an individual loan.
So their base mortgage rate, computed with a profit margin aligned with the bond market, is adjusted higher or lower for each loan they offer. Higher mortgage rates for higher risk lower rates for less perceived risk.
So the bigger your down payment and the higher your credit score, generally the lower your mortgage rate.
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Down Payment: 15% To 25%
Down payment requirements for an investment property range from 15% for a one-unit property to 25% for a two- to four-unit property. You may also be required to make a bigger down payment depending on your application and the type of loan you qualify for.
Private lenders sometimes called hard money lenders might also make asset-based loans. The borrower puts down 30% or 40% of the purchase price and the lender provides the balance.
Flippers often use such short-term mortgage loans to finance their deals. However, this can be risky. If the property does not sell for enough to cover the loan amount, or if the property does not sell at all, the borrower can face foreclosure and the loss of all equity.
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Make A Bigger Down Payment
The surest way to get a lower interest rate on your investment property is to make a bigger down payment. Much of the added cost goes away if you can put at least 20% down.
It might be worth borrowing against the equity in your current home to increase your rentals down payment. You can also buy a cheaper house, or find a foreclosure you can buy at below market value.
You could even consider if this is an exceptional investment borrowing against your 401.
How To Get A Home Loan For An Investment Property
For investor home loans, the requirements can be a little stricter, especially now that many banks and lenders have raised the bar on their stress tests and other criteria for non-owner-occupied properties. You’ll need to demonstrate that you have a certain amount of money set aside to manage the mortgage. If you already have an investment loan, the required value of the funds set aside might be higher than if it’s your first home loan. This will typically be evaluated in terms of a certain number of months of mortgage repayments for each property.The amount you’ll likely receive in rental income can also be a consideration for investment loans, since you might be able to cover the cost of your mortgage repayments and other expenses with this income. That means the investment might not actually lower your debt-to-income ratio , which is one of the factors in the loan approval process.Mortgage lenders also take into consideration the potential appreciation of your property over the course of the home loan. Both you and they may want to review information about vacancy rates for the area or property as well as trends in housing prices. These factors will come into play when you have your property valued.
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