Most people thinking of becoming real estate investors are not planning to buy those investment properties with their own money, even if they have the money. The majority of investors will need loans to acquire their assets. This is why one of the first things you need to know as a would-be property investor is how to qualify for a rental property loan.
Getting a mortgage for an investment property is a whole different ballgame from qualifying for a loan to buying your own home, says Revenue Scout. This is often the first major hurdle you have to cross as a property investor, and it is at this point, most people’s dreams of becoming property investors come to an end. Getting a rental property loan is difficult but not impossible if you take the proper steps.
What you need to know about investment property loans
Types of rental property loans
The standard type of loan you are looking for when buying a rental property is a long-term (30-year) fixed-rate mortgage. There are four main types of providers of investment property loans:
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Conventional mortgage
These are the most popular types of loans. Most banks and financial institutions offer them. They have the lowest interest rates but the highest requirements. These loans are usually targeted at owner-occupants and investors who plan on living in one of the units in their rental property.
They are also available to non-owner-occupier investors, but the terms are harder to meet. When buying your rental property with a conventional loan, you cannot use an LLC; the investment must be in your name, which can be a huge problem.
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Local banks and Credit Unions
Although less common, certain local banks and credit unions will have the same requirements as conventional loans and similar interest rates. One of the great things about using local banks and credit unions is that you are allowed to buy the rental property with your LLC.
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Non-Qualified Mortgage (QM) lenders
The first two options are for investors with the documents typically required by banks and credit unions. A Non-QM lender is where to go if you are short on the requirements for a conventional bank or credit union loan.
The terms for these loans are flexible, although the process is more tedious. When using a Non-QM lender, you can buy the property with your LLC, but the interest rate will be higher. The main problem with Non-QM loans is that you must go through a mortgage broker; finding a broker who does this kind of loan can be challenging.
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Portfolio lenders
This last option is for lenders who don’t look good on paper; for instance, you don’t have a bank statement, but your property is performing really well. Unlike the others in this list, these lenders do not focus on the documentation but on the property.
Portfolio lenders often provide hard money loans and long-term (thirty-year) fixed-rate mortgages. These investors are easier to work with because they focus on the rental performance, but, once again, interest rates will be higher than mortgage options.
Rental property mortgage requirements
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Debt-to-income ratio
Although lenders expect you to earn substantial income steadily before you can qualify for a rental property loan, your income is not the most important factor. A good debt-to-income ratio is more important.
This is the proportion of your monthly income taken up by credit card debts, car payments, and other debts. Lenders want you to have a DTI of 35%-36%; the closer you get to 50%, the more difficult it will be to get that loan.
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Credit scores
Lenders expect you to have a credit score of 620-700, but you will get the best rates if your score is 760 or higher. Credit scores are less of a requirement when buying an owner-occupied rental property if you use an FHA loan.
With bad credit, purchasing a non-owner-occupied home will be hard, if not impossible. If a bank does give you a loan, the interest rate will often be very high.
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Down payment
Lenders want you to have “skin in the game” – some of your own money must go to buying the property. The minimum out-of-pocket cost lenders ask for is 20% of the property’s purchase price. But for non-owner-occupied rental properties, the down payment can go as high as 30%.
The down payment requirements depend on your credit score; lower credit scores attract higher down payment. How much you pay down also determines the interest rate the lender will charge you.
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Proof of income
You must prove that you are earning enough money and that this income is regular. You will be expected to submit income statements, pay stubs, tax returns, and a letter from your employer. For business owners, income requirements include tax returns, bank statements, and business registration documents.
