How to Qualify for a Loan for an Investment Property?

When it comes to investments, there aren’t many sectors better than real estate. Real estate provides ample opportunity to make money either by holding on to property till it appreciates, quickly flipping properties for a profit, renting out a property, etc. Unlike stocks, real estate investment requires large capital. Luckily, several loans are available to help you achieve your dream of being a property owner. However, the type of loan you can access depends on several criteria, including the type of property you wish to invest in. If you’re interested in making passive income from your property, then an investment property loan is right for you. While these loans work similarly to regular mortgage loans, the requirements to get them are usually stricter. Here, we take a look at investment loans, their requirements, and how you can easily qualify for one. 

What are investment properties?

As the name implies, investment properties are real estate bought as an investment. These properties are purchased to generate income through rent or appreciated resale value. Any kind of property can be classed as an investment property. These range from single-unit condominiums, multi-unit rental homes, and multi-family apartments to high-rise office buildings.

Both individuals and groups can purchase investment properties. The major characteristic of investment properties, and what separates them from residential properties, is that the owner and occupant of these properties are separate entities.

What to consider before buying an investment property?

Before buying an investment property, you should ensure that you have considered the following;

Financial Stability

Owning an investment property requires that you have adequate finances to settle the initial home purchase costs, like down payment, inspection and closing costs,  and ongoing maintenance and repairs. Even if the property does not yield the expected profit, you have to play your part in keeping up its visuals. Thus, you must have the financial stability to cover these property-induced costs without relying on the income generated by the property.

Return on Investment

Before purchasing an investment property, it is essential that you do an ROI analysis, which is the approach typically taken by the best real estate investors. Calculating the potential ROI on a property will help you get a true measure of how good of an investment it is in the long term. What is considered a good ROI typically depends on your property’s location and the type of tenant typical of the area. Usually, an ROI of 3-7% is great for solid areas where tenants tend to stay long-term.

Time to Manage                                  

Except you have the finance to hire a manager, you will need a lot of time to effectively manage your property. Management activities range from advertising to interviewing potential tenants, inspecting the property for damages, and ensuring tenants pay on time. Thus, before buying an investment property, you should ensure that you have ample time to attend to your duties as landlord whilst still working in your 9 to 5 or any other activity you engage in.

Financing Investment Properties

Buying any property, investment properties inclusive requires a ton of cash. Now, unless you have millions of dollars cooling off in a bank or somewhere else, you will need some way to finance your purchase. This is where investment property loans come in.

Investment property loans work similarly to residential property loans; however, there are several differences. The most striking characteristic of investment property loans is the stricter requirements you must meet before accessing them. However, when you meet these requirements, you get access to the funds to meet your dreams. Before looking at these requirements, let’s first look at the different types of investment property loans you can access to fund your property purchase.

Types of Investment Property Loans

There are several investment property loans, each with different requirements and terms. Below is a brief description of the different types of investment property loans;

• Conventional loans: These are loans that conform to Fannie Mae or Freddie Mac guidelines and are not backed by the federal government. Conventional loans for investment properties typically require a 30% down payment. Banks typically give these loans and consider your credit score/history, income, and assets before making a decision.
• Hard money loans: These are short-term, high-interest loans, typically given by non-bank financial institutions. Hard money loans are typically used when investors want to flip a property for profit quickly. HM loans are easier to qualify for, with shorter waiting times. However, they have the downside of being really costly, with interest rates as high as 18%, as well as other fees like origination fees.
• Private money loans: These refer to loans gotten from private individuals such as family and friends. Private money loans are great for investing when you are an amateur investor since the terms are typically more favorable and the requirements lenient. However, the terms may also be predatory. The downside to PM loans is that they may interfere with relationships if terms are not honored.
• Home equity loans: If you already own a home with significant equity, you can borrow against it using a home equity loan or a home equity line of credit (HELOC). Home equity loans and HELOCs allow you to borrow up to 80% of your current home equity value to finance an investment property. While a home equity loan is paid in one lump sum at a fixed rate, HELOC functions like a credit card allowing you to borrow in bits with interest-only monthly payments.

Other types of investment property loans available to you include;

• FHA loans
• VA joint loans
• Non-QM loans
• Cash-out refinance

Requirements for Investment Property Loans

The requirements for obtaining an investment property loan are generally stricter than those obtained with a residential mortgage. The stricter requirements for investment properties are due to the higher risk of foreclosure, backed by stats that show a high default rate among investment property borrowers. Thus, the stringent requirements help to ensure that only those with the most likelihood of paying back can access these loans. These requirements generally include;

• Higher down payments: When purchasing a residential home with an FHA or VA loan, you typically only need to put a down payment of 3.5%, which can be completed using gifts. However, you will typically need to put a down payment of at least 15% when taking a conventional loan for an investment property. However, this down payment can be as high as 20% or even 25% (if you want better rates) and cannot be completed using gifts.
• Cash reserves: Investment property lenders want to know that you have the finance to cover your mortgage payments without relying on rental income. Thus, lenders will want to certify that you have at least 6 months’ worth of mortgage payments as cash reserves in the bank or as readily liquefiable assets before they can approve you for an investment property loan.
• High credit score: Unlike residential properties, which you can secure with a credit score of about 620, you will need much higher credit scores, even up to 740, to secure an investment property loan. However, the credit score requirement may be more lenient with a higher down payment.
• Low debt-to-income ratio (DTI): Investment property loans require that you have a very low income-to-debt ratio. Lenders want to ensure that you have a stable adequate income and that the income is not largely directed towards debt servicing. Thus, whereas you can get a residential mortgage with a DTI of up to 43%, your DTI should not exceed 36% for an investment property loan.
• The number of mortgages owned: The higher the number of mortgages owned in your name, the lower your chances of getting an investment property loan.
• Documentation: You are required to provide so many documents before you can obtain an investment property loan. These include; two years of tax returns showing rental income, two years of W2, two months of bank statements, copies of current leases, a rent roll history, etc. Lenders may also require an analysis of similar properties in the neighborhood.
• History of property management: Some lenders often require that you document your experience in managing rental properties.

As stated, investment property loans typically have a higher rate of default. Thus, lenders often mark up loan rates to cover this risk, making investment property loan rates 0.5 to 0.875 percentage points higher than residential mortgage rates. These rates may be higher with hard money loans. Typically, investment property loan rates are affected by your credit score and down payment. Thus, the higher your credit score and down payment, the lower your rates.

Application Process for Investment Property Loans

The process of getting an investment property loan typically follows the following steps;

1. Obtain pre-approval: Getting preapproved for a mortgage before beginning your home search helps you to know the range of homes you can afford.  The loan company will typically ask for your full financial information to provide a customized solution for you. If you do not meet the criteria for an investment loan, you can seek lenders that offer non-QM mortgages.
2. Find a property and make an offer: After obtaining preapproval, the next step is to find a high-potential property in a good location and make an offer for the property. When making an offer, it is best to go below the amount you have been pre-approved for.
3. Apply for a loan: Once you have a bid locked in for the property, fill out a loan application form with your loan company and wait for a decision. You would typically get a positive response having applied for preapproval; however, you may have to wait the normal processing time.
4. Agree on the terms: Perhaps the most important part of the loan application process is getting favorable terms. Again, a preapproval process may give you an idea of what the term may be when you apply; however, based n circumstances, the terms may change when applying. It is best to always seek out a company that offers you the best terms. Aurum and Sharpe offer you excellent terms for non-QM loans for investment properties.
5. Go through the loan underwriting process: You will need to provide the necessary documentation to support your application and enable the loan company to make a decision on your application. In some cases, you may complete the underwriting process during preapproval.
6. Sign final papers and close the deal

How to Boost Your Chances of Qualifying for an Investment Loan

Qualifying for an investment loan takes a lot of effort. You have to meet various requirements, which are typically steeper than what is expected for a residential mortgage The following actions will help improve your chances of qualifying for an investment loan.

Check your credit report and improve your credit rating

The best way to enhance your chances of a loan is to improve your credit score. To improve your credit score, you have to be up-to-date with your credit report. By law, you are entitled to one free credit report from Equifax, Experian, or TransUnion every year. Once you get your credit report, do well to review it properly and fix any mistakes (such as uncleared debts which you have actually cleared or out-of-date information) that can affect your credit rating. Thus, it is best to check your credit report at least 6 months before you plan to apply for a loan so that you can fix errors and work towards improving your credit rating.

Improving your credit rating entails paying off outstanding debt and accumulated bills, reducing your debt-to-income ratio, paying bills on time, and reducing new debts. Having a good credit score (at least 700) not just increases your chances of qualifying for the loan but also of getting an excellent rate. 

Lower your debt-to-income ratio

Lenders use your debt-to-income ratio to determine your ability to manage your monthly payments. A low debt-to-income ratio indicates a healthy balance between debt and income. Lenders prefer 36% or lower debt-to-income ratios, with no more than 28% dedicated to mortgage payments. In rare cases, lenders may allow you to qualify for an investment property loan with a DTI of 43%. You can reduce your DTI by reducing your recurring monthly debt or by increasing your gross monthly income. Reducing recurring debt is usually easier and entails cutting down on expenses, especially unnecessary ones. In terms of improving income, you may achieve that by taking a second job.

Maintain Cash Reserves

Many lenders want to see that you have adequate reserve cash to cover your mortgage payments for at least six months without relying on rental income (which may not work out as planned). Thus, if you can save up enough money to maintain this cash reserve, you will significantly boat your chances of qualifying for investment property loans.

A large cash reserve is an excellent way to gain the lender’s trust and assure them that you are not a high risk. Cash reserves are especially important if you intend to renovate and flip a property because you will require funds for repairs and improvements.

Make a large down payment

Making a large down payment gives a lender the idea that you are a smart investor. The larger your down payment, the lesser the loan-to-value ratio, and the better the loan terms are. Typically, investment property loans require a down payment of at least 20%. However, you can go beyond this and put down 30 or even 40%. Larger down payments significantly boost your chances of qualifying for these loans.

Gain experience in investment properties

One thing lenders look out for in investment property borrowers is experience. They want to see that you know what you are doing and can easily make money from investing in property. Thus, it is essential that you gain as much experience in the market as you can, either by shadowing larger investors or making smaller investments. The more your experience and the more successful you invest, the more risk a lender is willing to take on you.

Assess your proposed property properly

This ties in with the section on gaining experience. When you have experience in property investing, you will know how to asses properties properly. Lenders are typically looking to put their money in property with high potential; thus, if you present a property that fits what they desire, you will significantly increase your chance of getting approved for a loan.

Bottom Line

Investing in investment properties is risky, which is why lenders often put in place stringent requirements to ensure that only borrowers with a high potential to offset their mortgage can get it. However, obtaining the finance for an investment property will not be a hassle if you know where to look and how to present yourself as the best candidate for the loan.

If your dream is to become an investment property owner, then you have just been given the tools to make the best of your application. So go research properties in your area, apply the principles here, and you can bet you’ll get your investment property loan in no time.

Looking to refinance your current residential or investment mortgage? Look no further than Aurum & Sharpe. We put you first and ensure that you get the best rates possible. So pick up your phone now and contact us at 9177404325 to book an appointment today, or use the online form to get in touch.

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