How to Get a Mortgage for a Rental Property

Are you considering buying a rental property? Real estate is considered a profitable business and many investors dive into it without a proper understanding of mortgage financing, tenant-landlord interactions, and property maintenance. Like any investment, buying real estate has advantages and disadvantages but may be quite profitable. Investing in real estate is not a child’s play; it takes time, resources, and effort before you can start earning as a real estate investor.

However, financing is one of the loggerhead problems that investors face in the real estate industry. The purchase of a rental property is a well-liked strategy for having an additional income. Most likely, you will need a mortgage to finance your investment property. However, obtaining a mortgage for a rental property is typically more challenging than a primary residence. Understanding the prerequisites to successfully complete the rental property purchase process is crucial.

However, rental property owners have two options for managing their properties: either they manage them themselves or employ a property management company, which normally costs from 8% to 12% of the rent earned. A property manager is in charge of maintenance and repair work, assessing potential renters, and dealing with late rent payments, among other things.

Rental Property Mortgage vs. Home Mortgage

Both home mortgage and rental property applications follow similar procedures. But the main distinction is that the lender bears significant risk by providing a mortgage for a rental property. This is because lenders know that repaying your home mortgage will always precede paying a rental property mortgage if you experience any financial hardship. As a result, you have a greater possibility of defaulting on your loan for a rental property. Lenders impose tougher mortgage requirements on rental properties due to the greater likelihood of default. To be eligible, you must have excellent debt, income, credit, and employment history.

Requirements for Mortgage for a Rental Property

While real estate investing may have financial benefits, it has drawbacks. To finance a rental property, you may need to prioritize your investment property payment alongside a residential home. Since there are high potential risks of default for an investment property, lenders set stringent requirements before approving you for a mortgage. However, the requirements you need for a mortgage for rental property include:

1.    Credit Score

To a large extent, getting a mortgage depends on your credit history. With a high credit score, you can demonstrate to lenders that you pay your bills on time and don’t have a track record of excessive borrowing. As a result of your potential history of poor money management, a low credit score makes you a highly risky borrower in the eyes of lenders. To finance a rental property, lenders typically want a credit score of at least 620. If you want the best interest rates and conditions, you need to have a credit score of at least 740, which is regarded as being in the “very good” category. 

A credit score of at least 580 is required for a government-backed loan, though the exact requirement will depend on the loan you choose. You may be able to connect with more lenders and pay less interest if you have a higher credit score. Before applying for a loan, it’s advisable to build your credit score for a few months if it’s bad.

2.              Down Payment 

When purchasing a home, you may just need a 3% down payment to qualify, depending on your loan type. However, if your down payment is less than 20%, you will have to pay private mortgage insurance. This insurance shields the lender from certain monetary risks if you fail to repay the loan. 

However, mortgages for rental or investment homes are not subject to PMI. Therefore, if you want to finance an investment property, you’ll probably need to put down a bigger deposit, at least 20% to 25%. Although, some lenders might require that you put down more. For instance, a lender might want 30% down if you’re purchasing a house with multiple units.

3.              Debt-to-Income Ratio (DTI)

Your debt-to-income ratio (DTI) is a key factor that a lender also takes into account when evaluating your financial situation. This is the monthly ratio of your income to your debt. This calculates how much your gross monthly income is spent on debt repayment. Your DTI should preferably range from 36% to 45% to be eligible for a mortgage for investment property. 

Often, borrowers can use an additional 75% of their projected monthly rental revenue (as established by the appraisal) as qualified income to lower their DTI. Lenders don’t consider possible vacancies when calculating rental income at 100%. If you don’t have any prior experience as a homeowner, your lender might not take future rental income into account. In that case, your ability to obtain a rental property mortgage might depend entirely on your own personal income.

4.              Savings

You’ll need to demonstrate that you make enough money to pay off your debts and prove that you have enough cash in your bank account to meet unforeseen expenses. The complete mortgage payment, including principal, interest, taxes, and insurance, should be included in the 3-6 months’ worth of reserves that should be kept in an accessible bank account. This amount ought to cover the whole 3-6 month mortgage payment.

5.              Income and Job History

When you apply for a loan, one of the most important things mortgage lenders look at is your income. There is no predetermined annual salary requirement for property ownership. You must, however, demonstrate to your mortgage lender that you have a reliable source of income to repay the loan. Your employment history, monthly household income, and any additional sources of income you may have, such as child support or divorce payments, will all be factors considered by your lender.

6.               Assets

When you submit a loan application, lenders want to know if you have any additional cash on hand. The lender will be reassured that even if you experience financial difficulties, you will still be able to repay your loans. Any form of account from which you can withdraw money will be among the assets your lender requests to examine. Examples are savings accounts, retirement accounts, taxable investments, etc.

7.              Property Type

The kind of loan you qualify for depends on the property you purchase because different kinds of real estate hold varying levels of risk for your lender. Lenders recognize that residential property expenditures already play into most people’s budgets, so they will likely offer you better terms if you purchase a small single-family house for a primary dwelling. As opposed to investment properties, residential properties will supersede in the event of financial difficulty for the owner. 

Lenders will probably demand a greater down payment and a stronger credit score to be eligible for an investment property mortgage and balance the possible risk. Depending on the property you want, there are different interest rates and lender criteria. Remember that not all lenders finance all types of properties.

Type of Mortgage for a Rental Property

There are limited financing options available when seeking a mortgage for an investment property than a residential home. Always weigh your options to get a loan with the most favorable rates and conditions. However, you can consider the following types of mortgage loans.

1.    Conventional Bank Loans

A conventional mortgage adheres to rules established by Fannie Mae or Freddie Mac by Fannie Mae or Freddie Mac. Usually, a down payment of 20% of the home’s purchase price is required when using conventional loans. However, there are cases where lenders may insist on a 30% down payment for an investment property. In the case of a conventional loan, your credit rating, income, assets, and credit history influence your eligibility for approval and the type of interest rate that will be charged on the mortgage. 

Borrowers must undoubtedly demonstrate that they can afford their current mortgage and the monthly loan payments for an investment property. Future rental revenue is not considered when determining the debt-to-income (DTI) ratio. Most lenders require borrowers to have at least six months’ worth of savings left aside to pay both mortgage commitments.

2.              Hard Money Loans

A hard money loan is a short-term loan designed for flipping an investment property rather than buying, holding, or renting it out. You can use hard money loans to buy a property and pay off the loan with a conventional loan, home equity loan, or private loan. Hard money loans are great to use if you want to finance a house flip, and they are easier and quicker to qualify for than other mortgage loans. Lenders consider factors like property’s profitability, credit score, and income. Lenders use the home’s estimated after-repair value (ARV) to determine if the borrower will be able to repay the loan. The drawbacks of this loan type are high-interest rates, origination costs, closing costs, and a shorter time frame for repayments that is less than a year. 

3.              Private Money Loans

Private money loans are loans from individuals to real estate investors. Individuals like families and friends. Attending local real estate investment networking events is an excellent area to hunt for private money lenders if you don’t have friends or family who can lend you money to purchase an investment property. You can network by joining a local real estate investment club in your state. 

Depending on the relationship between the borrower and the lender, loan terms and interest rates on private money loans vary greatly, from exceedingly beneficial to exploitative. Often, these loans are guaranteed by a legal agreement that gives the lender the right to seize the property if you fall behind on your payments. If you are new to real estate investment, think twice before you sign a contract with a loved one because it could damage your connection with the person if you don’t pay.

4.              Home Equity

Another approach to finance an investment property is to use the equity in your home, either through a home equity loan, home equity line of credit (HELOC), or cash-out refinance. Usually, you can borrow up to 80% of the equity in your house to pay the cost of buying, renovating, and maintaining an investment property. Depending on the sort of loan you select, using equity to finance a real estate transaction offers both advantages and disadvantages. The rate is sometimes flexible; interest rates may increase if the prime rate increases.

Required Documents Needed to Get a Mortgage for a Rental Property

Before applying for a loan, arrange all of your documents to facilitate the application process. However, the documents you need to submit include:

1.    Proof of Income

• At least two years of federal tax forms
• Two most recent W-2s and pay stubs
• 1099 forms, or profit and loss statements, if you’re self-employed
• Divorce decrees, child support decisions, and any other legal documentation that confirms that you will continue to receive payments for at least another three years, if applicable.
• Legal documentation that proves you have been receiving alimony, child support, or other types of income for at least six months, if applicable.

2.              Credit Documentation

Lenders will request your verbal or written consent before viewing your credit record. They will review your credit history and check for any red flags (such as bankruptcy or foreclosure) to determine if it would be difficult for you to obtain a loan.

3.              Proof of Assets and Liabilities

• Account statements for up to 60 days that attest to the assets held in your checking and savings accounts
• A copy of your most recent retirement or investment account statement
• A copy of the title transfer if you sold a car or any other sales records for assets you sold before you applied.
• Proof and verification of any gift money deposited into your account within the last two months

Also, if you have any outstanding debts, such as a student loan or an auto loan, your lender can ask you for more details. If you cooperate with your lender, the mortgage loan procedure will go more smoothly; ensure to send any information requests as soon as possible.

How to Apply for a Mortgage for a Rental Property

Applying for a mortgage can be challenging and easy, depending on how prepared you are. However, the following process will help you with a successful application.

• Obtain pre-approval: Before starting your home hunt, getting pre-approved for a mortgage enables you to determine the price range of the houses you can afford. To offer you a solution that is specifically tailored to your needs, the loan provider will normally request your complete financial details. You might look for lenders who offer non-QM mortgages if you don’t meet the requirements for an investment loan.
• Make a good offer: Finding a high-potential property in a desirable area and making an offer on the property are the next steps after receiving pre-approval. It is preferable to make a lower offer than what you were pre-approved for.
• Apply for a loan: Once your bid has been accepted for the property, apply for a loan with your lending institution and wait for a response. After applying for pre-approval, you would likely receive a favorable response, but you could need to wait the usual processing period.
• Agree on the terms: Obtaining favorable terms is arguably the most crucial step in the loan application process. The terms may vary when you apply, but a pre-approval procedure can give you a glimpse of what they might be. It is best to look for a company that gives you favorable terms.
• Underwriting process: You must submit the required supporting papers for the loan firm to consider your application. In some circumstances, you might finish the underwriting procedure during pre-approval.
• Sign final papers and close the deal: This is quite easy. You will be presented with papers to finalize the terms, conditions, and other agreements. Ensure you read through all the terms and agreements before signing and closing the loan deal.

Conclusion

Investing in real estate is profitable if done properly with the right knowledge. When you apply for a mortgage, lenders consider a variety of variables. Your income, employment history, credit score, debt-to-income ratio, assets, and the kind of property you intend to buy will all be assessed. You can start applying for loans once you meet the lender’s criteria. Once your loan has been approved, you must attend a closing meeting, sign the closing documents, and pay your down payment and closing costs. 

However, if you are looking for a lender with favorable loan terms and a fair interest rate, you should consider Aurum and Sharpe. Aurum and Sharpe is a lending company that offers loans tailored to your needs. To get started with your loan application, contact us at 9177404325 to book an appointment today, or use the online form to get in touch.

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