Financing your rental property can be a huge headache. Qualifying for a rental property mortgage is an even bigger headache! So many investors, especially beginner real estate investors, fear entering the real estate investing world because of rental property mortgages. No matter how intimidating it may be to get approved for a rental property mortgage, it shouldn’t stop you from investing in real estate. That is why this blog was prepared to provide you with everything you need to know about rental property mortgage.
What is a mortgage?
First things first, what is a mortgage? Simply put, a mortgage is a loan given by a lender to real estate investors who want to purchase properties. So instead of paying for your rental property in full cash, you can use a mortgage to pay off most of the price. You as a real estate investor are required to pay a minimum down payment which is usually a 20% down payment. Of course, this may vary from one lender to another. You must pay the lender the mortgage over a certain amount of years and also the included interest rate. There are different types of rental property mortgage or to be precise, there are three different loan categories.
Read Also: Buy a Rental Property Using a Mortgage or Cash?
Types of rental property mortgages
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Owner-occupied mortgages
This type of loan that many lenders refer to as “owner-occupied” is for people purchasing a home that they intend to live in. It is required that you move into your residential property within the first 60 days of closing the loan. It is also required that you live in your home for a minimum of one year. After a year, you are allowed to rent it out as a form of investment without your mortgage contract terms changing.
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Second-home mortgages
This type of rental property mortgage is for residences that are considered as your second home. These types of loans are only for people who intend on using the property as a second home for family or friends. However, lenders prohibit renting it out and if the real estate investor is caught, he/she will be forced to pay the house price all at once!
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Non-owner occupied mortgages
This type of rental property mortgage is for real estate investors who want to buy an investment property for the purpose of renting it out to tenants. You can still decide to use the property for yourself or make it owner-occupied without changing the terms of the loan.
Rental property mortgage rates
Every specific type of real estate investment has a certain rental property mortgage rate. It’s very hard for real estate investors to understand what the best mortgage rate is for them. Many factors affect the rental property mortgage rate such as where you take your mortgage from. A rental property mortgage is usually taken from a bank and can be either taken from a local bank or national bank. These banks select the down payment and interest rate that you will have to pay. Usually, local banks are known to be an advantage for investors when compared to national banks. This is due to their smaller operation scale. They can provide you with more attention and can even offer to lower your down payment.
Related: Investing in Real Estate: What Rental Property Mortgage Rates Can You Expect in 2018?
In general, mortgage rates are affected not only by where you take them from but also what type of rental property you need the mortgage for. Rental property mortgage rates on non-owner-occupied investment properties tend to be higher than on homes. This is because mortgage lenders categorize them as “riskier” to support than owner-occupied properties.
How to qualify for a rental property mortgage
Qualifying for a rental property mortgage is not an easy job. Just because you need money, doesn’t mean you shouldn’t have money to get approved for a mortgage loan. Here are the main aspects you must take into consideration before applying for a rental property mortgage.
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Your credit score
This is the first thing that mortgage lenders look at to see if you qualify for a mortgage loan. Your credit score shows lenders what type of real estate investor you are and whether or not you pay off your debts. You want to always aim for a high credit score. For investment properties, a minimum credit score of 620 is preferred. Some lenders might accept 600 but always aim to have a higher score. The lower your credit score is, the lower your chances are for qualifying.
Read Also: What Is a Good Credit Score? Everything Real Estate Investors Should Know
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Your debt-to-income ratio
Basically, your debt-to-income ratio is the percentage of your income that is used to pay off your debts. You might have to pay off debts like car loans, credit card debts, student loans or any other type of debts you may have. Unlike your credit score, the lower your debt-to-income ratio is, the better. A good debt-to-income ratio is 36% or less.
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Your cash reserve
As mentioned, most real estate investors think they don’t need to have the cash to qualify for a mortgage loan because the whole point of a mortgage is to GET cash. Not having a cash reserve is a major reason why most investors get rejected for investment property loans. Mortgage lenders want to see that you have at least a 6-month cash reserve for your rental property.
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Is your down payment ready?
You should know by now that a typical down payment for a rental property mortgage is 20-25% of the price of the property. Some lenders will accept a lower down payment, others will not. That is why you need to always come prepared and have your down payment ready to ensure you get qualified for a rental property mortgage.
Related: Why You Shouldn’t Put Less Than 20% Down Payment
Rental property mortgage vs. Traditional mortgage
Unlike traditional mortgages, the requirements to qualify for a rental property mortgage are much stricter. It’s not impossible to get a mortgage for a rental property but it can be tougher. Mortgage lenders tend to have different guidelines that must be followed to make sure you have the money needed to pay off the mortgage payments. Rental properties have more risks involved due to the rental income and tenants not paying rent on time. That is why banks and mortgage lenders are more cautious in terms of rental property mortgages.
Interest on a rental property mortgage
A mortgage for rental property tends to have a higher interest rate than a mortgage for a home. In fact, that’s why rental properties under non-owner occupied mortgages can be changed to a residence which puts the lender at less risk. Interest rates for a rental property mortgage are about 0.25% to 0.75% higher than home mortgages.
The bottom line
Investment property financing is an important part of real estate investing. That is why you need to understand everything about rental property mortgages. Let this blog be your first step to gaining the right knowledge. Once you’re sure that you have everything to qualify for a rental property mortgage, go ahead and let your real estate career begin!
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