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How To Get A Mortgage For A Rental Property

There may be a lot of economic uncertainty in the world. Yet, there is no better time to invest in rental property than now. Owning rental property provides multiple benefits that may even serve as a source of stability in these unstable times. Some of the benefits include, but are not limited to: potentially stable monthly income, tax benefits, and appreciation.

What is a Rental Property Mortgage?

A rental property mortgage refers to a loan that helps the lender purchase a property that a tenant occupies. The lender does not purchase the property to live in it, but rather as a means to generate income. This form of mortgage is usually undertaken by real-estate investors, novices, and people who can not afford to buy real estate.

Difference Between a Mortgage for Rental Property and a Regular Home Mortgage

The processes of applying for traditional home loans and rental property mortgages are very similar, with just a few key differences.

The first major difference between both forms of loans is that the risk of default in rental property mortgages is higher than in a regular home loan. It is only reasonable for a lender to assume that a borrower would rather default on a rental property mortgage than on a mortgage for his home. The implication is that the application process for rental property loans is stricter and more comprehensive. Therefore, requirements like income, credit scores, and employment history are more heavily scrutinized, with stricter thresholds.

Another major difference between a mortgage for a rental property and a traditional home mortgage is the interest rates. A mortgage on a rental property typically comes with higher interest rates than a primary home residence. Traditional homes and rental properties typically have different interest rates between 0.5%-1%

How To Get A Mortgage For A Rental Property

Before you can get a rental property mortgage, certain qualifications must be met, and we discuss each of them in detail below:

Down Payment

For rental property mortgages, a down payment of about 15% to 20% is usually required depending on the specific loan program and lender. This is quite unlike traditional mortgages on primary residences, where the down payment could be as low as 3%. However, it is important to note that with traditional mortgages, you will be required to pay private mortgage insurance (PMI) if your down payment is less than 20%. PMI protects the lender from financial losses should you default on your mortgage.

Credit Score

With a credit score of 620, most lenders are good to go for a mortgage on a rental property. However,  to get the best deals and rental property mortgage rates, you should have a score of about 740 or more.

Rent Readiness

Generally, lenders will check the property to ensure it is rent-ready before approving the loan. This means it is in your best interest to ensure the property is in good shape before applying for the loan.

Debt-To-Income-Ratio (DTI)

This is a major factor for lenders. DTI measures the percentage of your gross income that is used to service your debt on a monthly basis. Lenders generally require that your DTI falls between 36% and 45% for you to qualify for a rental property mortgage. A borrower may also include a percentage of their potential rental income to help improve their chances here. Some lenders will not allow this source of income if you have never been a landlord.

Reserve Requirements

It is also important to show lenders that you have reserves in the form of liquid cash or readily convertible assets that allow you to pay for the mortgage for a substantial period (3-6 months) in case of unexpected issues like high vacancy rates in the property.

Options for Financing A Rental Property Loan

Generally, there are fewer options for getting a mortgage on a rental property compared to a traditional home mortgage. For instance, experts have noted that government-sponsored programs such as Veteran Affairs, Federal Housing Administration, and U.S. Department of Agriculture loans are unavailable on rental properties.

However, there are three options that you can keep in mind for financing your rental property. They are:

1. Agency Loans

Here, lenders make loans based on a thorough assessment of your cash flow. This includes your personal income and rental income. It is also important to note that borrowers undergo an uncertain and extensive underwriting process with this option. Lastly, you should note that you cannot refinance,  borrow, or cash out from a legal entity to protect other assets with agency loans.

2. Alternative Lender

These kinds of lenders are unique because of the flexibility they offer. Alternative lenders may also be referred to as non-qualified mortgage lenders [Non-Qm]. They are not restricted to the rules set by government-sponsored entities (GSE) or bank regulators.

Most alternative lenders give out loans based on cash flow from the property and not necessarily personal income. This means that you will require fewer documents to apply, and they will not review your tax returns or employment history. Nonetheless, you should note that alternative lenders usually possess higher interest rates and fees. They also have prepayment penalties.

3. Regional Banks

Another option for rental property loans is regional banks. These banks are quite flexible in underwriting loans because they plan to retain loans instead of selling them. They will do these in exchange for higher rates and fees. However, banks cannot give 30-year loans. Instead, they give 5-10 years to pay off a 15-25 year loan.

One of this financing option’s drawbacks is that banks have a changing policy that creates uncertainty. This means they can be financing rental properties for one month and not doing so the next month.

In conclusion, one of the best ways to finance your rental property is through a mortgage.

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