Owning rental property is one way to diversify your investment portfolio and earn passive income. Yet, getting a loan for an investment property can be complicated.
Financing a rental home isn’t like financing a primary residence. Even though a rental property can generate income to cover the mortgage payment, these types of properties are riskier for lenders.
But although it’s easier to get approved for a primary residence loan, several strategies can make the process of getting an investment property loan easier, too. The key is knowing what lenders require.
Loan Options for Buying a Rental Property
Some property investors start off buying a primary residence, and then convert this home into a rental property a few years later. This is one way to get started as an investor, and this approach works whether you have a conventional, VA, or FHA loan.
Another option is to buy a home that “only” serves as a rental property. In which case, you never live in the home. Just know that in this scenario, you’re limited in the types of loans you can use for the purchase.
Some investors use conventional loans, also known as conforming loans, as well as portfolio loans.
Conventional loans are those backed by Fannie Mae or Freddie Mac and sold on the secondary market. These are often favored by real estate investors because they’re able to carry up to 10 conventional mortgages at a time. Plus, the property doesn’t have to serve as a primary residence to qualify. You can use conventional financing for investment properties, too.
Another option is to get a portfolio loan through a bank or mortgage company. These loans aren’t sold on the secondary market. So, lenders can customize the terms to meet a borrower’s need, thus allowing the borrower to use this financing for an investment property that never served as a primary residence.
The rules are slightly different when using a government loan to buy a rental property.
You can only use an FHA and VA loan for primary residences. If you’re thinking about buying an income-generating property with one of these loans, you would have to purchase a multi-family unit and reside in one of the units.
The only exception is when a single-family home, condo, or townhouse “first” served as a primary residence.
Per some mortgage agreements, if you buy a single-family unit with a government-backed loan, you must owner-occupy the home for a period of about a year before converting it into a rental property.
Down Payment Requirements for a Rental Property
Keep in mind that down payment requirements for rental properties are higher than down payment requirements for a primary residence.
If you’re using a conventional home loan to buy a rental property, you’re typically required to put down between 20% and 25%.
If you’re buying a multi-unit home with FHA or VA loans, you don’t have to worry about a higher down payment. Since the property also serves as your primary residence, FHA allows down payments as low as 3.5%. There’s no minimum down payment when buying a multi-unit home with a VA loan.
A higher down payment when using a conventional loan can be an obstacle to buying rental property, especially if you’re a new investor with limited cash flow.
One option, though, is to use equity from an existing home. You might qualify for a home equity loan, a home equity line of credit, or a cash-out refinance. In all three scenarios, you can borrow up to 20% of your home’s equity, and then use this money to fund the down payment on your investment property.
Credit Score Requirements for a Rental Property Loan
You’ll also need a higher credit score when using a conventional mortgage to purchase rental property. Standard conventional loans require a minimum credit score of 620. But given the risk nature of investment loans, many lenders have a higher credit score.
If you’re buying a multi-unit home and using an FHA or VA home loan, your minimum credit score may differ. VA loans don’t have a minimum credit score, but it’s best to always consult with your lender.
Other Requirements for a Rental Property Mortgage
Similar to getting a mortgage for a primary residence, expect the lender to request proof of income. You’re required to submit tax returns and W2s from the prior two years. You’ll also provide bank account statements and other financial statements so the lender can verify your assets.
Depending on the lender, you might have to meet other specific guidelines before getting an investment mortgage. For example, a lender might require a history of managing rental property for a larger loan, either your own investments or with a property management company.
Additionally, you might need six months of mortgage payments in liquid reserves or other assets.
Getting a mortgage for rental property involves tighter lending standards, and it often takes longer to approve these loans. But if you have cash in reserves, meet a lender’s credit requirements, and understand loan programs available to you, you can successfully secure a loan and start investing in real estate.
FirstBank Mortgage would be happy to speak with you about loan options for investment properties. Please contact us to learn more.