Buying an investment property can be a great way to put extra cash in your pocket, but you may need a mortgage to pull it off. (Technically, a property is considered an investment property if the owner does not make their primary residence there.) Because there’s more risk involved for lenders, mortgage rates for “non-owner-occupied” property tend to be higher. This article will discuss types of investment property loans, typical rates, and more.
Key Points
• Investment property loans carry higher rates due to greater risk.
• A strong credit score can lead to more favorable mortgage terms.
• Reducing debt-to-income ratio enhances approval chances and better rates.
• Larger down payments decrease loan-to-value ratio and interest rates.
• Sufficient cash reserves improve financial stability and secure lower rates.
Why You Might Need an Investment Property Mortgage
Purchasing a rental property or buying a fixer-upper could be a rewarding way to invest your money, but if you don’t have the cash to pay out of pocket, you’ll need another way to fund the deal. For many, that means taking out an investment property loan.
Recommended: How to Shop for a Mortgage
Types of Investment Property Loans
The type of mortgage loan you choose can affect your interest rate and required down payment. How you plan to use the investment property and the number of units it contains also will affect your loan choices.
Conventional and Government Loans
If you live in one unit of a multiunit property and rent out the others, a conventional loan may be an option when buying two- to four-unit properties. Buildings with four or fewer units are considered residential and eligible for the same loans as a single-family home when owner-occupied.
Those with five or more units require a commercial loan, which usually has a higher rate, higher down payment requirement, and shorter term. Note: SoFi does not offer this type of loan.
Federal Housing Administration (FHA) and U.S. Department of Veterans Affairs (VA) loans are government-backed home loans, can be used to buy a two- to four-unit property with a low down payment or none at all, respectively, if you live in one of the units.
Is the sky the limit? Not exactly. The Federal Housing Finance Agency sets conventional conforming loan limits each year that depend on the number of units (one, two, three, or four) and the cost of the area. Staying under a loan limit means you’ll most likely obtain a lower-cost mortgage.
But jumbo loans, which exceed those limits, have their place. Lenders set their own limits and other criteria.
FHA loan limits for one to four units are set at 65% of the new year’s conforming loan limits. There are no VA loan limits for active-duty military members, veterans, and others who have full VA loan entitlement.
Home Equity Loan or HELOC
If you have enough equity in your primary residence, you may be able to take out a home equity loan or home equity line of credit (HELOC) to fund your investment.
Other Kinds of Financing
Finally, if you’re serious about getting an investment property, you can think about and read up on these options:
Understanding Investment Property Mortgage Rates
However much inflation affected mortgage rates, the rates are even higher for investment properties. Though rental property mortgage rates can vary, they are often at least 0.50% to 1.00% higher than rates for a primary residence.
Why are investment mortgage rates higher? Lending to an investor is inherently riskier. While someone who purchases a primary residence is likely to prioritize the mortgage payments for their own home, an investor who has a primary residence elsewhere will likely prioritize making payments on their own home above paying the mortgage for the investment property if cash runs short.
If the investment property is a flip but doesn’t sell as quickly as expected, the investor must keep making mortgage payments on the home after investing money to renovate — and may struggle to do so. And if the investment property is a rental, a vacancy results in no rental income to put toward the mortgage.
Recommended: Home Loan Help Center
What Determines the Rate?
So what determines investment property mortgage rates? Fannie Mae and Freddie Mac set rules regarding conventional investment property mortgages, including rate increases for single-unit and multiunit properties. Beyond that, mortgage rates for rental properties depend on a few additional factors:
Credit Score
As with any loan, a higher credit score typically results in a lower interest rate for an investment property mortgage.
Recommended: 18 Mortgage Questions for Your Lender
Debt-to-Income Ratio (DTI)
The lower your debt-to-income ratio, the better your chances of loan approval — and at a better rate. To calculate your DTI, add all your monthly debt payments, divide them by your gross monthly income, and multiply the result by 100.
Generally, 43% is the highest DTI you can have and still qualify for a mortgage, but many lenders prefer to see a 36% DTI or lower.
The lender may factor in 75% of your projected rental income when calculating your DTI, which works in your favor.
Cash Reserves
Because you may not immediately make money from an investment property — you typically need time to find renters or to rehab and list — lenders often like to see that you have adequate cash reserves.
Cash reserves refer to liquid (i.e., accessible) money that you have set aside for use in an emergency; in this case, it’s to cover the mortgage until your investment starts showing some ROI.
Though it can vary by lender, having six months’ worth of mortgage payments is often a good start. Having even more could improve your chances of approval and a lower rate.
Loan-to-Value Ratio (LTV) on the Investment Property
As with a traditional mortgage, lenders consider the loan-to-value ratio on the investment property. LTV expresses the ratio between how much money you’re borrowing and the appraised value of the property.
The closer those two numbers are, the higher the LTV ratio (expressed as a percentage) will be. By making a larger down payment and financing less, you can lower the LTV and potentially increase your chance for approval at a lower rate.
Making a Larger Down Payment
On a related note, you might benefit from offering a larger down payment. Although you may get approval with only 15% down — and some people even manage to buy a multifamily property with no money down — a larger down payment may yield a lower rate.
Not sure where to start? You can use a mortgage calculator to see how different down payment amounts may affect monthly payment and interest paid.
Getting a Lower Investment Property Mortgage Rate
Now that you know what determines a rental property mortgage rate, let’s see how you can use that info to potentially earn a lower one.
Coming in With a Good Credit Score
Other than an FHA loan, which is more lenient about credit scores, lenders usually require a minimum credit score of 640 for investment property loans; some set the barrier for entry at 680.
Regardless, catapulting your number into the high FICO® score range can improve your chances of a lower rate.
Paying Off Debt
A lower DTI ratio may also improve your chances of approval and a lower interest rate. But repaying debt is easier said than done; you may need to wait on an investment property if you’re working toward paying down a lot of credit card debt.
Increasing Your Cash Reserves
Showing a lender that you can cover the mortgage and other expenses like renovations or maintenance increases the odds of approval. The more liquid money you have, the lower your interest rate could be.
The Takeaway
Investment property loans are a good way for investors to purchase real estate for a rental property or a house flip, but the rates tend to be higher than rates for mortgages for a primary residence. A lender may offer a lower rate depending on a potential borrower’s credit score, down payment, debt load, and cash reserves.
Find more advice on setting yourself up for mortgage success in a home loan help center.
FAQ
Can I get a mortgage for an investment property?
You can if you qualify, but keep in mind that investment property mortgage rates are typically higher, and lenders may have stricter requirements for approval.
Do investment properties have higher mortgage rates?
In general, yes, because lenders take on more risk when lending to an investor than to a person or family shopping for a primary dwelling.
What’s the minimum down payment for an investment property mortgage?
The minimum down payment for an investment property depends on the type of loan you’re using. For a conventional loan, you usually need to put down at least 15%. An FHA loan for an owner-occupied one- to four-unit property calls for a down payment as low as 3.5%; a similar VA loan, no down payment.
Photo credit: iStock/Drazen Zigic
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