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Rental Property Loans: How to Finance Your Investment Property

Published on: April 29, 2022

rental property loans

If you’re interested in purchasing a home to rent out, it’s essential to understand that rental property loans have different requirements than mortgages for personal homes.

What is a rental property loan?

Rental property loans provide financing for an investment home you plan to rent out. Lenders consider rental property loans riskier than mortgages for personal residences. That’s because lenders assume if you’re short on cash in the future, you’re more likely to keep up with the payments on your home than on an investment property. 

How does a rental property loan compare to a primary residence loan?  

With a mortgage for your home, you can use either conventional financing or get a government-backed mortgage, such as an FHA loan. Government-backed loans often have lower credit requirements than conventional loans. Rental property financing usually involves a conventional loan. 

Rental property loans and traditional mortgages have some similarities. Both require you to make a down payment and pay off the mortgage in monthly installments that cover principal and interest. 

But rental property financing comes at a price. Because lenders are taking a larger risk by financing an investment property, they require a bigger down payment. Lenders typically charge higher rental property loan rates than they charge on home mortgages, too. The mortgage on a rental property may have an interest rate that’s 0.25 to 1 percentage points higher than the prevailing rate for a primary home. A higher interest rate means your monthly payments will be larger, and you’ll pay more in interest over the life of the loan. 

Loan requirements for rental properties vs. primary residences 

Lenders set stricter loan requirements on rental properties than primary homes. They may require you to have a higher credit score, put up a larger down payment, and have a lower debt-to-income ratio, although they may consider a portion of the expected rent as income. 

The lender may ask for additional documentation about your finances and require you to have a large cash reserve to cover mortgage payments for up to six months.  

At a glance: requirements for rental loans vs. primary residence loans 

Requirement  Rental property loans Primary residence loans* 
Credit score  620  500 
Debt-to-income ratio  35% to 45%  43% 
Down payment  15% to 20%  3.5% 
Interest rate  Up to 1% higher than on a primary home loan  Varies 
Cash reserves  6 months’ worth of mortgage payments  Varies

(*) Requirements for a primary residence mortgage vary depending on the kind of loan. Most VA lenders accept 0% down payments. 

Types of loan options for rental properties

While traditional lenders generally offer conventional mortgage loans for rental properties, you may have other options for financing your rental property. Each type of loan has its pros and cons. 

Conventional loan 

A conventional loan is any loan not backed by the government and is provided by a private lender, such as a bank, credit union, or non-bank mortgage lender. The requirements for a conventional rental mortgage are stricter than for a primary residence home loan. Requirements generally include: 

  • A credit score of 620. 
  • A down payment of 15% for qualifying credit score. 
  • Maximum debt-to-income (DTI) ratio of 35% to 45%. 
  • Minimum cash reserves of six months of mortgage payments. 

Pros:  

  • Multiple lenders to choose from. 
  • No upfront costs for mortgage insurance (not required if you put enough money down). 

Cons:  

  • May require large amount of cash for down payment and cash reserves. 
  • Harder to qualify for if you have a lower credit score.

FHA loan 

A government-backed loan may be an option if you are willing to buy a two- to four-unit rental and live in one of the units. The FHA insures multi-family loans for owners who will live in the property, and the borrowing requirements are less stringent than those of a conventional mortgage. Requirements include: 

  • Credit scores as low as 580 (with 3.5% down).
  • Down payment of 3.5% with a 580 credit score; 10% with a credit score between 500 and 579. 
  • DTI maximum of 43%. 

Pros:  

  • Less cash needed because of lower down payment requirement. 
  • Lower credit score acceptable. 

Cons:  

  • Requires upfront and annual mortgage insurance premiums, so the loan costs more. 
  • Borrowers must live in the building for at least one year. 

Seller financing 

In some cases, you may arrange seller financing. You can ask the current owners to finance the sale if they own the building outright or have substantial equity in it.  

In this situation, there’s no specific credit score or DTI requirement; it’s up to the seller. The seller can also charge a higher interest rate than you’d get from a mortgage lender. The loan may be for a shorter term, perhaps five years, so you must be able to refinance before the loan is due. 

Pros:  

  • No set credit requirements or down payment. 

Cons:  

  • May be difficult to find a seller willing to finance the sale. 
  • Higher interest rates, shorter loan terms. 

Portfolio loan 

Lenders sometimes offer portfolio loans, which they hold in their investment portfolios instead of selling them on the secondary market, as they do with conventional mortgages. Because the loan won’t be sold, the lender doesn’t have to follow the same credit rules that a conventional mortgage or FHA loan requires. 

With a portfolio loan, the lender can be more lenient about credit rules or put more emphasis on the cash flow the investment will bring. So, you may qualify for the loan with a lower credit score or a DTI ratio that doesn’t meet regular loan standards. In return, you may pay higher interest. The lender may also charge higher fees and impose a prepayment penalty. In some cases, the opposite may be true, in that the lender’s portfolio loan requirements are stricter than a conventional or government-backed mortgage.  

Pros:  

  • Lender may offer less stringent credit requirements. 

Cons:  

  • Higher fees and interest rates.

How to get a loan for a rental property

Before you apply for a rental mortgage, assess your finances to ensure you meet the credit requirements. In many ways, the steps you take are similar to what you would do if you were applying for a mortgage to buy a new home. 

Determine where you’ll get the cash for the down payment. If you don’t have enough saved, you could consider finding a co-investor or getting a home equity loan. 

Make sure you can meet the credit requirements. While the minimum credit score for a conventional loan is 620, a higher score may qualify you for a lower interest rate. You can take steps to improve your credit score: 

  • Check your credit report for errors and ask the credit bureau to correct any mistakes you find. 
  • Pay off debts to improve your debt-to-income ratio. 
  • Limit your use of credit to improve your credit utilization score. Using more than 30% of your available credit can lower your credit score. 
  • Avoid opening new lines of credit. New accounts and credit inquiries hurt your credit score. 

Get your paperwork ready. The lender will want to see documents showing your income and debt, so gather them before applying for the loan. With a home loan, the lender usually wants two years of tax returns, but with a rental loan, the lender may request more. Documents needed may include: 

  • Tax returns 
  • Bank account statements 
  • Investment account statements 
  • Existing lease for the house or other documents showing the income the property will generate 

Where to find rental property loans 

It may be harder to find a mortgage for a rental property than a regular mortgage, but it’s not impossible. Finance of America Mortgage offers rental property loans, as do other mortgage companies, banks, and private lenders. You could also work with a mortgage broker. 

How to lower rental property mortgage rates and fees 

Lenders charge higher rates and fees for rental property mortgages because these loans are inherently riskier than a mortgage on a borrower’s home.  

You may qualify for lower interest rates and fees by showing the lender you’re creditworthy. Having a higher credit score shows that you’re a responsible borrower, and increasing your credit score can translate into better terms on a mortgage. 

Putting more money into the deal upfront also results in lower rates and fees. When you make a large down payment, the lender knows you’re less likely to default on the loan and may charge lower rates. Some lenders may allow you to buy down your rate as well. 

You may also be able to save money by shopping around for a mortgage. Getting multiple mortgage rate quotes can save borrowers thousands of dollars over the life of the loan. Research from Freddie Mac shows borrowers who get just one rate quote may end up paying $1,500 more over the life of the loan compared to borrowers who get two quotes. Borrowers who get five rate quotes may save $3,000 compared to borrowers who don’t shop around.

Rental property FAQs

How do I measure rental property performance after a mortgage?

You can use a rental property calculator to analyze your return on investment, cash flow, and capitalization rate. You’ll need to know the purchase price, loan terms, rental income, and property operating expenses for your rental property. 

Can I rent out my house without telling my mortgage lender? 

Whether you have to tell your mortgage lender you’re renting out the house may depend on the wording in your mortgage. The mortgage may specify that the owner must occupy the property. An FHA mortgage, for example, stipulates that the borrower must live in the home for at least a year. Read your mortgage documents to see if there is an occupancy clause.

What is the 2% rule in real estate investing? 

The 2% rule states that the monthly rent you charge for the rental unit should be at least 2% of the purchase price. So, if you purchase a $150,000 property, you should be able to rent it for $3,000 under this rule. The 2% rule is a quick way to determine if a rental property will provide adequate cash flow, although with rising real estate prices some investors say the rule is outdated. 

Are you interested in purchasing an investment property? Talk to a local Finance of America Mortgage Advisor today to discuss rental property loans. 

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