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A quick guide to home loans on investment properties
January 2, 2020
While primary home mortgages help borrowers purchase homes to live in, property investment mortgages are designed specifically for real estate investors. In other words, the borrower doesn't necessarily plan on living in the property but rather plans on using it as an income-generating opportunity.
The biggest difference between the two is the availability. In general, investment property loans are harder to come by than primary home loans. They're more expensive, fewer lenders provide them and they come with stricter qualifications for the borrower. If thinking about investing in real estate for the first time, you might be asking, why are mortgages for investment properties more expensive and harder to acquire?
Property investment loans are considered riskier for the lender
According to The Mortgage Reports, borrowers are more likely to let property investment loans default before their primary home loans do. For this reason, property investment mortgage rates will almost always be more expensive. In addition, interest rates for these loans are .50-75% higher than they are for primary home loans.
But it's not just the monthly payments and interest rates that are more expensive. If you're trying to obtain a property investment mortgage, expect the lender to require a down payment of at least 15%. It's important to note that the price of your rate and your down payment will vary depending on the dwelling. For example, financing a four-unit household could come with higher expenses than a one-bedroom condo.
Types of property investment loans
If you're new to investing in real estate and want to start off financing a single property with fewer than four units, you should consider a government-backed loan. These mortgages are bought, securitized, and guaranteed by government agencies like the Federal National Mortgage Association, which makes them less risky in the eyes of the lender. As long as the loan is conforming, which means it does not exceed the limits set by the Federal Housing Administration, government agencies will back it. Benefits of these mortgages include cheaper rates and down-payments, as well as less strict qualifications for the borrower. It's important to mention that in order to qualify for government-backed property investment loans, you may be required to live in the property for at least a year.
If you're looking to expand your property investments beyond single-family homes, you'll probably need a commercial loan. Typically, these mortgages are borrowed by companies in the real estate market, not individuals. If you (or your company) are purchasing a building with more than four units, a conventional loan won't cover it. With a commercial loan, you can use the income you make from your property (rent/ lease money) to satisfy the monthly payments. Once the mortgage is paid off, your profit margin for that property will grow substantially. These loans, though necessary for big real-estate investors, are usually more expensive and more complicated to set up.
If you don't qualify for a conventional loan with most banks and mortgage companies, you may have to look elsewhere for a portfolio loan. This is a good fit for borrowers with bad credit, a high debt-to-income ratio, or less money to spend on a down payment. With portfolio loans, there is no government backing, so the lenders assume greater risks. Therefore, if you end up going with this type of loan, you can expect much higher monthly rates.
Tips for getting a property investment loan
There are a handful of ways to make your property investment mortgage rate cheaper. First, shop around and compare the options and rates between different banks and mortgage companies. Once you've found a lender that works for you, try to get the best deal possible by keeping these variables in mind:
Having a good credit history will help you when applying for a property investment mortgage because it shows that you're trustworthy with borrowed money. You'll need a FICO score of at least 650 to be considered by most lenders. And the higher your score is, the less you're rate will be.
Paying a big down payment is another way to help lower the cost of your monthly mortgage rate. If you're able to put more than 20% down, you'll enjoy cheaper rates. Also, in many cases, if your down payment is equal to one-fifth of the property's value, you can avoid paying Private Mortgage Insurance fees each month.
Finally, consider living in your investment property. Usually, primary home loan lenders will allow borrowers to rent out their property after one year of living there. So if you buy a house that you plan on renting out in the future, you could purchase it with a conventional loan (which will be much cheaper), move in for a year, then start renting it out without an increased rate.
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