Mortgage for rental property is essentially similar to mortgage for primary residence. Still, there are couple of differences that investors should seek to understand. Although they are following the same application processes, investment property or rental property tends to come with higher risks. Specific rules and requirements have to be strictly approved by the lender, and investment property comes with slightly higher interest rates.
The underwriter have stricter standards. Generally, mortgage lenders check the first three major factors to get pre-approved – the down payment, the credit score, and the debt-to-income ratio.
Despite that, getting qualified for a rental property has introduced a couple of differences to the said requirements. Higher minimum down payment compared to a primary residence, stricter credit score, and debt-to-income thresholds. Additionally, the lenders are subject to heavily scrutinize your employment history and income.
Let us further discuss some key factors you should consider in order to get qualified for an investment property loan or rental property loan.
Credit Score
Generally, a minimum credit score of 620 is required when financing a rental property. But in some cases, you should have a credit score of 740 or higher to secure the best interest rates and terms. This credit score of 740 is acknowledged as an ideal range.
Down Payment
You can possibly put down as little as 3% with conventional mortgage, depending on the specific lender and loan program. A down payment of less than 20% may ask you to pay for the private mortgage insurance. It protects the lender from some financial loss if you default on the loan. While this doesn’t apply to investment property loan, you are like required to make larger down payment. A down payment of at least 15% to 20% can finance a rental property. In some properties like multiunit investment properties, at least 25% down payment is required.
Debt-To-Income
DTI measures the percentage amount of your monthly gross income that goes directly for debts. Your DTI must fall between 36% and 45% to qualify for a rental property mortgage. The lenders do not consider 100% of rental income in order to account for potential vacancies. But, if you do not have a history of being a landlord, your lender may not consider future rental income. Your ability to acquire a mortgage for rental property may entirely rely on your personal income
Savings
Aside from proving your sufficient income compared with your debt obligations, having your own savings in the bank is also a must to cover financial hiccups. An equivalent of 3 to 6 months of reserves in your account including the full mortgage payment with principal, interest, taxes, and insurance are ideal.
Now you might think you are all set to apply for a rental property mortgage. But let’s be reminded of these things too before applying for a loan.
Determine Lending Limits
You are lucky if you are working with the right lender. They can help you plan strategically both the long-term plan and short-term plan to fully take advantage of your 10-loan limit.
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Work With an Investor-friendly Lender
Your lender also plays a huge part in developing a strong, reliable, and successful rental property investment.
Work directly with a lender to seek some advice towards a successful investment. Others might get mistaken with a broker being the right person to seek advice from. Mortgage broker can be helpful when you are in the market for your primary home. The broker can shop around your financial profile to their long list of lenders. This could take quite a lot of time and money for you. Whereas if you work directly with a lender, you are in direct contact with the decision makers.
Credit Requirements are Stricter with Multiple Loans
Unlike other lenders, Fannie Mae can allow up to 10 loans per investor. However, there are two different credit-qualification guidelines to obtain these loans. One is for 1-4 properties and second is for 5-10 properties. 1-4 loans require at least 630 credit score, while 5-10 loans require at least 720 credit score.
More Loans Means You Need to Pay More Upfront
Multiple sets of guidelines for down payments also arise just like there are for your credit. Loans 1-4 require 20% down payments; loans 5-10 require 25% down; loans 1-10 also require 25% down. On that note, other lenders will require you to settle 30% after loan 4.
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Lender is Subject to See The Receipt
Lenders are subject to do cross checking on the receipts like your W-2. A minimum of two solid years of W-2 income will be required to prove you have been at your job or have kept working in the same industry for at least two years.
Your annual income will be calculated by the underwriter. This can be done by averaging your past two years of gross income. Let’s say you earned $100,000 this year and $50,000 for the previous year. Your average annual income then would be $75,000. You can get an idea on your annual income through this annual income calculator.
For self-employed individuals, you will be asked to provide two years of tax returns, a year-to-date profit and loss statement, as well as a letter from your CPA confirming your previous tax returns’ validity. Calculations for your annual income is just the same as the W-2 employee.
