How to Get a Mortgage for a Rental Property

If you've ever considered venturing into the realm of investing in rental property, the present moment may present a promising opportunity. With historically low mortgage rates and the potential for rental income to serve as a safeguard amidst the prevailing economic uncertainty, the conditions seem favorable. Additionally, economists are anticipating a surge in foreclosures in 2021, which could lead to increased demand for available rental properties.

However, the question remains: How does one go about financing a rental property? For the majority of individuals, the answer is quite similar to financing the purchase of their own residence through a mortgage. Regardless, whether you intend to inhabit the property yourself or not, a mortgage offers the most reliable means of financing a rental purchase due to its inherent security, being backed by the property itself.

Potential for a Shorter Mortgage Term 

In certain cases, the loan term for a rental property mortgage may be shorter than the standard 30-year term offered for primary residences. However, similar to other types of mortgages, a rental property loan can be either fixed or variable, depending on the specific loan and the borrower's relationship with the lender, explains Tom McCormick, the regional officer of branch administration at Trustco Bank in Saratoga County, New York.

Understanding the Distinctiveness of a Rental Property Mortgage 

Mortgage lending revolves around varying levels of risk. The risk associated with a mortgage for an investment property is higher compared to that of a primary residence since the mortgage holder does not reside in the property.

Here are three key ways in which a rental property mortgage differs from a mortgage for your primary residence:

Potentially Larger Down Payment Requirement 

In most instances, an investment property necessitates a minimum down payment of 15% to 20%. Conversely, when purchasing your own home, you may be able to make a down payment as low as 3% in certain cases.

However, when the down payment for your own home is less than 20%, you are typically required to pay for private mortgage insurance (PMI), which can cost between 0.25% and 2% of the loan balance annually. PMI does not cover investment properties, so investors are required to provide a larger down payment.

Borrowers usually secure the best interest rate if they put down at least 25%. Request an estimate from a lender for both a 20% down payment and a 25% down payment to enable you to compare the difference in interest rates and payments.

Likely Higher Mortgage Rate 

Even in a low-interest rate environment, the interest rate for a rental property mortgage is generally higher. For most borrowers, the rate is approximately three-quarters of a percentage point higher for an investment property compared to a primary residence, which currently falls within the mid-3% range.

Varieties of Loans for Rental Properties

When it comes to obtaining a mortgage for your primary residence, you have a range of options at your disposal, including government-backed loans offered by the Federal Housing Administration (FHA), Veterans Administration (VA), and U.S. Department of Agriculture (USDA). However, these loan types are typically limited to financing primary residences, making them ineligible for the purchase of rental properties unless the property in question is a multi-unit dwelling and you plan to reside in one of the units.

Generally, the most common loan options available for rental properties are conventional mortgages and jumbo loans. If you are already a homeowner, you might be able to tap into the equity of your current property to finance the purchase of a rental property. This can be achieved through either a home equity loan or a home equity line of credit, providing you with access to the accumulated equity in your home.

Applying for a Rental Property Mortgage: A Step-by-Step Guide

According to Dalzell, the application process for a mortgage remains consistent, whether it's for a primary residence or an investment property. The process involves several essential steps, such as buyer qualification, property appraisal, title research, and loan underwriting.

Typically, you will need a credit score of at least 620 and a debt-to-income (DTI) ratio ranging from 35% to 45%. Additionally, you must provide documentation to demonstrate that your income is sufficient to cover both the rental property mortgage and your other monthly obligations.

One notable difference for investment property mortgages is that projected rental income can sometimes be factored into the qualification process if you plan to generate income through property rental. An appraiser can develop a rental income schedule to estimate the property's potential rental value. The lender can then consider this projected rental income as part of your overall income, which may help you qualify for more favorable terms and offset your mortgage payment.

Many lenders impose additional requirements and documentation specifically for investment property mortgage applications. For instance, banks often treat real estate investors as commercial customers, necessitating a commercial loan relationship with the institution. The document requirements for commercial loans differ significantly from those for mortgages for primary residences.

In commercial loan scenarios, borrowers are typically expected to provide financial statements for the past three years, financial projections for the next 12 months, tax returns for the past three years (usually two years for residential mortgages), current personal financial statements, tax returns of principal owners, and copies of current and projected rent rolls for loans involving rental properties.

In conclusion, if the coming months witness a wave of foreclosures, particularly after the expiration of the government's COVID-related foreclosure moratorium, there is likely to be a substantial increase in rental property applicants. 

This surge in demand would be advantageous for rental property owners. For investors who qualify for a rental property mortgage and are willing to manage or delegate property management responsibilities, the current period presents an opportune time to make a long-term investment with promising returns in the years to come.

Is Now a Favorable Time to Obtain a Rental Property Loan? 

Despite the additional paperwork and documentation involved, securing a mortgage for an income-generating rental property may be a wise decision, particularly in the current climate. The presence of low mortgage rates contributes to increased affordability in real estate acquisitions, and the prevailing economic uncertainty makes the availability of a passive income stream through rental properties appealing.

If the property in question generates consistent cash flow and is situated in a desirable location, it can serve as a strong long-term investment. Median rents have demonstrated steady growth over the past five decades, providing a reliable income source for rental property owners.

While low rates have attracted interest from a diverse range of real estate investors, rental properties are generally considered safer investments. Short-term real estate ventures, such as flipping properties, can carry higher risks in the current real estate landscape. 

The anticipated surge in foreclosures might result in an influx of available real estate inventory, potentially depressing prices and posing risks to real estate speculators in 2021. However, sustained demand for real estate in recent months may partially offset these risks.