Like many other investments, real estate can be very lucrative but may also be very risky. Much of the craze in real estate investing, romanticized by popular “reality” TV shows, is focused on buying homes, renovating or improving them, and reselling them quickly in a process known as “flipping.” Most real estate investing, however, involves longer periods of ownership with the expectation that rent payments and time will result in a significant return. Here are a few things to know about obtaining a mortgage to finance a rental property.
You Will Need Very Good Credit
Though much of the public perception about how hard it is to qualify for a mortgage to purchase a home you want to live in is overstated, that is not the case if you are buying an investment property. You will have to be a well-qualified buyer. The reasoning on this is rational: if you run into trouble, which are you likely to let go first? The home you live in or the home you rent to others? From the lender’s point-of-view, the best way to manage this risk is to only lend to those that do not exhibit much risk in the first place. You can have some minor blemishes in your credit history, but anything more significant than a late payment or two in the last several years and anything at all in the last 24 months could make getting approved a challenge.
You Will Need Money
Here again, many people, especially those in the news media, seem to think you have to put down 20% to buy a home you intend to live in and, for the most part, they are wrong. For an investment property, though, you will be hard-pressed to find many financing options with less than 20% down. Twenty percent is something of a magic number with lenders with regard to mortgage insurance. Most of the time, if they lend more than 80% of the value of a home, they want mortgage insurance to cover some of their risk. There aren’t many mortgage insurance companies willing to insure investment properties; in fact, at the time of this article none of the prominent national MI companies offer MI on investments.
Quick tip: a popular source of funds for the down payment on investment properties is the equity in the investor’s primary residence.
You May Need a Great Debt-to-Income Ratio
There was a time when it was not all that difficult to qualify for the payment on an investment property because the expected rent would cover the new mortgage payment, or come very close. The result was that your Debt-to-Income ratio really didn’t have to be able to support the mortgage payment on the rental home, just your current debts. Not anymore.
Now, if this is your first investment property, you will most likely have to qualify for the entire mortgage payment without any income support from the expected rent. It is not uncommon for this to be the case unless you have at least a 2-year history of managing rental properties. The ability to qualify for two full housing payments in addition to the loans and lines-of-credit that many of us have these days is not an easy requirement to overcome and may take some planning to overcome.
These are just a few things to consider and begin investigating if you are thinking of buying a rental property. The process is similar to buying an owner-occupied home, but the requirements are much different. As always, I am here to help you collect any information you need to make informed decisions and achieve your financial goals. Do not hesitate to contact me at your convenience.