Mortgages as They Relate to Landlords

Posted in Blog  
  on Dec 17, 2015

Getting a loan for a rental property is not the same as getting a mortgage for a residence. While the two situations have some similarities, they also have important differences. Landlords who are considering applying for a loan to purchase a new rental property should look at the requirements carefully.


Credit Scores
You can do a few things before you apply or put in an offer to make getting a mortgage and closing on the loan easier. First, make sure your credit score is where it should be. Fannie Mae allows up to 10 loans for investment properties at a given time, but the credit score requirements vary; more loans mean higher risks.

  • The first four loans require a minimum credit score of 630.
  • The remaining six loans require a minimum credit score of 720.

Cash Reserves
You also need cash reserves. Many lenders require six months of loan payments in savings to ensure you can make the payments even if your property remains unrented for a period of time. Cash reserves may include the mortgage payment for the rental property and any other loans or expenses you have.


Down Payment and Income
Another requirement is a higher down payment. You may be required to put down 25 or 30 percent, but the minimum is usually 20 percent. Many investment mortgages have stringent limits on loan to value. Unlike personal home mortgages that allow up to 97 percent LTV, investment loans may limit the LTV to 70 or 80 percent.
You must show stable income on your W-2s or tax returns. Your rental income may be considered if you have a history as a landlord. If you are a first-time landlord purchasing an initial rental property, your regular income must be sufficient. You need to have higher income to qualify, especially if you already have a personal mortgage.


Find the Right Lender
Not all lenders are experienced with investment properties. Make sure the lender you choose has handled loans for landlords and investors in the past. Otherwise, you may end up in a nightmare with delays and even the loss of a property you want.
Ask your lenders about their experience. Even better, work with lenders who have purchased investment properties. They will understand where you’re coming from. Find out how many loans they allow for investment properties. Just because Fannie Mae increased its allowance from four to 10 doesn’t mean every lender has relaxed their standards.


Rent Loss Insurance
Another requirement you can expect for many investment loans is the need to purchase rent loss insurance. This policy protects you if you should lose out on rent income for various reasons that result in damage to the property. This can include fire, water damage, or other natural disasters. It doesn’t cover you if your property is vacant because you can’t find a tenant.
This policy is usually included in your property insurance once you let the insurance provider know what kind of property it is. It is purchased at an additional cost based on cost of property, mortgage payments and vacancy rate in the area.


FHA
You may be surprised to learn you can get an FHA loan for a rental property. Most people assume these loans are limited to people who plan to occupy the residence. In essence, this is true because you are required to live in the property for 12 months. After that time, you can rent it out.
An FHA loan is a viable option for someone who wants to get started in real estate investment with limited cash. Only one loan is allowed from FHA, so you have to find other options for your second and future rental properties.


Types of Loans
If you plan to rent out your property immediately, you have to choose between a residential and a commercial property loan. The residential loan is usually designed for properties with four or fewer units and is most similar to traditional mortgages. You still have more stringent requirements, but not as complex as for commercial investment loans.
The benefit of this type of loan is that previous experience as a landlord isn’t generally required, and the interest rates are only slightly higher than for traditional home mortgages.
Commercial loans aren’t just for rental properties, but for any type of business. They require much of the same information as residential investment loans, but the details may be different. For instance, lenders look closer at the amount of cash flow that is expected over just verifying income. They also check your background and experience in managing the properties.
These loans include DSCR or Debt Service Coverage Ratio. This means the lender is checking the cash flow as compared to the income and expenses. The formula is DSCR=(Net Operating Income)/(Debt Service).
It’s possible to get a loan to purchase new rental properties, but be prepared for things to work differently than with a traditional home loan. Know what is expected and find a lender who can guide you and support you through the process.

 


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