What Are the Requirements for a Mortgage on a Rental Home?
Securing a mortgage for a rental home can be a headache. Although these mortgages work similarly to conventional mortgages, they often have stricter qualification requirements. Below are some you may be expected to meet.
Your credit score plays a significant role in determining your eligibility for a mortgage on a rental home. The biggest influences on your credit score are your payment history and debt load – together, these two components account for 65 percent. Lesser influences include the length of your credit history and the age and mix of your credit accounts. Maintaining a credit score of 720 or higher can help you to qualify you for a low interest rate on your rental home mortgage. Below that, lenders may charge you a higher interest rate.
In addition to checking your credit score, lenders examine your credit report to gauge your readiness to repay your mortgage debt. All lenders use information from at least one of the three national credit reporting bureaus: Equifax, TransUnion, and Experian. If your credit report reveals that you have liens or judgments against your name, you will need to pay these off in full, or negotiate a payment plan with your creditors, before obtaining a mortgage.
The maximum loan size for a rental home is linked to the income you expect to receive once your rental home is tenanted. Lenders typically require your potential rental income to be 25-30 percent higher than your mortgage payment. They may also request proof of your personal income and cash reserves to ensure that you have sufficient funds to cover any void periods – times when your property is untenanted or rent is not paid.
Rental home mortgages are a serious financial commitment and lenders rely on a stable employment history to determine your ability to make your repayments on time. Most lenders require at least two years' verifiable work history, as well as proof that your employment is likely to continue for a minimum of three years. Lenders verify your employment history by checking with your current and past employers and/or requesting pay stubs and tax returns. If you are self-employed or work on commission, lenders may ask for at least two years' worth of accounts to substantiate your employment history.
Debt to Income Ratio
Most lenders require that your debt be no more than 30 percent of your income. This is your debt-to-income (DTI) ratio. The higher your DTI ratio, the more interest you will pay on your rental home mortgage. If your DTI ratio is too high to qualify you for a mortgage, consider paying off high interest debts to get below the required limits.
Rental home mortgages often require larger down payments than conventional mortgages to compensate for the risk of void periods. Most lenders request a down payment of at least 15 percent of the loan amount. A higher down payment may be required if you are a new investor and/or you have a credit score below 620.
Understanding the requirements for a mortgage on a rental home is an important first step in the buying process. Knowing that you meet the requirements can boost your confidence and make it easier for you to negotiate with lenders.
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