The Difference Between Rental Property Loans and Conventional Home Loans

If you’ve taken out a mortgage for your primary residence in the past, you’ll find similarities in the process whenever you try to finance a non-owner-occupied property. With an investment loan, you’ll still need to fill out an application, verify your income and assets, and the lender will check your business credit scores

But there are also some key differences you may experience when you apply for your first rental property loan. 

1. Lenders are more stringent. 

Loans for investment properties are inherently riskier for lenders than standard, owner-occupied mortgages. The probability of late payments and default on rental property loans is higher. When money gets tight, real estate investment loans usually aren’t at the top of someone’s priority list. 

Imagine the following scenario. You’re a homeowner, and you owe the bank a mortgage on your primary residence. You also own a rental home, and you owe a mortgage on that property as well. 

Now, imagine something changes in your financial picture. Your income decreases and your tenant stops making his rent payments on time. All of a sudden, you can’t afford to make the mortgage payments on both your primary residence and your rental property. So which mortgage do you choose to keep current? Many people will choose their primary residence. 

Because of the increased risk involved with investment property loans, lenders may require you to jump through more hoops before they approve your mortgage application. For example, you might need:

  • A larger down payment (commonly 20% or higher)
  • More cash reserves (often six months per existing mortgage plus the new mortgage)
  • Sufficient income to cover existing debts and a new mortgage (debt-to-income ratio, aka DTI, should ideally be at or below 36% for the best rates and terms)
  • A higher credit score to secure better rates and loan terms (often 720 and up)

2. Interest rates may be higher. 

Not only may it be tougher to qualify for a rental property loan than for a mortgage on a primary residence, but it’s generally more expensive too. Again, the pricing of your mortgage is directly related to the amount of risk the lender believes its taking. 

Even borrowers with excellent credit scores may pay a higher interest rate on a rental property loan than they would on a traditional mortgage. How much higher? Rates can vary widely from lender to lender. It’s common to see interest rates between .5% and .875% higher on real estate investing mortgages compared with standard residential mortgages. 

For example, say you qualify for a 30-year fixed-rate mortgage at 3% interest for your primary residence. In this scenario, you might expect to pay around 3.5%–4% for a similar investment property mortgage. 

3. Qualifying property types may be different

According to Quicken Loans, an investment property typically needs to fit into one of the following categories: 

  • Condo
  • House
  • Single-Family Unit
  • Multi-Family Unit

In general, you’ll need to stick with one to four-unit properties when you apply for a rental property loan. If you want to buy an investment property with more than four units, you might need to consider a commercial residential loan or an apartment loan as an alternative. FHA multi-family financing might also be a good fit.

It’s worth noting that if you purchase a multi-family unit and plan to live in one unit yourself, you might be able to take out a primary mortgage on the property. For owner-occupied properties, you may be able to use an FHA loan or VA loan to finance your purchase. A conventional mortgage could also be worth considering. Any of these financing options might translate to a lower interest rate and better terms on your mortgage. Loan-to-value ratio (LTV), down payment requirements, and DTI requirements may be less strict in this scenario as well. 

4. Private mortgage insurance doesn’t apply to many rental property loans

On the positive side, you often won’t be charged private mortgage insurance (PMI) for rental property loans. PMI generally doesn’t apply to investment property loans when you’re putting down 20% or more to secure a conventional mortgage. But, the CFPB warns, if your down payment is less than 20%, PMI might raise the cost of your loan.

PMI is a type of insurance that protects the lender in the event you borrow money but eventually default on your monthly payments. Although PMI isn’t designed to protect you, you’re the one who pays for this insurance when it comes to conventional financing. The monthly insurance premium is usually added to your mortgage payment. 

You could potentially save a lot by securing a conventional mortgage with no PMI for your rental property. PMI adds an average fee of 0.5% and 1% of your loan amount per year. So, on a 250,000 rental property, you might pay an extra $2,500 per year — potentially adding $208 to your monthly mortgage payment. Providing a 20% down payment (as is the norm with many rental property loans) would likely help you avoid the extra cost of mortgage insurance.

Other creative financing options

If all else fails, sometimes you have to get creative. Fortunately, there are several other available options to finance your investment property.

Peer-to-peer lending

Peer-to-peer lending has become popular in recent years with several lending platforms popping up online. This is a way for investors to connect with borrowers who need financing for various purposes. Investors like them as a form of alternative investment, but, of course, there is also someone on the other side. Fees and interest rates are generally low, depending on creditworthiness.

Fix-and-flip loans

Fix-and-flip loans, as their name implies, are generally short-term loans intended for house flippers. These are hard money loans with interest rates typically in the range of 12 to 18 percent, plus two to five points. If you come across a property you would like to fix up and sell in the next 12 to 18 months, a fix-and-flip loan might be worth a look.

Life insurance policies

Life insurance may be considered a liquid asset (depending on the type), which is preferable for lenders. In particular, a permanent life insurance policy gives you easy access to cash. You can borrow against that money which can help when purchasing a new home. This makes you more attractive to lenders and could make it easier to secure financing.

Credit cards and personal loans

Credit cards and personal loans can be an easy way to finance part of your home purchase. Some credit cards have zero percent introductory offers and personal loans may let you borrow up to about $100,000.

While both are a convenient form of financing, personal loans often have high interest rates, as do credit cards after any introductory offers. Thus, this shouldn’t be your first option, but it can provide some additional financing in a pinch.

Margin loans

Margin loans are a line of credit that can be used to finance a property and are backed by a borrower’s investments. They’re typically used as a short-term funding tool and come with a number of risks such as margin call and amplified losses if your investment portfolio declines in value.

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Alternative Rental Property Financing

If you can’t find the loan you need to purchase a rental property, there is one other option you might consider: seller financing. With seller financing, the person you’re buying the property from acts as the lender, at least initially. Often, you may have a few years (perhaps three to five), after which you’ll owe a balloon payment of the remaining balance to the seller. By this point, you would need to have the cash to pay off the property or another form of financing lined up. 

If you’re hoping to buy a rental property with no money down, this might be something you can negotiate with the seller. Just keep in mind that no money down may be a big ask, depending upon the situation. Many sellers may turn down your request. 

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8. Hard money loan

House flippers are known for using hard money lenders to help them house hack into a real estate deal.

Hard money loans are non-conforming loans that are generally provided by private lenders, individual investors, or groups who offer money upfront for short-term borrowing.

It’s private money lent with high interest rates and short terms, and this loan option allows investors to secure financing based on the property’s current or even future value.

Hard money lenders may pull your credit score, but the underwriting process is typically less strict than with a traditional mortgage loan.

If you find a deal on a fixer upper, and you qualify for a hard money lender’s loan-to-value guidelines, you may be able purchase with little or no money down.

“If you are buying an investment property, you will need collateral, such as a separate property, going this route,” says Meyer.

2. Leverage home equity with a HELOC or cash-out refinance

Using a home equity line of credit (HELOC) or cash-out refinance to buy property is another financing option for existing homeowners.

If you own a home, you may be able to use your home’s equity for a down payment on your next place.

One way to do that is by borrowing cash secured against your home equity. Homeowners may be able to obtain a standard home equity loan, or a HELOC, to fund a down payment.

Using a HELOC, you secure a line of credit against your home, and then draw on it whenever you need cash flow. And you can begin paying the loan back with rental income.

Cash-out refinance

The other type of loan that leverages your home equity is cash-out refinancing.

A cash-out refinance lets you refinance your mortgage for a higher amount than you actually owe. Then, you take that extra loan amount out as a lump sum of cash.

In this scenario, the money advanced to you by a cash-out refinance can be used to make the down payment on an investment property.

In other words: If you have enough equity in your current home, you may be able to start investing with no money out-of-pocket.

Potential cash flow from rental property investments

Cash flow is the difference between the rental income of an investment property and its expenses, or whatever is left over after paying all of the bills.  Bills can include utilities, property management, repairs, and season expenses (lawn maintenance or snow plowing). It goes without saying, but the more positive cash flow your property can earn, the better of an investment it will be.

Something that may not be as obvious, that financial income may also be used during the loan qualification process that is if you’re already a landlord. That’s right; you can use the rental income of your current investment property to qualify for a new investment property mortgage, assuming you want to manage multiple real estate properties. Just be prepared, you’ll need to document property management experience for at least two years.

4. Ask for owner financing

In the days when almost anyone could qualify for a bank loan, a request for owner financing used to make sellers suspicious of potential buyers. But now it’s more acceptable because credit has tightened and standards for borrowers have increased.

However, you should have a game plan if you decide to go this route.

“You have to say, ‘I would like to do owner financing with this amount of money and these terms,’” Huettner says. “You have to sell the seller on owner financing, and on you.”

This game plan shows the seller that you’re serious about the transaction and that you’re ready to make a real deal based on the practical assumptions that you’ve presented.

What affects my investment property interest rate?

Fannie Mae and Freddie Mac guidelines aren’t the only things that affect your investment property mortgage rate. All the personal factors that determine mortgage rates are in play, too.

That includes:

In fact, your personal finances — including your credit report and possibly your tax returns — will be put under even stricter scrutiny when you buy an investment or rental property than when you buy a home to live in.

It will take a more robust financial profile to qualify for your investment mortgage — and to score a competitive rate on top of that.

Investment property loans require larger down payments

Most rental property buyers will finance their homes via conventional loans. Following are down payment requirements to buy a rental property.

Loan type1 unit2-4 unit
Fixed-rate mortgage15% down25% down
Adjustable-rate mortgage15% down25% down

A down payment of 15% to 25% is a considerable amount, especially compared to the 3% you could put down on a conventional mortgage for a primary residence — or the 0% down payment for homebuyers qualifying for the USDA or VA mortgage loan programs.

Bigger down payment requirements are just another way lenders protect themselves against risk when underwriting loans for real estate investing.

Investment property credit score requirements

When you finance an investment property, lenders generally want to see a better credit score than they do for primary residence buyers.

For instance, Fannie Mae borrowers putting at least 25% down could get approved with a 620 FICO score for a primary home. That minimum credit score increases to 640 for a rental.

If you don’t have great credit, you can try an FHA loan — its underwriting is much more lenient.

FHA loans are available for homes with up to four units, and credit score requirements start at 580. The catch? You must live in one of the units, so the building is still technically a primary residence.

Other guidelines for rental and investment property loans

When you apply to buy a rental property, underwriters will verify your ability as a potential landlord. If you’ve never owned a home or managed any property, you’ll have a tougher time.

Some lenders allow first-time real estate investors to get around this by hiring a property manager. There is nothing definitive about this in the official guidelines so check with your loan officer.

There are limits to the number of properties you can own with mortgages on them, if you go with conforming (Fannie Mae or Freddie Mac) financing.

And you’ll be required to have reserves — several months of mortgage payments — in the bank to cover those months when your property is unoccupied.

Build Your Wealth, Carefully

Rental properties can be excellent sources of income for the right buyer, and in the long run can be valuable assets in a diversified portfolio. They are also a good choice for first time investors who are looking for creative ways to build their personal wealth.

However, purchasing any investment property can be a complicated matter. First-time investors should take their time and carefully consider all of their financing options, as well as their responsibilities as a borrower and a landlord, before agreeing to any long-term financial and social commitments.

Seasoned investors tend to be well aware of the benefits found in owning rental properties. Wealth and cash flows are often managed best by an asset such as some rental real estate, which is why it has consistently remained a solid investment idea for more than 145 years.

When it is time to build your wealth, a careful review of rental property ownership will no doubt be a foundational part of the best laid plans.

Andover Homeowners May Want to Refinance at Today’s Low Rates & Save Contact New American Funding today to see how much you can save. Lower Interest Expenses: Pay off higher interest rate credit cards & pay for college tuition. Leverage Your Equity: Cash out & debt consolidation options available. Trusted Lender: Over 170,000 positive reviews with an A+ rating with BBB. Flexible Terms: Borrow from 8 to 30 years.

Andover Homeowners May Want to Refinance at Today’s Low Rates & Save Contact New American Funding today to see how much you can save. Lower Interest Expenses: Pay off higher interest rate credit cards & pay for college tuition. Leverage Your Equity: Cash out & debt consolidation options available. Trusted Lender: Over 170,000 positive reviews with an A+ rating with BBB. Flexible Terms: Borrow from 8 to 30 years.

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