Regardless of the real estate seminar or property flipping reality television show that you devote your loyalty, there are two very basic economic objectives of purchasing residential investment properties.
- Cash-Flow- The proceeds of rental income after the expenses of the property; the mortgage payment, property taxes, homeowner’s insurance and HOA dues are paid.
- Equity Increase- The increase of value of the home when the value of the property increases
Basics of Home Loans for Investment Properties
To purchase an investment property not to exceed the conforming loan limit which for most counties in the US will increase to $424,100, the minimum down payment is 15% with the use of a conventional loan insured by Fannie Mae or Freddie Mac. Interest rates on conventional investment properties improve dramatically with a down-payment of 25% or more.
When someone is purchasing or refinancing an investment property a lender is going to want to require evidence of savings that will cover the mortgage payment including property taxes, homeowner’s insurance and any HOA fees on an investment property in the event of an eviction or challenge finding a renter, this amount of money is referred to as reserves and is a requirement of all investment property home loans. A good rule of thumb is 6 months of reserves per investment property. Late 2016, Fannie Mae updated their reserve requirements for conventional purchase or refinance transactions. Instead of a specific number of months per property, the amount of reserves will be calculated by applying a specific percentage to the aggregate of the outstanding principal balance for all current and future mortgages.
Those percentages are based on the number of financed properties (as determined above):
- 2% of the aggregate UPB if the borrower has 1 to 4 financed properties
- 4% of the aggregate UPB if the borrower has 5 to 6 financed properties
- 6% of the aggregate UPB if the borrower has 7 or more financed properties
The changes make it a bit more difficult for a loan officer to give you an exact payment reserve requirement, but the new calculation is very helpful for investors with multiple properties at low outstanding mortgage balances.
Different mortgage programs will have different calculations of reserve requirements, but all home loans on investment properties will all carry reserve requirements.
Condo or Single Family Residence as in Investment Property?
The Benefits of an Investment Condo
The primary benefit of purchasing a condo as an investment property is the price point. In many parts of the country, the price point of a single family residence is in excess of $450k requiring a minimum down-payment of 15% to purchase an investment property or minimum down-payment of $67,500. In comparison, condos in many of these same areas are available in the price range of $325,000 requiring a minimum down payment of 15% or $48,750 or 28% less than of a down-payment on a condo versus a house. In some investment situations with limited down-payment, the cash-flow on a condo can be break even or even negative, but it is the equity increase that makes the purchase of a condo in many situations an easier investment to start with compared to a single family residence.
Another reason that some investors prefer the purchase of a condo versus a single family residence based on the lower cost of property maintenance. Typically, the home owner’s association fees of a condo will include the costs of common area maintenance and will cover a portion of the home owner’s insurance related to the liability of the physical building.
The Challenges of an Investment Condo
It is no secret that comparatively speaking, a property that is zoned as a single-family residence will have less restrictions than that of a property classified as a condominium. Condos have an additional cost of ownership which not all single family residences share, the home owner’s association fees that will minimize cash-flow but the most important difference from a financing perspective is the requirements in securing a loan on condo versus a single family residence.
Potential Challenges in Securing a Loan on an Investment Property Condo
The purchase or refinance of any condo designated as an investment property will require an evaluation of the occupancy of the complex as well as a review of the financial strength of the Home Owners Association thru a review of a Condo Certification filled out by the property management company.
If there are aspect of the complex that do not meet the condominium requirements of Fannie Mae or Freddie Mac, the complex will be considered non-warrantable which will limit the lenders that will lend on a property.
What makes a Condo Non-Warrantable?
There are many factors that go into making a condo non-warrantable:
- The complex is involved in some form of construction defect litigation
- New Construction condos with limited sales history
- Condo complex where one owner owns more than 10% of the total units
- HOA with inadequate insurance coverage
- Condo complex where more than 15% of the owners are behind on their HOA dues
- Condo complex where more than 50% owners are investors
Any one of these factors will make the loan process on a condo increasingly difficult as the vast majority of lenders will not have access to the programs to lend on an unwarrantable investment condo.
How to Buy a Non-Warrantable Investment Condo?
In many situations, investors identify non-warrantable condos as a value in the market place compared to other condos. In many situations, this lower price is the result of a lack of availability to financing which is driving the price of the condos down. There are 3 ways to purchase a non-warrantable condo:
- Cash is King: without a loan, there is no any requirements of the complex. Unfortunately, not many investors have access to the several hundred thousand dollars laying around.
- Seller Carry: If you are able to identify a seller of a property willing to carry the terms of the sale to you as the buyer, a condo that is non-warrantable will not make any difference in the financing decision.
- Identify a Lender that offers non-warrantable condo loans: There are smaller credit unions and banks that will provide loans on condos that are in construction defect litigation, complexes where a single owner owns more than 10% of the units and will also finance the purchase of an investment property with less than 50% owner occupancy. These loans are not underwritten to Fannie Mae or Freddie Mac guidelines so the decision of lending is more centered on the strength of the borrower. Without question, these loans will have both higher down-payment requirements and comparatively higher interest rates than that of a warrantable condo, but they will allow you to purchase the property and add to your investment portfolio.