Mortgage loans for personal property are fairly common, and most people understand the purpose and basic details behind this financing.
Loans for investment property, on the other hand, are a little different. Fewer people use them, which means fewer people understand them. But if you are considering an income property, you will likely need a loan, which means you need to know the details of this financing.
Loans for Investment Properties vs Your Residence
Note: These are General Statements That Don’t Apply to All Mortgages
Before we start, we’d like to point out that these are general statements about loans for investment properties compared to loans for your personal residence. With so many loan options available, there are certainly products and loan offerings that buck these trends. For example, while we can reasonably say that most investment loans, in general, have higher interest rates, you can certainly find a specific loan for a primary residence that has a higher rate than a specific loan for an investment property.
Few Government Programs for Investment Properties
One of the main differences between these two types of loans is the availability of government-supported financing. For personal homeownership, there is a variety of options that are supported by state and federal governments, including FHA loans, VA loans, and USDA loans. Even Fannie Mae and Freddie Mac, which are government-supported entities, help support homeownership.
Because personal homeownership is believed to enhance individual lives and therefore create a stronger economy and society, many programs have been created to encourage and support the purchase of a home. The same can’t be said for investment loans.
There are ways to use government programs to purchase an investment property, but they are rare, and they don’t come with the same advantages.
When purchasing an investment property, you can reasonably expect the downpayment requirements to be higher. Mortgage lenders simply can’t provide the same leeway on investment loans as they do on personal residences, so they may require that you have a downpayment of 20% or more, which is rare for personal homes.
Because of less risk to lenders and the support of government programs, you rarely need a large downpayment for a personal home. Usually 5% is enough to qualify for a moderate loan, and FHA loans are available with as little as 3.5% down. If you qualify for a VA or USDA loan, you can actually make the purchase with 0% down. Honestly, 0% down is virtually unheard-of when discussing investment properties.
The income requirements are pretty much the same for both loans, but the process at which you can use specific incomes may vary. In general, you can expect that your regular salary (paychecks, bonuses, etc.) can be used for either loan. However, with a personal residence, you may be able to use retirement income and other sources of cash for qualification. This may be possible with an investment loan, but it could be more complicated.
With an investment loan, on the other hand, you may be able to use future rent checks as part of your qualification. After a market assessment has been completed, suppose you can reasonably assume that you’ll bring in $1,000 a month in rent checks. In this case, you can use that $1,000 as qualifying income. This is only an option with certain loan products (and through certain lending agents), but it could make investment loans more accessible.
When a loan has higher risk, there is usually a higher interest rate, which essentially acts as a financial incentive to lenders. (If there were no interest, there would be no incentive to make loans.) As we have mentioned, investment loans create a higher risk than loans for personal houses, so you can reasonably expect a higher interest rate on this form of financing.
The differences will vary, but you can expect loans for investment property to have interest rates about .5 to 1.0% higher than a typical home loan.
Your credit score is a reflection of your past relationship with debt. People with good scores have a history of making timely payments and maintaining a responsible debt load, and they are more likely (statistically speaking) to continue making payments on time.
When it comes to loans for investment properties, lenders are especially careful to ensure the borrower is trustworthy and reliable, so they place an even greater emphasis on the credit rating. To be certain, you can get an investment loan with a low credit score, but they could have even larger downpayment requirements or the interest rate could be even larger.
Higher Asset Reserve Requirements
Lenders like to loan money to borrowers who have a nice pile of reserve cash. If something were to happen with the borrower’s income, cash reserves can be used to make the payments until the issue is settled.
Reserve assets are rarely required for a loan on your personal residence, but they may be required for an investment loan. Depending on the size of the loan, as well as other factors, you may need six months to a year’s worth of payments in reserve. So if the monthly payment is $2,000, a loan requiring a year of reserves would need $24,000 in available assets. ($2,000 times 12 months = $24,000.) These assets are often just cash in the bank, but they can also be investment funds or even valuable physical assets.
Loan Approval Often More Time Consuming
If you are securing a loan for an investment, you should assume that the process may take a little longer than usual. Because investment loans are more complex and come with higher risk, you may have more steps to complete before finalizing the loan.
For example, if you are using future rent to qualify, you will need to conduct a market survey. This survey, which is completed by a professional, can take weeks or months to complete, creating significant delays in the process.
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“We’re loving our new place and we’re very pleased with how smoothly everything went through closing. Thanks for keeping us up to date on the possibility of refinancing at a lower rate; we trust your judgement as far as waiting until the rate is around 5% lower before we refinance. We’re very interested in pursuing that if rates drop to that level. Thanks so much for all your help and personal attention!”
“This is the second time that I have worked with Chad (home purchase & refinance). He has become my subject matter expert and someone I depend on for all finance needs related to our home and real estate investments. My favorite things about Chad are his depth of knowledge, responsiveness, honesty and the great service he provides. I have referred countless friends and family of mine to work with him for no other reason than I know that he will treat them well and equip them for the best possible outcome. Chad will add tremendous value to any real estate transaction that you have and I am grateful to have him as a resource.”