Why (and How) are Investment Loans Different Than “Typical” Mortgages?

Most people are familiar with mortgage loans on a primary home. If you have purchased a home in the past, chances are high that you made the purchase with a mortgage. Therefore, you understand the process for qualification, including downpayments and required documents.

But what about loans on investment properties? How are they different from a “typical” mortgage, and what’s the reason for these differences?

The properties themselves are unique, which means the qualification process, as well as the terms and conditions, are also unique.

What is Unique Investment Loans?

To understand how an investment property loan is unique compared to a typical home mortgage, we need to first examine the differences between an investment property and someone’s primary residence. These differences have a profound impact on how the property is owned, managed, cared for, and lived in. And because of these differences, the loans on the properties are different as well.

Investment Properties vs Primary Homes

A “primary home,” legally speaking, is where you spend at least 51% of your time. To qualify as your primary residence, you need to live in that property over half the year.

But the differences go much further than legal distinctions. It’s also emotional, which has a tangible impact on the loans.

Your primary home is the roof over your head. It’s where your children play. It’s where you have a customized sports bar, a billiards room, or a craft shop. It’s where your friends gather for meals, where family comes together during the holidays.

There is an emotional attachment to our primary residence. It’s also an essential part of our life. The primary residence is our shelter; it’s where we eat, sleep, work, and refresh out minds and bodies. Country home or downtown condo; out home is often part of our identity. 

An investment property, on the other hand, is a calculated purchase. The top investors make purchases based on ROI, cash flow, and break-even points. These are assets made for future financial gains, designed to bring long- or short-term profits and financial stability.

An Example of the Differences in Action

The difference between the two, from a lender’s perspective, is best understood if we do a little thought experiment. Imagine an investor named Ingrid. Ingrid has a stable career as an engineer which consumes most of her time. She owns here home, where she lives with her husband and two children. Ingrid and her husband also own an investment property which, when occupied, brings a small profit.

Ingrid’s career has been going well but her firm experiences rapid decline. In a cost-cutting effort, Ingrid is laid off. At the same time, the her tenants in the investment property leave and she is having trouble filling the space. In a matter of months, she is cut off from both her work income and the rental income.

Now, with only her husband’s sole income, Ingrid can only afford payments on her primary residence or the investment property. What will she do?

Under extreme circumstances, most owners will protect their home while allowing an investment to go into default.

While the decision is rarely this simple, Ingrid basically has a choice between making payments and protecting the roof over her family’s head or protecting an asset that generates income and gains value. If she had to lose one or the other, most would, quite reasonably, lose the investment and protect their family’s home.

A primary residence, because of its importance to the owner, has far less risk to lenders. An investment property, however, can be replaced with far less upheaval. 

This is, fundamentally, the biggest difference. People don’t want to lose their investment properties, but when hard times strike, they will gladly give up their investment and protect their main home.

Wouldn’t you?

This difference in reflected in the loans on these properties. Because investment loans are more likely to experience delinquency, default, and even foreclosure, the loans themselves have a different structure.

Qualification Standards for Investment Loans

While it may not have an impact on the longterm financial results of the mortgage, there are difference in qualification. In reality, this is merely a difference in process, and may not impact the loan itself unless the process hinders approval.

For these loans, you may need to bring more documentation and information. You may need to bring reliable information on the property’s income potential. For example, a professional assessment on potential rent could be required. Essentially, when qualifying for an investment loan, you should be prepared for a longer, more detailed process.

The Big Difference: Interest Rates

The biggest difference most buyers will see is the interest rates. Interest on an investment loan is often higher than the interest on a typical mortgage, which is, again, a reflection of the added risk.

Interest is a complex issue, one that is impacted by a wide variety of factors. The interest on your mortgage can rise or fall depending on your credit history and debt load. In general, you should expect the interest on your investment property to be about 1% higher than what you might get on a regular mortgage. However, it could be 2% or even 4% higher, depending on the situation.

Downpayment Requirements for Primary Homes and Investment Properties

Lenders generally use two important tools to reduce risk. The first, which we have already discussed, is interest. The second is a downpayment. To reduce risk, lenders will require larger downpayments.

For primary homes, depending on what mortgage product you use, you can find loans with downpayments as low as 3.5%. Many will require something between 5% or 10%, while others, such as VA and USDA loans, can be utilized with zero down.

With investment loans, however, you’ll need a larger downpayment. Usually 10% is the minimum, while others will require as much as 25% down. Downpayments larger than this, while not common, are certainly possible.

Essentially, the initial cost of ownership for an investment property can be much larger.

However, not all programs require 25%. For more on this issue, see our article “Mortgage Mythology: The 25% Investment-Property Downpayment.”

Find the Best Possible Investment Loan for Your Next Property

Are you ready to start a collection of investment real estate? Contact our team today to learn more about the best investment loans for your next purchase. Whether you need a low downpayment or want the best possible interest rate, we are here with the service and support you deserve!