Where do you start when you want to finance an investment property? If you are looking for one or more investment properties to purchase and haven’t yet seen a mortgage professional, here are a few things you should be prepared for.
You should expect a minimum down payment of 20 percent. Debt-to-income ratios and asset requirements will be more stringent than if you are financing the purchase of a home that will be your main residence. Because neither FHA or VA mortgages offer any type of investment property financing, a conventional mortgage – those using Fannie Mae and Freddie Mac guidelines – will apply here.
Fannie Mae will allow investors to use rental income from the investment property on their mortgage application, but Freddie Mac won’t. In Fannie’s case, the amount of rental income that can be used will be based on what the appraiser determines is a fair market rent.
There will also be an occupancy rate of 75 percent factored in, meaning that lenders expect the property to be vacant some of the time. So if the market rent is $1,000, you as the borrower will be able to use $750 of it on the mortgage application.
The most important income factor to lenders (and something they look closely at) is ensuring that the borrower isn’t overextended. An inexperienced landlord may have challenges locating and/or retaining quality tenants. This is to be expected, and lenders understand this, but at the same they need to make sure that enough money is coming in each month to be able to cover this learning phase.
Asset requirements will be six months of monthly payments for each investment property the borrower owns, meaning principal and interest, taxes, and property insurance. This is due to the nature of investment properties and the fact that income is dependent on the rental market; the lender needs to ensure there are reserves.
This is another area where lenders hold investors to higher standards than their counterparts who are purchasing primary residences. They want high credit scores (720 and above) and no recent, if any, major credit blemishes. These refer to bankruptcies, foreclosures, or short sales; specifically, the lender doesn’t want to see any credit blemishes against other investment properties. Recent late payments may also deter lenders from loaning money, the feeling being that if a buyer is unable to keep up with current obligations, he or she probably shouldn’t assume any more. Being overextended is another deterrent to lenders. Even if bills are being paid on time each month, lenders won’t want to see lots of debt or several maxed-out credit cards. Lenders also will want to know that buyers have the resources available should water heaters or furnaces experience unexpected problems requiring significant cash outlays. Yes, there are asset reserves that are collected at closing, but buyers may run through those assets relatively quickly.
Before you receive a mortgage, you will need to prove you can address all potential issues that may arise in having a well-functioning, income-producing property. Any questions? I’m sure you might have a few contact me and I’ll be happy to help you with your efforts to finance an investment property.