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5 Things You Might Not Know About Financing Rental Property
It beggars belief that many people, both homeowners and investors, still think that successfully obtaining a mortgage from a lender to purchase real estate is a given.
As if it is a privilege!
This unhealthy mindset probably come about because the majority of the general public have satisfactory credit and are not making risky purchases when buying a house.
So by hearing about how easy friends are getting banks to approve their loans makes others think that it is the last thing they need to ponder over.
But do you know that lenders treat real estate purchases for owner-occupied and investment differently?
Categorizing them differently results in the use of different credit analysis guidelines when assessing whether to approve a loan. And if so, by how high a quantum and loan-to-value.
You have guessed right if you think that investment property suffers from tighter credit criteria.
The logic behind this is that lenders always err on the side of caution. And that owner-occupied properties are less risky than rental property.
Because of that added risk, mortgage applications for investment property come under more scrutiny compared to owner-occupied homes.
Here are some things that you might come across when trying to get a mortgage approved for the purchase of rental property for investment compare to one for your own residency.
1) Higher down payment
Newer investors might be puzzled as to why they could easily find lenders willing financing up to 90% of their current house, yet would only go as high as 60% now that they are buying another house for investment.
The answer again comes down to risks.
Investment properties are risky. Especially for newbies.
There is always a high chance that a new investor would suffer huge losses and compromise their financial ability to repay a loan.
They might even quickly find that being a landlord is just not their thing and neglect the rental property. Causing defaults on the mortgage.
So in order to ensure that an investor has enough skin in the game, lenders might require that a higher down payment be made in order to ease their minds.
This can be the case even when your debt ratios easily meet a comfort level to finance your second property at 90%.
2) Tighter credit criteria
We usually think about individuals with good credit scores being able to easily obtain loans and credit.
That is true to a certain extent. Especially when we are referring to homeowners buying houses for their own residence.
Buying rental property for investment can invoke much stricter credit policies that even people with good credit scores find difficult to pass with flying colors.
Lenders might look for above average factors like:
- High personal and household income
- High FICO scores
- Low debt to income ratio
And after all that, if you manage to survive that level of credit scrutiny, they might still subject you to higher interest rates to offset the risks they are taking on you.
3) Home equity loans
This might seem ridiculously unfair to you. But it happens from time to time.
Home equity loans have been gaining a lot of mass media attention over the years as a smart and savvy way to manage your finances.
But just like a traditional mortgage, equity loans are not privileges.
No bank is obligated to offer you an option to cash out your home equity via a term loan. It is never an entitlement.
Rental real estate is notorious for being tough to cash out with refinancing. This is especially so after 2008.
This is to prevent investors from taking excessive leverage to buy more and more real estate.
Everything thing could come tumbling down like a house of cards when just one property goes belly-up.
You might be able to refinance your mortgage. Why not when they are better rates available on the market?
But churning out cash from home equity might be a challenge.
4) Restricted line of credit
Just like home equity loans, a home equity line of credit (HELOC) can be difficult to obtain.
In theory, a HELOC would be easier to obtain compared to a typical home equity loan as it presents a lesser risk to the bank.
But it is not uncommon to see HELOCs against rental property to have a credit limit much less than what an owner-occupied property would usually get.
5) Best funding options might not come from a bank
In this day and age, it is becoming so simple to find lists of mortgage rates and sieve out the best online.
Yet for investment property, you might find that the best rates are only meant for owner-occupied property.
Mortgage rates for rental property might fall under a different category that comes with much higher interest rates.
Therefore, you might find that the best deals for financing would come from unconventional funding.
- Seller financing
- Private lenders
When you are walking down the road of creative financing, it is important to be extra careful and meticulous in what you are getting yourself into.
And if you feel that you are not ready, the best option is always to walk away.
This is when paying extra interest charges to a property reputable bank might actually be worth it.