Posted by Jeff Ball ● Apr 2, 2021 12:24:29 PM
Rental property loans: How they work and where to find them
The U.S. single-family residential (SFR) rental property market is $4.5 trillion and growing. Owned primarily by small, local real estate investors, SFR rentals offer a number of attractive benefits including potentially stable monthly income and appreciation, inflationary hedge, and tax advantages.
Demand for SFR rentals is strong and growing, as more than 70 million millennials get married and start families; and nearly 70 million baby boomers retire and downsize their spending.
If you have ever financed your own residence, then the process of financing an SFR rental will feel familiar. However, there are some important differences to understand.
What is a rental property loan?
A rental property loan is a first lien mortgage loan secured by an SFR that is occupied by a tenant rather than an owner-occupier. To qualify, the property must be rent-ready. Typically the tenant is long-term, but rental property loans also can be used for short-term rentals, such as vacation rentals.
What qualifies as an investment property?
The types of investment property that qualify for rental property loans include 1-4 units SFR, condos, and townhomes.
Difference between rental property loans and conventional home loans
Let's start with what is similar. You will fill out an application. The application may be more comprehensive than the application you filled out when buying your home. Your lender will pull your credit. The lender will order an appraisal and open title. So what are some of the important differences?
Lower Maximum LTVs
Down payments typically are quite a bit larger on rental property loans. You should plan on 20%.
Higher Interest Rates
Interest rates and fees typically are higher on rental property loans. You should expect them to be 100 to 400 basis points higher than on an owner-occupied property. A basis point is a hundredth of a percent. So, if a home loan is 4.5%, a rental property loan on the same property to the same borrower would be 5.5% or more.
Higher Reserve Requirements
You should expect to have to prove that you have liquid cash reserves equal to your down payment and closing costs plus 6-12 months of your monthly principal, interest, taxes, insurance, and any association dues. If you own more than one rental property, some lenders may require you to prove reserves on all of your financed rental properties.
For your home loan, the lender likely was interested in your employment history and personal income. You likely were asked to provide pay stubs and your personal tax returns. Just prior to the close, the lender likely asked you to represent that you were still employed in the same job that you had when you began the loan process. For some types of rental property loans, you’ll be asked for all of this information and then some, particularly if you already own other rental properties. For other types of rental loans, instead of focusing on your personal employment and income, the lender will focus on the rental property cash flow. This simplifies documentation greatly.
Financing options available for rental properties
For serious investors looking to grow a portfolio of rental properties, there are essentially three rental property loan options: agency loans (Fannie/Freddie), local banks, or an alternative lender such as Visio Lending. Let’s look at all three options:
Alternative Lender (Visio)
Alternative lenders, sometimes referred to as Non-QM lenders, offer rental loan programs specifically designed to help SFR investors grow their rental portfolios. Since alternative lenders are not confined to the rules set by bank regulators or GSEs (government-sponsored entities), they offer a lot more flexibility and appealing terms, such as 30-year terms. Additionally, most alternative lenders underwrite their loans based on the cash flow of a property rather than personal income. That means they have low document requirements and do not review your employment history or tax returns. There are some drawbacks to alternative lending, yet most seasoned investors are comfortable with them:
- Higher interest rates and fees: seasoned investors, particularly those in growth mode, are willing to pay higher interest rates and fees for more flexibility to achieve their wealth creation goals
- Prepayment penalties: prepayment penalties are not allowed for owner-occupied mortgages but are permitted for rental loans. Again, experienced investors are willing to accept one to five-year prepayment penalties if it means they can qualify for a loan that enables them to achieve their investing goals. Visio offers a variety of prepayment penalty options so investors can tailor their loan to their particular circumstances
Agency Loans (Fannie and Freddie)
Agency loans are the least expensive type of loan, yet the most complicated to obtain. Lenders typically underwrite agency loans based on a holistic review of an investor’s cash flow, including personal income from stable employment and net operating income from rental properties. These loans have some drawbacks for investors including:
- Substantial documentation
- Lengthy and uncertain underwriting process with substantial reserve requirements that increase with the number of loans outstanding (Basically, the more mortgaged rental properties you own, the more cash reserves you need)
- Down payment requirements that increase with the number of loans outstanding (the more mortgaged rental properties you own, the more money you must put down for each new property)
- Restrictions on cash-out refinances
- Inability to borrow in a legal entity to protect your other assets and identity
Some real estate investors have success financing their rental properties with local or regional banks. Because banks plan to retain these loans rather than sell them, they can be more flexible on underwriting in exchange for higher rates and fees. Banks, however, cannot portfolio 30-year loans, so they typically write five-year or ten-year loans on 15, 20, or 25-year amortizations. Some of the drawbacks of working with a bank are:
- Exposure limits typically mean an investor will have to line up multiple local banks to finance a good-sized portfolio
- Uncertainty in that local banks often change direction quickly in response to their most recent regulatory review. This means they might be in the business of financing rental properties one month and then not the next month
- Local banks are not set up operationally to originate mortgages in high volumes and tend to work slowly
How to qualify for an investment property loan
When qualifying for a rental property loan, the lender will make sure both the property and the borrower meet loan qualifications.
Choose the right size down payment
Plan on a 20% down payment. If you have stellar credit, you might only need 15%. If you have less than stellar credit, you may need as much as 35%.
Ensure you are financially ready
In addition to a more substantial down payment, plan on having 6-12 months of liquid cash reserves.
Improve your credit score
Lenders tend to vary pricing, terms, and conditions more on rental property loans than on owner-occupier loans. Do what you can to raise your credit score before applying. And, importantly, protect your credit score once you've applied so your loan closes smoothly.
Demonstrate qualifying income
If you're applying for an agency or bank loan, get your documents in order. You'll need pay stubs and tax returns with all of your tax return schedules. Get ready to answer questions about your tax returns for a year or two back. Also, make sure you have sufficient personal income, including any net operating income from your rental properties, to afford the monthly payment on your rental property.
Make sure the property is rent-ready
Construction is financed separately from rental loans, so most lenders will check to make sure the property does not need any significant repairs.
Rental property loan FAQs
What type of loan is best for an investment property?
This depends on the type of investment property. For SFR rental properties, it depends on your circumstances. If you have strong personal income, good credit, substantial cash reserves, only plan to own one or two rentals, an agency loan might be the right path for you. If you have good credit, an established track record and you're not looking to grow your portfolio but rather optimize your financing, a bank might be the right choice for you. If you are self-employed and/or looking to grow a portfolio of rental properties, then an alternative lender, such as Visio, might be your best choice.
Is it hard to get an investment loan?
The difficulty of obtaining an investment loan depends on the type of loan. Agency loans are going to have much more stringent requirements than an alternative lender. You should plan on 45-60 days to get a rental property loan. Typically bank loans are the most difficult to obtain followed by agency loans. You should find alternative lenders, such as Visio, the easiest to deal with on your rental loans.
Can you put less than 20% down on investment property?
An 80% LTV is considered the best-case scenario for rental property financing, but the more you can put down the better to lower your interest rates and monthly payments.
What credit score is needed to buy an investment property?
Most investors have a credit score of 700 or greater. You will find alternative lenders that will consider financing investors with FICO scores of 620 or greater.
What is the average interest rate on an investment property?
Interest rates and fees for rental property loans are higher than for owner-occupier mortgages. The difference depends on a variety of factors but typically ranges from 100 bps to 400 bps.
How is a rental property loan different from a hard money loan?
Typically to qualify for a rental loan, the property must be rent-ready without any significant deferred maintenance. Rental loans also typically have long terms of five, ten, 15, 25, or 30 years. Qualifying for a renal loan typically requires proving up either personal income or rental income to support repayment of the loan. Hard money loans typically have terms of 24 months or less and often provide some financing for property improvements. Hard money loans often require larger down payments than rental loans, but do not require personal income or rental income to support repayment. Hard money loans typically are significantly more expensive than rental loans and can be closed in 30 days or less.
Get fast and dependable rental property loans from Visio Lending
Visio is a leading provider of 30-year financing to investors in single-family (1-4 unit) residential rental properties, including vacation rentals. Visio underwrites its flagship product, the Rental360, based on property level cash flow and borrower credit, rather than the borrower’s personal income. As a result, the Rental360 is an ideal financing product for the self-employed investor or the investor that is building a portfolio of rental properties.
Key advantages of Visio’s Rental360 program over agency or bank portfolio loans include:
- No personal debt-to-income calculation: Visio uses either in place or market rents when estimating the property level cash flow
- Low documentation requirements: Visio does not require tax returns or employment verification
- Legal protections: Visio allows a customer to finance their rental properties in LLCs and corporations to shield their other personal assets from potential liability
- Scalable: With proven experience and payment performance, there is no hard limit to how many properties an investor can finance with the Rental360 program
Visio provides purchase and refinance financing up to 80% LTV. Commonly a customer obtains a cash-out refinance from Visio to purchase or improve another rental property. Since late 2015, Visio has financed more than $1 billion in Rental360 loans.