How to Finance a Rental Property
Choosing a Loan Type
So, you are looking to buy an investment property and you want to compare investment property mortgage rates. What are your options? You basically have three different types of rental property loans, including:
• Agency or qualified mortgage (we’ll refer to these as “Agency Loans”);
• Bank portfolio loans (we’ll refer to these as “Bank Loans”); or
• Non-bank, non-qualifying mortgage (we’ll refer to these as “Non-QM Loans”).
An Agency Loan is eligible to be purchased or guaranteed by Fannie Mae or Freddie Mac, often referred to as GSEs or government-sponsored enterprises. When you think of this type of investment property mortgage, you should think about the process you underwent in obtaining the mortgage on your primary residence. You will qualify based on your ability to repay the loan from all of your sources of income along with the strength of your credit. As part of the underwriting process, you’ll need to provide pay stubs, tax returns (with all of the appropriate schedules related to any investment property you own), bank statements, retirement states, and brokerage statements.
A Bank Loan is not eligible for sale to or guarantee by a GSE, so the bank has to hold the loan on their balance sheet in their own loan portfolio. Most local banks focus on financing commercial real estate and small businesses. Some allocate a portion of their assets for residential mortgage lending, including on rental properties. Often these loans are reserved for existing customers.
Bank regulators frown on banks originating and holding long-term mortgages because it is hard for banks to match those mortgages with long-term financing on their balance sheet. So Bank Loans often amortize over twenty or thirty years, but often include a balloon payment after five or seven years.
The qualification requirements for a Bank Loan typically are more flexible than on an Agency Loan. The bank will require you to provide documentation sufficient for them to document your ability to repay the loan. This will include your tax returns, pay stubs (if any), and personal financial statements.
A Non-QM loan, also referred to as a DSCR Loan or investment property loan, will have a full 30 year term and the lender will underwrite the loan based on your credit report and the monthly gross income generated by the investment property rather than your personal income. Non-QM Loans are not eligible for purchase or guarantee by a GSE, and most banks will not originate or purchase Non-QM investment property loans because they do not include underwriting the borrower’s ability to repay the loan based on their personal income.
If you’re interested in beginning the rental property loan process, contact us today to get started.
Other Investment Property Financing Options
While the three methods above are the most popular ways to obtain an investment property mortgage, real estate investors have some other options including:
• Hard money loans: A hard money loan is a short term option for investment properties. This loan type is typically used for construction projects, but can be used for rental properties as well.
• Home equity options: If you have a primary residence, you can use a home equity loan or a home equity line of credit to borrow against the equity and purchase an investment property. Keep in mind, your primary residence will be used as collateral when obtaining a home equity loan. It is essential that you keep up with each monthly mortgage payments in order to keep your home.
• Cash-out refinance: Cash-out refinancing is a great real estate investing tool and doesn't necessarily involve your primary residence. It enables investors to pull cash out of an existing property, including an investment property, to finance their next investment. Keep in mind, there will still be a down payment and closing costs associated with the loan.
Comparing Investment or Rental Property Mortgage Rates
There are a variety of online sources of mortgage rates for Agency Rates. The table above provides an indication of current rates for primary residences. To compare investment property mortgage rates to get an idea of current rates for each of the rental loan options, take the quoted rate below and then make the following adjustments:
• Agency Loan for a rental property: +100 bps (so if the quoted rate is 3%, then add 1%, so you could expect something around 4%);
• Bank Loan: +200-400 bps (so 5%-7%); and
• Non-QM Loan: +200-400 bps.
Lenders typically also have origination and other fees. Origination fees often are calculated as a percentage of the loan amount and often are presented as “points.” One point is equal to 1% of the loan amount.
Other fees, such as an underwriting fee, may be presented as flat amounts that do not vary with loan amount. Typically, you will be able to trade a higher interest rate for lower fees, particularly origination fees. Conversely, you often can reduce your interest rate if you’re willing to pay higher upfront fees.