Other Details to Consider When Comparing Investment Property Mortgage Rates
Interest rates and fees are important when evaluating how to finance a rental property, but there are other important issues to consider.
5 Things to Know about Agency Loans
1. Self-employed beware. To qualify, you’ll likely need strong, consistent personal income from a third-party employer. These loans are difficult to obtain if you own your own business.
2. Liquid cash reserves. You will need substantial liquid reserves and the required reserves will go up as you grow your rental portfolio.
3. Liability risk. You will have to hold title to your rental property in your personal name. This means you could be sued personally if someone is injured while at your rental property.
4. Documents galore. Your lender is going to go through your income, asset, and tax return documents with a fine-toothed comb. Be prepared for a laborious process.
5. Credit score impact. Agency Loans are reported on your credit report. This can limit your ability to access other types of credit.
5 Things to Know about Bank Loans
1. Low priority. Most community banks focus on making commercial real estate loans and small business loans. While some will make residential investment property loans, it is not their bread and butter. So don’t expect a smooth process.
2. Balloons. Bank regulators don’t like banks to hold 30-year mortgages on their balance sheet. So you should expect a loan that may have a 20 or 30-year amortization, but a term of 10 years or less. This means you eventually will have to refinance the property if you don’t sell it first.
3. Deposits. A lot of banks won’t make you a loan unless you have a deposit relationship with them. Be prepared for a bank to want you to keep some cash with them if you want a rental loan.
4. Reliability. Going along with the first point above, a bank might be willing to make you a rental loan one month, and then not the next month. Bank regulators require banks to make a diversity of loans. If a bank gets overweight on real estate loans, they have to sell loans or cut back production. That means you likely will need multiple bank lenders if you plan to build a portfolio of rental properties.
5. Rates. You’d think bank rates might be low, or quite close to Agency Loans. Yet, they typically are not. Since local banks are not really set up to make rental property mortgages, they are not very efficient at it. In other words, there costs to originate a rental loan are high relative to a lender that specializes in rental loans.
6 Things to Know about Non-QM Loans
1. DSCR. Instead of qualifying on your personal income, you can qualify on the cash flow generated by the rental property. The cash flow usually is measured using the Debt-Service Coverage Ratio, or DSCR. The DSCR is monthly rent divided by the sum of the monthly payment of principal, interest, property taxes, insurance and association dues (if any), or PITIA for short. A DSCR greater than one means that the monthly rent is greater than the monthly payments. This is encouraging to lenders because it means the cash flow or rent of the property is sufficient to cover many of the monthly mortgage payments associated with the investment property.
2. Self-employed. A Non-QM Loan is for you if you’re self-employed. While a lender may ask what you do for a living, they will understand if you don’t have a normal pay stub.
3. Liability and anonymity. If you don’t want to obtain your investment property mortgage in your personal name, a Non-QM Loan is for you. By holding your rental properties in a corporate or limited liability company, or LLC, you can help shield your identity and other assets from liability.
4. Portfolios. Non-QM Loans are ideal for investors looking to build a portfolio of properties because they don’t rely on personal income to qualify.
5. Typically not reported. Most Non-QM Loans for rental properties are not reported to the credit bureaus. As a result, those loans will not negatively impact your ability to obtain other types of credit.
6. Prepayment penalties. Most Non-QM Loans will include a prepayment penalty, or PPP. These can take a variety of forms but usually, they are represented as a percentage of the unpaid balance at the time of payoff. For example, if you have a loan with a 5/4/3/2/1 PPP, if you pay off the loan in the first year, you will pay a penalty equal to 5% of the unpaid balance when you pay it off. If you pay it off in the fourth year, the penalty is 2%. If you pay it off in year six, there is no penalty. Often you can buy down or buy out the PPP by either paying more upfront in origination fees or by paying a higher interest rate. Agency Loans do not have PPPs. Bank Loans often have PPPs.