Permanent Financing for Long-Term Rentals and Vacation Rentals
A rental property loan is a first lien mortgage loan secured by a single-family residential property (1 to 4 units), or SFR, that is occupied by a tenant rather than used as a primary residence. 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. Rental property loans sometimes also are referred to as investment property loans, non-QM loans, or investor DSCR loans. For the purposes of this post, we are going to focus on buy and hold single-family properties, though it is important to note that an investment property loan can also refer to loans for a fix and flip or commercial property. Let's take a closer look at:
Investment Property Loans vs. Conventional Home Loans
How to Finance an Investment Property
Let's start with the basic similarities. For both investment property loans and conventional loans, you will fill out an application. The application likely will ask some different questions from the application you filled out when buying your home. The lender likely will be less interested in your personal income, assets and employment history, but may want to know more about your investment experience and strategy. Your lender will pull your credit score. The lender will order an appraisal and open title. So what are some of the important differences?
Down payments typically are quite a bit larger on an investment property loan. You should plan on 25% (but this will vary and depend on your credit score), compared to the 3% often necessary for some government sponsored consumer mortgages.
Interest rates and fees typically are higher on an investment property loans. You should expect them to be 100 to 400 basis points higher than on a traditional mortgage. A basis point is a hundredth of a percent. So, if a conventional mortgage is 6.5%, an investment property loan on the same property to the same borrower would be 7.5% or more. See our Guide to Investment Property Mortgage Rates for more details.
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 investment property, some lenders may require you to prove reserves on all of your financed investment properties. A conventional mortgage, on the other hand, require anywhere from 0-6 months of reserves.
For conventional loans, 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 investment property loans, you’ll be asked for all of this information and then some, particularly if you already own other investment properties. For other types of investment property loans, instead of focusing on your personal employment and income, the lender will focus on the investment property cash flow. This simplifies documentation greatly.
When qualifying for an investment property loan, the lender will make sure both the property and the borrower meet loan qualifications.
Plan on a 25% 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%.
Financial stability is key to success. In addition to a more substantial down payment, plan on having 6-12 months of liquid cash reserves. This will help you in the event of hard times and make sure that you won’t immediately lose the property due to missed payments and foreclosure. You'll also need to have cash for closing costs and underwriting fees. Further, the larger your down payment, the lower your interest rate and the better your DSCR. Therefore, it is best to have the highest possible down payment.
Lenders tend to vary pricing, terms, and conditions more on investment 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. Most lenders will do a hard credit pull to get the full scope of your credit score, so it is wise to be prepared.
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. If you are applying for a non-qm or alternative loan, you will need to make sure the rental income covers the cost of the monthly payment.
Construction is financed separately from rental loans (usually in the form of fix and flip loans or hard money loans), so most mortgage lenders will check to make sure the property does not need any significant repairs.
In addition to having a minimum down payment, most lenders also have a minimum loan amount and specific requirements based on their loan programs. A conventional mortgage always has the most stringent requirements, while investment property loans are more flexible. Do your due diligence on the mortgaged lenders you are looking to borrow from.
The investment property loan process is very similar to any other mortgage loan process. Here's how it works.
The loan programs available for an investment property are more involved than the loan programs available for an owner occupier. The first step in searching for a lender includes determining which loan programs work best for you. If this is your first rental property, then you should consider a government sponsored loan. If you own multiple mortgage rentals, you'll want to consider an alternative or Non-QM loan program. Many banks and lenders offer investment property loans. Ask your real estate agent or other investors for a recommendation.
Be sure to dot all your I's and cross your T's to make sure you like the lender before filling out an application for an investment property loan. You don't want to get an unnecessary hard credit pull.
Like any other mortgage loan, once you apply for an investment property loan, your loan file will move into processing. Here, the loan processor will collect any remaining documentation.
Once your investment property loan has been processed, you will move into the closing stage and your loan will be funded.
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.
The difficulty of obtaining an investment property loan depends on the type of loan. Agency loans are going to have more involved 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.
An 80% LTV is considered the best-case scenario for an investment property loan, but the more you can put down the better to lower your interest rates and monthly payments.
Most investment property loans have a credit score requirement of 700 or greater. You will find alternative lenders that will consider financing investors with FICO scores of 620 or greater.
Interest rates and fees for investment property loans are higher than for owner-occupier mortgages. The difference depends on a variety of factors but generally ranges from 100 bps to 400 bps. See our Guide to Investment Property Mortgage Rates for more details.
Typically to qualify for an investment property 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.
Investment Property Loan Nuances
Investors typically turn to alternative lenders like Visio Lending for a few reasons. The first situation is if they are self-employed, including owning their own business. Another reason would be that they already own too many properties to qualify for another conventional loan. Finally, and importantly, they may turn to an alternative lender because they want to own their investment properties in a legal entity to protect their other assets. That is not allowed with conventional loans. Here are some of the key nuances of financing an investment property.
Traditionally, for rental properties, appraisers fill out a 1007 report on comparable rents for long-term leases; think a year or more. Appraisers primarily appraise homes for owner-occupiers. As an alternative lender, Visio considers any actual rent performance available on the property and then augments that information with comparable data from a variety of data sources. Unlike a licensed appraiser, Visio is not limited in the information it can use to establish an appropriate rent estimate.
Insurance on a rental property is quite different from your personal home. Even many insurance agents who don’t regularly deal with rental properties don’t understand the nuances. Visio has a dedicated team that can help you properly insure your rental property investment and protect you against some of the not-so-obvious risks you may encounter as a real estate investor.
Many owners of rental properties also engage in fixing and flipping properties. If that’s you, you might think twice about financing both your rentals and your flips with the same lender. Flips are subject to much greater market risk than rentals. Even the best flippers have deals that go sideways or the wrong way. Many lenders include cross-default provisions in their loan documents that provide that if you default on one loan it also counts as a default on all of your other loans. You don’t want to have a bad flip deal trigger a default on your rental properties.
Visio Lending 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 rental income 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 conventional 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 investment 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
Laser-focus: Visio Lending's laser-like focus and investment property loan expertise simply cannot be matched.
Eliminating Cross-Default Provisions: Choosing a specialized rental lender instead of financing all of your investment properties, such as fix and flip projects, through one lender could avoid cross-default provisions. Essentially, through a cross-default provision, if a borrower fails to pay interest or principal on time for one loan, the lender has the right to default the borrower on all of their loans. Fix and flip projects are risky investments, even for the best investors, so it is a good practice to keep your rentals elsewhere.
Common-sense underwriting of your short-term rents: Visio Lending has mastered financing for vacation rentals.
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 $2.1 billion in Rental360 loans.