Learning how to finance a rental property is similar to financing a primary residence or vacation home. Most lenders follow the same general set of guidelines and funding often comes from the same sources. In general, mortgage financing for rental properties is often approved using standards set by Fannie Mae or Freddie Mac, although there are also other lenders who offer their own programs that fall outside of Fannie or Freddie’s realm.
If you’re thinking of buying and financing a rental property, this article can help.
How to Finance a Rental Property: An Overview
Perhaps the most important element is how lenders treat the rental income from the prospective rental property. It’s not uncommon to find an individual who owns not just one or two rental properties but multiple rental units. The reason for this is related to how mortgage lenders view income generated from the rental.
For someone who is buying their first rental property, the income from the rental typically can’t be used to offset the mortgage payment. That said, once you own more than one rental property, this changes. Rental income can be used to offset your mortgage, along with taxes and insurance. And mortgage lenders take this into account when deciding to approve your loan.
New buyers must be able to qualify for a mortgage without the benefit of any potential rental income. However, once that first property has been purchased and financed, subsequent rental purchases can use the rental income to help qualify. In this instance, real estate investors can buy multiple properties that generate cash flow each and every month to help build wealth.
If you’d like to discuss your specific financial goals, feel free to schedule a call or reach me directly at (408) 610-8011.
How to use potential rental income to qualify
In general, real estate investors must show ownership of a rental property for at least two years before rental income can be used to help qualify for other loans. Lenders want to verify your ability to maintain the monthly payments as well as keep the property rented and maintained.
Lenders can also have their own guidelines as it relates to vacancy rules. Rental units are rarely occupied 100% of the time. When someone moves out of a rental property, typically the unit needs to be cleaned, repaired, perhaps painted and other maintenance. Lenders often consider a 25% vacancy factor, meaning if the rent is $3,000 per month, qualifying rental income will be 75% of that amount, or $2,250. In addition, when an appraisal is required, the appraiser completes a market rent analysis and presents a viable rent that would be comparable for the area.
If you’re a new buyer, just start watching the calendar. Once you’ve been the owner of a rental property for at least two years, you can refinance and use rental income to help qualify for a new mortgage that fits your emerging financial goals.
What to expect with closing costs and fees
Closing costs for rental properties are typically slightly higher for new buyers (e.g., the down payment, origination fees, appraisal fees, title insurance). Conventional loans for a primary residence often seek a 3.0-5.0% down payment. Quick note: when a down payment falls below 20%, private mortgage insurance, or PMI, will be required.
Government-backed loans such as FHA, VA, and USDA loans can be used to finance a primary unit but can’t be used to finance a non-owner-occupied property. Down payments for rental properties are typically 20-25% of the sales price. Because PMI is not available for rentals, a low down payment conventional mortgage is only available for a primary residence or a vacation home.
Typical mortgage rates to finance a rental property
Finally, let’s talk about interest rates. Mortgage rates are typically higher than those reserved for primary residences. Buyers can expect to pay an interest rate anywhere from 0.50% to 1.00% higher compared to a primary residence. One option to consider is buying a duplex or four-unit property and making one of the units your primary residence. This will give you better options and a lower interest rate when it comes to mortgage financing.
If you’re thinking of buying real estate as an investment, financing a rental property is a great option to build wealth.
We work with homeowners throughout California, Oregon, Washington and Colorado. Our goal is to help you reach financial freedom and save money on your mortgage. Financing a rental property can often be a great next stop for many homebuyers. Feel free to reach me directly at (408) 610-8011.