Why the Second Rental is So Much Easier to Finance

For those thinking about dipping into the investment real estate world, there are some important things they need to know. At its most basic level financing a rental property is not much different as it relates to income, assets, credit and the like. First time buyers of rental property can expect to make a larger down payment compared to an owner occupied home as well as finding out interest rates will be slightly higher for a rental. Not a lot higher but higher nonetheless

When lenders evaluate someone’s first purchase of a rental property, it is assumed the risk of making that loan will be a bit higher. Why? Because when someone finds themselves headed into some degree of financial stress, the last thing they want to give up is their home. Other assets can be sold but they’ll still need a place to live. Someone living in an owner-occupied home will take care of the property themselves. A rental property will be primarily maintained by the tenants. And while most do take care of someone else’s property while living in the home there are still instances where the tenants let deferred maintenance continue.

With an initial rental, buyers must be able to comfortably afford the new purchase along with their current mortgage. Lenders use the mortgage payment on the new property which includes principal and interest, taxes and insurance in addition to what they’re currently paying on their current home. That might sound a bit unfair at first because a rental property typically generates enough income each month to more than cover the costs of ownership. Otherwise, real estate investors might pass on a unit that doesn’t cash flow. Otherwise, the new property turns into a monthly expense instead of monthly income. Ultimately it means qualifying with two house payments even though the income is there, it’s just that lenders won’t consider it. But things change with the next rental property.

With the second rental, the income generated from the home can in fact be used to help qualify. That is after two years have passed. Why the time test? Lenders want to see the owners can properly manage the property, keep it rented and maintained. Being a landlord means extra work. After the first year or so of ownership, some first time investors find out that managing the property is simply too much work. Some might hire a property manager which is certainly a good option, but property managers don’t work for free and will take a cut each month off the rent.

If after two years have passed, the income can be used. Now there is effectively just one mortgage payment, the primary residence. The second rental unit mortgage payment is not only offset by the rent coming in each month but providing the owner with some additional income at the same time.

When investors discover this underwriting guideline for a second rental, they may decide to acquire a third or fourth. Qualifying for the second unit and beyond is much easier due to the fact that lenders use the additional income. In fact, it’s not uncommon for investors to own multiple rental units because it’s so much easier to qualify for the subsequent purchase. When an investor does own several rental units, a property manager is essentially a must. It can also be the case where investors who own multiple units decide the ‘working world’ isn’t worth it any longer and instead own, manage and maintain their units and live off the rent.

If you’re thinking of buying a first rental or you currently own one unit but thinking of another, let’s talk about what your plans. I can give you an idea on what you can expect to pay in mortgage payments each month and provide estimates for property taxes and insurance. We can then take those estimated payments and compare them to what the rental unit is generating each month. If there’s a positive cash flow, then it’s time to submit an application and get the preapproval process moving forward.