Financing a second rental property can be much easier the second time around. For those thinking about dipping into the investment real estate world, there are some important things to know. At its most basic level, financing a rental property is not much different as it relates to income, assets and credit. First time buyers of rental property can expect to make a larger down payment compared to an owner occupied home and interest rates might be slightly higher for a rental.
How to Finance a Rental Property
When lenders evaluate someone’s first purchase of a rental property, it is assumed to be a higher risk. 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 people 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. While many tenants will take care of the property, there are instances where the tenants defer maintenance.
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 cover the costs of ownership. Otherwise, real estate investors might pass on a unit that doesn’t generate cash flow. Ultimately it means qualifying with two house payments. Even though the income is there, lenders won’t consider it to qualify. But things change with the next rental property.
How Rental Income Can Help You Qualify
With the second rental, the income generated from the first home can be used to help qualify. There is a two year waiting period. 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 from the rental income.
After two years have passed, the income can be used to qualify. 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.
Why Financing Additional Rental Properties Get Easier
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. Often, investors who own multiple units decide the ‘working world’ isn’t worth it any longer. They decide to own, manage and maintain their units and live off the rental income.
If you’re thinking of buying a first or second rental property, let’s talk. I can give you an idea on what to expect in mortgage payments 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.