Owning investment property has significant financial benefits; these include an additional source of monthly income, equity growth, and owning a tangible asset. There are two different types of investment properties, a property that you could flip and make an instant profit, or a home you could rent out to create additional monthly income. The benefit of keeping an investment property as a rental, is that someone else (the tenant) will be paying the mortgage. If you intend to keep the property for rental income, the key is to find a property that will generate a positive monthly cash flow. Mortgage guidelines have started to loosen, creating opportunities for individuals to purchase investment properties. Fannie Mae and Freddie Mac are the two main pseudo-government agencies where mortgage lenders sell their loans. Below are some of the standard guidelines used by lenders to underwrite both Fannie Mae and Freddie Mac mortgages for investment properties.
• Loan Terms – Only 15 and 30 year fixed rates or 7 or 10 year ARM products are available for investment properties.
• Down Payment – The down payment requirement can range anywhere from 15% to 25%, which is determined by the borrower’s middle credit score, number of properties owned, and type of property being purchased.
• Credit Score(s) – Investment loans typically require a middle credit score of at least 700. When an individual has a middle credit score greater than 740, they will likely be offered better rates and terms.
• Number of Properties – Lenders will typically offer financing to individuals who currently have 4 mortgages or less. Financing is available for individuals who currently hold 5 to 10 mortgages, but they will have to meet additional restrictions and requirements.
• Rent Loss Insurance – Lenders will typically require proof of six months of rent loss insurance for each investment property they finance.
• Reserves – Lenders will require a minimum of six months mortgage payment reserves for each investment property they finance. If an individual currently has less than four mortgages, they will typically only have to show an additional two months reserves for each of the other rental properties that they have mortgaged. If they have more than four mortgages, they will likely be required to prove they have a minimum of six months reserves for each of their other rental properties.
When lenders qualify individuals for an investment loan, they have strict guidelines they must follow if they use rental income. Lenders also have strict debt to income ratios for mortgages on investment properties, the maximum total debt ratio typically can be no greater than 45% of their income. Investment property mortgages do not allow gift funds and only allow a maximum seller concession of 2% towards buyers closing costs. The appraisals required for investment properties are more in-depth and typically require a rent comparison schedule. Lenders will use the average of an individual’s rental income or loss on their last two years tax returns for mortgage qualification purposes. If an individual does not have two years’ experience with owning rental property, they will most likely have to qualify for the mortgage without using the projected rental income as noted in the appraiser’s rent comparison schedule. Even with the stricter lending standards on investment loans, now may be the perfect time to invest in rental properties. In most areas of the country, housing prices have appreciated nominally over the past 5 years. Interest rates are near their lowest level in years and the benefit of diversifying your assets through a tangible asset such as housing may be the perfect long-term investment solution.