What Are My Options for a Residential Rental Property Mortgage Loan?

Posted on Tuesday, July 5, 2022 in Mortgage Lending

What Are My Options for a Residential Rental Property Mortgage Loan?

First National Bank offers a variety of investment property loans for qualifying residential rental properties, including one- to four-unit residential properties and vacation properties.

Grey Duplex On the surface, a rental property mortgage is essentially the same as a primary residence mortgage. However, there are some important differences to understand because getting a residential rental property loan is more difficult than getting one for an owner-occupied home, and usually more expensive.

Just because it is more challenging to get an investment property loan doesn’t mean you shouldn’t try. Just beware of these conditions that can affect the success of your loan application.

Credit Score. A credit below 720 will not doom your application, but it will trigger higher interest rates, higher fees, and lower loan-to-value (LTV). To secure the best interest rate and term, you should have a credit score of 740 or higher, which is considered to be in the “very good” range.
Down Payment. With a conventional mortgage for a primary residence, it is possible to put down as little as 3%, depending on the loan program. If your down payment is less than 20%, however, you will be required to pay private mortgage insurance. A bigger down payment creates a lower LTV ratio, and results in a lower mortgage payment and potentially increased cash flow. You will likely be required to make a larger down payment of at least 15% to 20% to finance a rental property. Some properties, such as multi-unit investment properties, require at least 25% down.
Debt-to-Income Ratio (DTI). DTI measures the percentage of your monthly gross income that goes toward paying off debt. To qualify for a mortgage for rental property, your DTI should ideally fall between 36% and 45%. In many cases, borrowers can count 75% of their potential monthly rental income (as determined during the appraisal) as additional qualifying income to help reduce their DTI. Lenders do not consider 100% of rental income in order to account for potential vacancies. Lenders may not consider future rental income if you don't have a history as a landlord. If that is the case, your ability to get a mortgage for a rental may rely on your personal income alone.
Cash Flow Statement. When you apply for a rental property loan, the lender will want to see an existing cash flow statement or a pro forma income statement if the property currently is not rented to a tenant. When you calculate potential cash flow, be sure to take the following income and expense items into account:
- Gross potential rental income
- Vacancy allowance (to account for lost rental income during the time the property is vacant)
- Leasing and property management fees
- Operating expenses (repairs, maintenance, usually 20% of the gross rental income)
- Utilities (usually if the property is multifamily with a master gas or water meter)
- HOA fees
- Property taxes
- Insurance
- Mortgage payment (principal and interest)
Term. Fixed-rate rental property loans can be amortized up to 30 years, which means the payment amount is the same every month. That makes cash flow management easier.
Interest rates are higher and down payments are larger because lenders view investment property loans as being more risky compared to a mortgage for an owner-occupied home.
Underwriting Standards. The underwriting standards also tend to be stricter. For instance, your employment history and income are more heavily scrutinized when you are buying a rental property. In addition, some underwriters may look for evidence of previous experience as a landlord.
Cash Reserves. In addition to showing that you have sufficient income compared with your debt obligations, you will also need to show that you have plenty of money in the bank to cover financial hiccups. It is a good idea to have six months of liquid reserves (cash or assets) that can be easily converted to cash.
Type of Property. Single-family, small multi-family, and townhomes qualify for residential rental property loans.
Number of Mortgages. Once you have four mortgages on your credit, most conventional lenders will not approve your fifth mortgage. Despite a program introduced by Fannie Mae that allows 5-10 mortgages to be on a borrower’s credit; finding a bank that will give you a fifth mortgage can be difficult, despite the guarantee from Fannie Mae.

Residential Rental Property Loan Types

Even if you do not qualify for a conventional mortgage, you might get one backed by the Federal Housing Administration or Veterans Administration. You could also opt for a home equity line of credit.

Conventional Loan

Conventional or conforming loans are mortgages that most people are familiar with. They are offered by traditional lenders like banks and credit unions.
Interest rates are usually lower than other options, provided you have a good credit score, and down payments may be less than 25%.
Conforming loans must meet Fannie Mae or Freddie Mac guidelines. While Fannie and Freddie allow up to 10 mortgages by the same borrower, First National Bank’s investor limits borrowers to four financed properties.

FHA Loan

Federal Housing Administration (FHA) loans are also offered by traditional lenders and mortgage brokers.
Credit score requirements and down payments are usually lower than a conventional loan, and income from an existing rental property can be used to help qualify.
FHA loans are a good option for multifamily property investors looking for a rental property loan for a new purchase, new construction, or renovating an existing property. To help qualify for an FHA multifamily loan, the investor will need to use one unit as a primary residence for at least one year.

VA Loan

Veterans Affairs (VA) multifamily loans are an option for rental property loans offered by banks, credit unions, and mortgage brokers.
Mortgages backed by the U.S. Department of Veterans Affairs are available to active-duty service members, veterans, and eligible spouses.
There are several benefits to using a VA loan for a rental property if you qualify. There is no minimum down payment or minimum credit score, and you may be able to purchase up to seven units. However, one of the units must be your primary residence.

Home Equity Lines of Credit (HELOC)

HELOCs are revolving credit lines that usually come with variable rates. HELOCs are similar to credit cards, you can withdraw any amount, any time, up to your limit.
With a HELOC, you use your existing property as a down payment for another rental property loan. This strategy is an example of the waterfall technique where investors use the cash flow and equity built up from existing rental properties to fund future purchases.
With a HELOC, lenders generally set a borrowing limit of between 75% – 80% of the property equity.
Interest rates and fees may also be higher compared to doing a cash-out refinancing using a conventional loan.
Because many real estate investors defaulted during the 2008 housing bust, most banks, including First National Bank, won’t approve home equity lines of credit that are secured by investment properties.

Apply for a Residential Rental Property Mortgage Loan

Ready to start investing? See what loan programs are available to you and find out what rates are available. Contact a First National Bank mortgage lender today.

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