The appeal of real estate investment is growing, thanks largely to a tight rental market and rising rents. Know your financing options.
Ready to dip a toe—or maybe both feet—in the real estate market? Are you aiming to become the next Donald Trump one square foot at a time? The appeal of real estate investment to those who understand its risks is growing, largely thanks to a tight rental market and rising rents.
Rental rates jumped a seasonally adjusted 4.2% year-over-year in July, according to Zillow. Demand increased in part as the number of Americans who actually own homes has fallen to a 48-year low at 63.4% of the overall population, according to the Census Bureau. This combination creates an attractive brew for potential real estate investors.
So how do you go about it? Some investors pay cash. Outside of that, qualifying for a mortgage for an investment property is different from obtaining one for your primary home. Lenders categorize home loans into three property classifications: primary (a dwelling you intend to occupy much of the time), secondary (a place to crash part of the time), and investment property (where you’ll never move in yourself).
Banks have different expectations for primary and investment property loans, including approval qualifications, down payment requirements, and average interest rates, says Ray Rodriguez, vice president, regional mortgage sales manager for metro New York, at TD Bank.
“Lenders are more cautious underwriting investment properties because they are riskier,” says Rodriguez. “Historically, there is a higher default ratio for investment properties over a primary residence. If the rental market dries up and the investor can't find a renter, then typically they’re the property owner that’s more willing to throw in the keys and say 'your problem, not mine.’”
Credit scores. Generally, lenders want to see a higher credit score for an investment property loan over a primary mortgage. "Lenders want to make sure this person who is becoming a landlord, possibly for the first time, pays their bills," Rodriguez says. While each lender has its own standards and requirements, a credit score in the range of 740 to 780 may be needed to qualify for an investment property loan, versus an average 640 to 660 for a primary loan, he says.
Interest rates. The interest rate attached to an investment property loan will be higher than a primary mortgage, as these are viewed as riskier loans for lenders. For instance, a one-unit investment property such as a condo could carry an interest rate that’s 0.375% higher, while the rate on a two- to four-unit investment property could be 0.5% to 0.625% higher, Rodriguez says.
Down payment. Investors should be prepared to shell out more cash for a larger down payment on an investment property than their own residence. Depending on various programs designed for first-time homebuyers, a borrower could qualify for a primary mortgage with as little as 3% down (depending on the loan size) in today’s real estate climate. That compares to 15% down for a one-unit investment property, or 25% down on a multi-unit real estate investment, Rodriguez says.
"Lenders do have a strong appetite for these types of loans, but we do look for higher-credit-worthy borrowers in this area," he says.
Check back for part two to learn more about becoming a first-time landlord. Sometimes it’s not as easy as simply collecting a rent check each month. Hint: Beware of broken pipes and bad tenants.
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