Financing Income Properties

Many lenders impose tight guidelines on investment properties.

Many lenders impose tight guidelines on investment properties.

Financial instability or a focus on short-term planning have caused many people to rent rather than buy homes. You can cash in on this and boost your monthly income if you tap into your savings nest egg and turn a residential home into an income property. If you do not have enough money to cover the entire cost of the home, you can take out an investment property mortgage to cover the shortfall. However, while obtaining financing for your current pad may have seemed easy, qualifying for an investment home loan can prove a little more difficult.

Loan Products

You can finance an income property with the same type of loan you used to buy your primary residence. If you are in it for the long haul, you have the option of a fixed 15-year or 30-year term loan. If you only want to hold onto the house for a few years you can apply for an adjustable rate mortgage with an initial term of low monthly payments. Some lenders also offer home equity lines of credit that you can use to buy rental properties. You only have to make interest payments on these loans until either you sell the home or the loan term ends, at which point you pay off the principal.

Loan To Value

As with primary residence loans, lenders sell large numbers of investment property loans to government-sponsored enterprises Fannie Mae and Freddie Mac. These entities limit the loan-to-value ratio on home loans, which basically means the amount of the property that you can actually finance. For investment homes, Freddie Mac limits the LTV to 85 percent, meaning you have to come up with a hefty 15 percent down payment. In contrast, Freddie Mac allows you to buy a primary home with a down payment of just 5 percent. Most lenders impose similar restrictions on loans that are retained and not sold to Freddie Mac or Fannie Mae.

Income

Although you plan to use your investment home as a cash cow, you cannot list the rental income on your loan application. Freddie Mac allows you to include rental income on your application only if you have a steady two-year history of collecting the rent payments. Obviously, you cannot fulfill this requirement on a home you have yet to buy. This could hurt you because aside from your credit, a lender evaluates your loan application on the basis of your debt-to-income ratio. Typically, you cannot qualify for a loan if more than 45 percent of your existing income is dedicated to paying your current debt. Simply put, you must prove you can afford the mortgage without receiving a single cent from your renters.

Considerations

DTI and LTV restrictions bring down the curtain on many income property mortgage applications. However, in the long run you may avoid some headaches if your loan application is denied. If you can barely raise the cash to buy the home or cover the payment, how will you handle ongoing maintenance, liability insurance and periods of time when you cannot find renters? The underwriting guidelines clearly protect the interests of lenders, but guidelines are also there to prevent you from taking on more debt than you can handle.

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