In a depressed housing market, buying rental property can be a smart move. You can snap up property at lower prices and rent to people who’ve been shut out of the market because of tightened credit restrictions. But getting a loan to buy your rental property is a little different from financing an owner-occupied residential property. Banks look at these loans – and at you, the buyer – with a more critical eye. Knowing what you’re up against can help you make your best bid for financing that rental property.
Because mortgage lenders view rental properties as at higher risk of default than your primary residence, they charge higher interest rates for these types of loans. After all, if you’re in a financial bind, you’re going to pay your mortgage first and payments on your investment property second. Your interest rate will depend partly on your credit score, and you can often negotiate a lower rate of interest by agreeing to pay points on the loan.
Your lender will require you to have a down payment of at least 20 percent of the purchase price before they’ll consider you for a loan. A 25 percent down payment is even better. A larger down payment may also help you qualify for a better interest rate on the loan.
Lenders take a close look at borrowers who are seeking mortgages on rental property. You’ve got one house payment and other debt and now you want to take on more debt? You’d better have your financial house in order. You need to have a good credit rating – above 740 if possible. That doesn’t mean you won’t be able to get a loan with a lower credit rating, but you may have to jump through more hoops to please the lender and you won’t get as favorable an interest rate. You’ll need to show your ability to make the mortgage payments, even if the market tanks and you’re unable to rent your property for several months.
To prove your ability to carry a rental property in addition to other debts, your lender will probably require you to have a reserve fund equal to six months or more of mortgage payments and maintenance for your rental property. A lender doesn’t want you depending solely on rent coming in to make your mortgage payments. If your renter falls behind on his rent or the home sits empty for several months, your lender wants to know you’re good for the money you owe him.
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