The number of renters in the U.S. housing market is increasing by some 2,600 new renters every day, according to the Rental Protection Agency (RPA). With such steady growth, it’s no surprise that the number of new landlords is also increasing; the RPA reports that more than 500 people take the plunge into owning a rental property each day. If you have the time and money and are interested in becoming a landlord, real estate can make a great addition to your investment portfolio, but financing the purchase of rental properties can be a bit tricky. What do you need to know about getting a loan for a rental property?
Getting a Loan for a Rental Property
Mortgages are complex financial instruments, so it’s always important to work with competent financial professionals you trust. However, deciding that you want to use a mortgage to purchase a rental property can up the level of difficulty when it comes to getting a loan.
Ultimately, it’s a matter of risk. As The Mortgage Reports explains, when things go wrong, borrowers tend to walk away from their rental properties more quickly than their primary residences. Therefore, extending a loan to fund the purchase of rental or investment property is riskier than loaning money for the purchase of an owner-occupied home. This increased risk makes lenders more cautious, so you’ll face some challenges and extra scrutiny when requesting a loan for a rental property.
Common Challenges When Buying a Rental Property
Homeownership has long been part of the American dream, and there are numerous organizations and programs designed to promote it. Becoming a landlord doesn’t have the same glamour, and there’s less community support. When you’re seeking a loan for a rental property, you’ll need to be ready to prove that you’re financially prepared by meeting stricter requirements. Bigger Pockets notes several common challenges investors face when trying to get a loan for a rental property:
- The cost of borrowing is higher. Both interest rates and fees are generally higher for loans on rental properties as lenders try to offset their increased risk.
- The down payment is greater. It’s best to plan on making a down payment of at least 20 percent. A larger down payment means that you have more skin in the game and makes the loan a more attractive prospect from the lender’s point of view. In fact, putting more money down may help you get a lower interest rate.
- Good credit is important. Lenders want to be repaid, so a strong credit history, sufficient income to manage this new purchase, and suitable cash reserves are crucial. You might still get the loan with imperfect credit, but better credit will save you money in the long run by helping you secure better terms.
- There are limits on how many mortgages you can have. You might think a proven track record as a successful landlord would make getting a loan for a rental property easier, but too many mortgages on your credit report can stymie your efforts. In fact, many lenders refuse to extend new loans to anyone who already has four or more mortgages.
Tips for Securing Financing for a Rental Property Purchase
Securing financing for a rental property may be tricky, but it is certainly possible. Some aspiring landlords skirt the challenges inherent in finding a loan for a rental property by buying owner-occupied properties instead. As Zillow explains, they purchase properties to serve as their primary residence, live there for a year or so, and then turn them into rentals as they move on to their next property. Others get creative by financing their purchase with home equity loans, a cash-out refinance, or some form of private financing.
What if you want to cut to the chase and fund your purchase of a rental property as an investment property with a mortgage? U.S. News offers a few useful tips to those who want to get a favorable loan for their rental property purchase:
- Maintain good credit and know what you can afford.
- Pay down debt first to lower your debt-to-income ratio.
- Have a solid down payment and appropriate cash reserves.
At PrimeLending of Kansas City, we thrive on helping our clients secure the right loan product for their needs. Whether you’re buying your first home, purchasing a rental property, seeking a renovation loan, or interested in refinancing, we’re ready to assist you. Contact us today to learn more about our offerings.