Qualifying for a loan on an investment property may be more rigorous than for a residence.
- Determining the cash flow of an investment
property is very important. - The type of investment property determines
the type of loans available.
Qualifying for a loan on an investment property may be more rigorous than for a residence.
Because an investment property is more expensive and more difficult to refinance than a residence, most borrowers choose either a hybrid loan that has an interest rate fixed for at least seven years, or a fixed rate loan—unless they plan on selling the property in the first few years. If the plan is for a ‘quick flip’, an ARM without a prepayment penalty may be the best choice; however, some ‘quick flip’ investors prefer a hybrid ARM with an interest rate fixed for three or five years in case they need to wait out a soft market.
Cash flow is an important consideration in an investment purchase. If you don’t feel comfortable with negative cash flow, then a loan with the option of making an interest-only payment may be a good choice. That would allow you to make the interest-only payment in the early years, and, as rents rise over time, use any positive cash flow to pay down principal. When deciding on which type of mortgage, it is important to be conservative. You want to make sure that you can afford to keep the property if rents don’t rise as fast as you planned, or if values don’t increase as rapidly as you had hoped. For more information on choosing a loan see Which is the best loan for me?
Although the same types of mortgages are available for investment properties, the interest rates, especially with a small down payment, are higher than those on mortgages for owner-occupied properties. These loans are also more likely to include a prepayment penalty. Qualifying for a loan on investment property may be more rigorous, with lenders wanting a lower debt-to-income ratio; remember that a lender will add to your income only 75% of the current or market rent from the property you are buying, less taxes and insurance, to determine your debt-to-income ratio. If you are stating your income the lender may require a higher credit score and more reserves for an investment property loan than one for a primary residence.
One of the first considerations when buying investment property is to determine whether the property is classified as residential, or whether it is commercial or multi-family. Residential properties include condominiums, single family residences, and 2-to-4 unit properties. Some mixed-use properties may also qualify for residential financing, these are generally residential condominium projects which also have a small amount of commercial use, ground floor retail in a five-story condominium building, for example.
Commercial properties include retail, office, mixed-use where the use is primarily commercial, and a grab-bag of things from trailer parks to marinas, and require commercial loans. Loans for multi-family properties—those with more than four units—are classified as apartment loans. The lenders, programs, interest rates, and qualifying standards are completely different for commercial and multi-family loans than they are for investor loans on single family residences, condos, and 2-4 unit properties. These loans are best-handled by those who provide them on a regular basis, banks and commercial mortgage brokers, not by residential mortgage brokers or lenders.
