Who out there has not toyed with the idea of buying an investment property? From houses with potential in need of a little TLC to move-in ready steal deals, owning an investment property can have many rewards. But before you jump into an investment property deal, make sure you consider all the risks as well as the potential benefits.
With so many housing markets across the country bouncing back, an investment property purchase may allow the buyer to reap the rewards of rising home values and simultaneously build equity! Online sites like airbnb, Homeaway and VRBO have enticed millions to try their hand at lucrative short-term rentals. Depending on the market, for would-be landlords it can create instant cash flow. Those looking to fix up and flip can also do well, especially if the real estate in question is in a popular area, such as a tourist destination, college town, historic district or up and coming neighborhood. Investment property loans can be used to purchase single-family homes, condos, townhomes and multi-family dwellings with up to 4 units. Some investment property loans also come with a few tax advantages!
There are helpful points to consider before looking into loans for such a purchase:
- As opposed to conventional loans, these usually come with slightly higher interest rates and require larger down payments.
- A number of investment properties, especially those in condo complexes and resort areas, may require additional expenses in addition to the monthly mortgage. Examples of these extras include, HOA dues, cleaning, landscaping and maintenance fees, possible flood insurance and assessments for future improvements.
Before taking the plunge, prospective property investors should also be aware of the following factors that can impact home values:
- Zoning ordinances
- Historic appreciation rates
- Utility improvement plans
- Changes slated for redevelopment
- Proposed annexations
- Proposed changes to roads and traffic patterns
- Neighborhood expansion plans
As for financing, there are loans especially for purchasing investment properties and for refinancing existing ones. They may also be used to invest in new construction, spec homes and land development.
A potential investor will first need to research the rate and term profiles of any loans they are considering. For the purposes of this article, we’ll examine investment loans for residential properties. Although they are very similar to a typical home loan, the qualifying standards and procedures vary a little.
- Your credit score will need to be on the high end to be considered for an investment property loan. Ranging from 300 to 850, a score of 700+ is typically needed to secure this type of financing.*
- Lenders use what’s known as the debt to income ratio (DTI) when calculating the risk involved with prospective borrowers. It determines one’s financial ability to pay back the funds that they’d be borrowing. An example used by the biggerpockets.com blog is: “If you have $2000 per month in monthly debts on your credit report, but have an income of $6000 per month – your debt to income would be 33.33%.”According to an article from bankrate.com, lenders look at a “front-end” ratio and a “back-end” ratio. The first considers housing costs only, such as the monthly payment, taxes, insurances, etc. The back-end accounts for all debt commitments, including car loans, student loans, and credit card debt. Lenders agree that the front-end should be 28 percent or less with the back-end ratio at 36 percent or less.*
- Yet another ratio that lenders consider when calculating risk, is loan to value (LTV). It actually helps them calculate the total loan amount to the total fair market value of the property. The LTV is determined by dividing the loan amount by the home’s least appraised value or the purchase price. Lower LTV rates may help a borrower qualify for lower mortgage rates. An LTV of about 70 to 80 percent is the norm for investment property loans.*
- Borrowers who want to secure financing for multiple loans for several investment properties may be expected to have previous landlord experience. That’s because a possible borrower’s DTI ratio would be so high they would not be eligible for financing unless their rental income is added to their regular monthly income. Please note that most lenders want the borrower to have a 2-year minimum of landlord experience.
*Underwriting guidelines can vary by lender and are subject to change. Talk with an eLEND mortgage professional for the most accurate and updated loan requirements.
Entering into an investment property scenario is a very exciting prospect, however, it pays to be well informed! Make sure you have evaluated the potential risks and loan approval requirements carefully before you decide to take on an investment property.