For those who are thinking about adding real estate to their investment portfolio, there are a few different guidelines compared to financing a primary residence. Lenders place a slightly higher risk for investment real estate and additional guidelines reflect that. The additional guidelines aren’t too restrictive by any means but there are more requirements, nonetheless. First, to offset the additional risk, interest rates will be slightly higher compared to rates for a primary residence. How much higher? It can vary but in general rates for investment, homes can be anywhere from 0.50 to 1.00 percent higher. For your situation, you should contact me directly for an updated rate quote when thinking about financing a rental.
You can also expect to bring a bit more money to the table. While closing costs are relatively the same for an investment property compared to a primary residence, the minimum down payment for a rental will start at 15 percent down. As with most conventional mortgages with a down payment of less than 20 percent, a 15 percent down payment loan will require an additional monthly private mortgage insurance premium or PMI. A 20 percent down payment will avoid private mortgage insurance but by putting down 25 percent, borrowers can get a slightly higher rate.
Seasoned real estate investors will tell you that cash flow is king with regard to investment real estate. You’ll want to get an idea of what rental rates are for the area you’re looking to buy to make sure the property cash-flows each month. You should add together the principal and interest payment, taxes, insurance (PITI), and mortgage insurance when needed. Next, make sure the monthly rental income is more than what your payments will be.
Speaking of income, let’s talk about that a little further. When buying your first rental property, you’ll need to be able to qualify without the benefit of any rent that’s coming in. That includes the PITI from both your current residence and the PITI from the rental. Yet this changes over time. By keeping your first rental for at least two years, guidelines will allow using rental income to help qualify. This is why it’s not uncommon for real estate investors to own multiple rentals. The rental income is more than enough to cover the ownership expenses. Additional properties become an income stream and are not looked at as an expense.
When qualifying for a rental property, lenders will use 75 percent of the income for qualifying purposes. This 25 percent discount is an allowance for vacancies. The rental unit won’t be occupied 100 percent of the time as tenants come and go. There’s a little math homework when reviewing a potential investment property purchase, so if you’re thinking of buying your first rental, let’s have a quick conversation and we can go over the basics together.