Permanent Financing for Long-Term Rentals and Vacation RentalsIf you dream of a healthy passive income from commercial property, either through long-term rentals or short-term vacation properties, you may be dismayed by the high cost of getting involved. However, there are plenty of mortgage options to reduce the upfront cost and help you get started as a real estate investor.
What Is an Investment Property?An investment property is one that is bought for the express purpose of generating income; this can include short-term renters, long-term tenants, or the profit from a resale, as with house flippers. They may be held for a short period of time or for decades, and they may be either residential or commercial property types. What Is an Investment Property Loan?
A rental property loan provides you with the funds you need to buy an investment property, whether that is for short-term or long-term use. A lender will provide funding for a variety of different property types, such as: • Long-term residential rentals As a mortgage loan for a commercial building is typically higher risk, they generally have higher interest rates, especially those from private lenders. However, they also have higher loan amounts. You can also choose between short-term loans and those with longer loan terms, giving you the flexibility you need to pay back the mortgage. |
Let's start with the basic similarities. For both investment property loans and conventional loans, you will fill out an application. The application likely will ask some different questions from the application you filled out when buying your home.
The lender likely will be less interested in your personal income, assets and employment history, but may want to know more about your investment experience and strategy. Your lender will pull your credit score. The lender will order an appraisal and open title.
So what are some of the important differences?
Down payments typically are quite a bit larger on an investment property loan. You should plan on 25% (but this will vary and depend on your credit score), compared to the 3% often necessary for some government sponsored consumer mortgages.
Interest rates and fees typically are higher on an investment property loans. You should expect them to be 100 to 400 basis points higher than on a traditional mortgage. A basis point is a hundredth of a percent. So, if a conventional mortgage is 6.5%, an investment property loan on the same property to the same borrower would be 7.5% or more.
You should expect to have to prove that you have liquid cash reserves equal to your down payment and closing costs plus 6-12 months of your monthly principal, interest, taxes, insurance, and any association dues. If you own more than one investment property, some lenders may require you to prove reserves on all of your financed investment properties. A conventional mortgage, on the other hand, require anywhere from 0-6 months of reserves.
For conventional loans, the lender likely was interested in your employment history and personal income. You likely were asked to provide pay stubs and your personal tax returns. Just prior to the close, the lender likely asked you to represent that you were still employed in the same job that you had when you began the loan process.
For some types of investment property mortgages, you’ll be asked for all of this information and then some, particularly if you already own other investment properties. For other types of investment property loans, instead of focusing on your personal employment and income, the lender will focus on the investment property cash flow. This simplifies documentation greatly.
How to Finance an Investment PropertyFor serious real estate investors looking to build an investment portfolio, there are essentially three investment property loan options: agency loans or GSE loans (Fannie/Freddie), local/regional banks, or an alternative lender such as Visio Lending. Sometimes rental investors will obtain owner financing or a hard money loan, yet those are rarer. Let’s look at the three main options, as well as some less common alternatives: Alternative Lenders Like Visio Lending
Additionally, most alternative lenders underwrite investment property mortgages based on the rental income of a property rather than personal income. That means they have low documentation requirements and do not review your employment history or tax returns. There are some drawbacks to non-QM loans, yet most seasoned investors are comfortable with them: Higher Interest Rates and FeesSeasoned investors, particularly those in growth mode, are willing to pay higher interest rates and fees for more flexibility to achieve their wealth creation goals. 30-year terms, Prepayment Penalties, and Legal EntitiesGSE loans typically have 30-year terms and no prepayment penalties; however, they require full income and asset verification, including fully completed tax returns. When using a GSE loan, you also have to borrow in your personal name. Banks that make investment loans typically do not offer 30-year terms and they include prepayment penalties. Banks often will allow you to hold the property in an LLC or other legal entity and extend the investor loan to the entity rather than you personally. Alternative lenders offer 30-year terms, allow you to borrow in a legal entity, and include prepayment penalties. Again, experienced investors are willing to accept prepayment penalties if it means they can qualify for a loan that enables them to achieve their investing goals. Visio offers a variety of prepayment penalty options so investors can tailor their loan to their particular circumstances.
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Agency loans are the least expensive type of investment property loan, yet the most complicated to obtain. They are easiest to obtain for your first investment property, rather than the next several. The Fannie Mae guidelines can be strict. Lenders typically underwrite agency loans based on a holistic review of an investor’s cash flow, including personal income from stable employment and net operating income from rental properties. These loans have some drawbacks for investors including: |
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Some real estate investors have success obtaining loans for an investment property with local or regional banks. Because banks plan to retain these loans rather than sell them, they can be more flexible on underwriting in exchange for higher rates and fees. Banks, however, cannot portfolio 30-year loans, so they typically write five-year or ten-year loans on 15, 20, or 25-year amortizations. Some of the drawbacks of working with a bank are: |
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While these are rarer, there are additional loan options for buy and hold real estate investing, including:
Hard Money LoansHard money lenders offer short-term loans on investment properties. Typically, real estate investors use hard money lenders for construction projects, yet they can be used for rentals as well. If you're considering working with hard money lenders, be prepared to have an exit strategy for loan terms up to two years and a high interest rate. We have a guide that covers the process and nuances of working with hard money lenders more in-depth. Home Equity LoansIf you have a primary residence, you can use a home equity loan to borrow against the equity and purchase an investment property. Keep in mind, your primary residence will be used as collateral when obtaining a home equity loan. It is essential that you keep up with each monthly mortgage payment in order to keep your home. VA LoansA VA loan is a loan program offered through the U.S. Department of Veterans Affairs for active military and veterans and their surviving spouse. VA loans are one of the strongest loan programs available for those eligible. If this applies to you, it is worth talking to a mortgage lender about obtaining a VA loan. |
When qualifying for an investment property loan, the lender will make sure both the property and the borrower meet loan qualifications.
Plan on a 25% down payment. If you have stellar credit, you might only need 15%. If you have less than stellar credit, you may need as much as 35%.
Financial stability is key to success. In addition to a more substantial down payment, plan on having 6-12 months of liquid cash reserves. This will help you in the event of hard times and make sure that you won’t immediately lose the property due to missed payments and foreclosure. You'll also need to have cash for closing costs and underwriting fees. Further, the larger your down payment, the lower your interest rate and the better your DSCR. Therefore, it is best to have the highest possible down payment.
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Lenders tend to vary pricing, terms, and conditions more on loans for rental properties than on owner-occupier loans. Do what you can to raise your credit score before applying. And, importantly, protect your credit score once you've applied so your loan closes smoothly. Most lenders will do a hard credit pull to get the full scope of your credit score, so it is wise to be prepared.
If you're applying for an agency or bank loan, get your documents in order. You'll need pay stubs and tax returns with all of your tax return schedules. Get ready to answer questions about your tax returns for a year or two back. Also, make sure you have sufficient personal income, including any net operating income from your rental properties, to afford the monthly payment on your rental property. If you are applying for a non-qm or alternative loan, you will need to make sure the rental income covers the cost of the monthly payment.
Construction is financed separately from rental loans (usually in the form of fix and flip loans or hard money loans), so most mortgage lenders will check to make sure the property does not need any significant repairs.
In addition to having a minimum down payment, most lenders also have a minimum loan amount and specific requirements based on their loan programs. A conventional mortgage always has the most stringent requirements, while investment property loans are more flexible. Do your due diligence on the mortgaged lenders you are looking to borrow from.
The investment property loan process is very similar to any other mortgage loan process. Here's how it works.
The loan programs available for an investment property are more involved than the loan programs available for an owner occupier. The first step in searching for a lender includes determining which loan programs work best for you. If this is your first rental property, then you should consider a government sponsored loan. If you own multiple mortgage rentals, you'll want to consider an alternative or Non-QM loan program. Many banks and lenders offer loans for investment properties. Ask your real estate agent or other investors for a recommendation.
Be sure to dot all your I's and cross your T's to make sure you like the lender before filling out an application for an investment property loan. You don't want to get an unnecessary hard credit pull.
Like any other mortgage loan, once you apply for an investment property loan, your loan file will move into processing. Here, the loan processor will collect any remaining documentation.
Once your investment property loan has been processed, you will move into the closing stage and your loan will be funded.
Investment property mortgage rates are higher than those for residential loans because they are a greater risk for the lender. Generally, this means that they are about 125 to 300 basis points higher than that for a residential conventional loan. So, for example, if the current mortgage rate for a 30-year fixed-rate loan on a residential home is 6.75%, the range for commercial real estate loans would be 8% to 9.75%.
We provide a breakdown of current rates, as well as an explanation of the reason they're higher, in our discussion of investment property mortgage rates.
Investors typically turn to alternative lenders like Visio Lending for a few reasons. The first situation is if they are self-employed, including owning their own business. Another reason would be that they already own too many properties to qualify for another conventional loan. Finally, and importantly, they may turn to an alternative lender because they want to own their investment properties in a legal entity to protect their other assets. That is not allowed with conventional loans. Here are some of the key nuances of financing an investment property.
Traditionally, for rental properties, appraisers fill out a 1007 report on comparable rents for long-term leases; think a year or more. Appraisers primarily appraise homes for owner-occupiers. As an alternative lender, Visio considers any actual rent performance available on the property and then augments that information with comparable data from a variety of data sources. Unlike a licensed appraiser, Visio is not limited in the information it can use to establish an appropriate rent estimate.
Insurance on a rental property is quite different from your personal home. Even many insurance agents who don’t regularly deal with rental properties don’t understand the nuances. Visio has a dedicated team that can help you properly insure your rental property investment and protect you against some of the not-so-obvious risks you may encounter as a real estate investor.
Many owners of rental properties also engage in fixing and flipping properties. If that’s you, you might think twice about financing both your rentals and your flips with the same lender. Flips are subject to much greater market risk than rentals. Even the best flippers have deals that go sideways or the wrong way. Many lenders include cross-default provisions in their loan documents that provide that if you default on one loan it also counts as a default on all of your other loans. You don’t want to have a bad flip deal trigger a default on your rental properties.
Get fast & dependable investment property loans from Visio LendingVisio Lending is a leading provider of 30-year financing to investors in single-family (1–4 unit) residential rental properties, including vacation rentals. Visio underwrites its flagship product, the Rental360, based on rental income and borrower credit rather than the borrower's personal income. As a result, the Rental360 is an ideal financing product for the self-employed investor or the investor who is building a portfolio of rental properties. Key advantages of Visio's Rental360 program over conventional loans include:
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Visio Lending is the nation's premier lender for buy and hold investors offering, long-term loans for SFR rental properties, including vacation rentals.
