“I should have known this before,” Said Mark, your buddy.
Mark made an offer to buy an investment condo in the downtown area of the city. When he applied for the investment property mortgage, his application was turned down by the lender.
As per the lender, they don’t take the projected rental income (from the condo) into consideration as a reliable source of income in case of the first-time investor like Mark. They’d have considered it in case of an experienced investor.
And Mark does not have enough personal income that can qualify to service the combined mortgages for his primary home and investment property.
The lender did offer an option. That was to show enough savings equivalent to the 1-year rental income of the subject property, which he can use in case of non-payment of rent by the tenant.
If only Mark knew about all these, well in advance.
“I guess, I’d let it go” Mark submitted disappointingly.
You know it was so frustrating for your buddy. He was so excited to become a real estate investor.
You, too, are thinking of buying an investment property. But it looks like a lot of complications, especially with the investment property mortgage. You never had any issue with your primary home mortgage.
What should you do?
The one-word answer to this question is … Homework!
You have to start researching the subject well ahead and know how exactly the investment property mortgage is different than the homeowner’s mortgage.
But let me assure you, you are in the right place.
I have compiled a list of general guidelines on which investment property mortgages work, for someone like you!
There may be some changes in these guidelines based on individual lender and market.
Let’s start right away.
Investment Property Mortgages is Different. How?
Tip#1—Not Backed-up by PMI-Private Mortgage Insurance
Homeowner’s mortgage is legislated to be insured by the insurance is called PMI (Private Mortgage Insurance) in the USA and Mortgage Default Insurance In Canada. But when you buy an investment property, your mortgage is not insured by insurance to protect the lender. This is one of the main reason why investment property mortgage is treated differently than the homeowner’s mortgage.
Tip# 2 — Rental Income Less Stable Than Personal Income
You’ll pay mortgage installment on your house from your own income. If you own investment property at the same time, you’ll pay that mortgage from the rental income from that property.
What if your tenant stops paying. Lenders know rental income may not be as stable as your personal income.
This is another reason why investment property mortgages are treated differently.
Tip# 3 — Tenants Can’t Take Better Care Than You
In your personal case, you, the borrower, occupies the collateral asset (your home). The lender feels better when the borrower occupies the collateral property. In case of investment property mortgage, the collateral asset is the investment property which is going to be occupied by the tenants. They are not expected to keep the best care of the property.
Tip# 4 — Easier to Walk Away in Crisis Time
Lenders also know the fact that even a good payer will stop paying the mortgage, the investment turns bad. In the crisis time, the borrower would behave less responsibly towards the rental property, compared to how he would behave if he is living there with his family.
Eligibility Requirement for the Investment Property Mortgage
Fact# 5 — Number of properties
After 2009, Fannie Mae changed the mortgage rules. An individual investor can own up to 10 mortgage financed properties including a primary home. There was a restriction of 4 properties before 2009.
In Canada, an individual investor can own a maximum of 4–5 mortgages financed property including a primary home.
Tip# 6 — Down Payment
You can’t buy an investment property with less than 20% down payment*. For 1–4 investment properties, you have to have at least 20% down payment for each property. Once you own 4 properties, your down payment increases to 25% of the purchase price for property number 5 to 10.
* If you don’t have 20% down payment and if you want to buy an investment property, you have house-hack. You can use the first-time homebuyer program to buy owner-occupied multi-unit properties. You need around 5% of the purchase price for the down payment.
Tip# 7 — Credit Score
Credit score requirement for investment property mortgages may not change in the beginning when you buy your first investment property. As you acquire more, lenders expect a better score to qualify you for more loan.
Tip# 8 — Interest Rate
Most lenders charge half a percentage point higher for the rental property mortgage because of higher risk.
Qualification of Personal Income
For investment property mortgage purpose, the lender would require you to have enough personal income that would service the mortgage of your primary residence.
Tip# 9— Personal income, if You Are a Brand New Investor
For the beginners, lenders would be more reliant on your personal income rather than the future rental income. Wells Fargo allows rental income to be counted for loan purpose, only if you have 2 years of landlord experience.
For the first investment property, many lenders choose not to consider the projected rental income (from the property which you are going to buy) at all for the qualifying purpose. Your personal income should be high enough to service both your personal mortgage and investment property mortgage.
From a lender’s perspective, you don’t have enough experience of handling the rental property, so the rental income is not a reliable source of income.
Tip# 10— If You Are a Salaried Person
If you are a salaried person, the lender will count 2-3 years income of your recent past.
If you have recently changed your job, your new job should be in the same industry of your qualifications or experience.
Tip# 11 — If You Are Self-employed
The lender needs a CPA certified profit and loss statement from your income tax return. It needs to be ensured that you are earning a regular, recurring income from your business.
For example, if you have sold stocks and earned income, that would not be considered as income for qualifying purpose. As that kind of gain is just a one-time gain.
How Does Lenders Qualify the Rental Income?
Lenders have stringent criteria for qualification of investment property mortgages.
Tip# 12 — 50%-75% of the rental income
In most markets, lenders count 50%-75% of the actual rental income for qualifying purpose. This is because they have to account for rental vacancy and other expenses like utilities, property tax etc.
Tip# 13— Appraised Rental Value
If the property is vacant, the lender requests the rental appraisal to decide the would-be rental income of the property and use it. Sometimes, lenders use this option in a situation like a student-rooming house too.
Tip# 14 — Rent Receipts with Corroborating Evidence
To establish the reliability of the income produced by the investment property, some lender would allow you to show actual rent receipts with evidence like deposits in the bank account. Or even a visit to the property.
Tip# 15— Income Tax Return
The rental income shown on your income tax return is the most reliable source of your income from the lender’s perspective. And oftentimes, if you are not able to provide proof of the rental income verified by your income tax return, your application is declined.
Tip# 16 — A Magic Tool called ‘Exception’
When your overall credentials are good but there is something that’s restricting you to get qualified, most of the lenders have a magic tool called ‘exception’ available in their kitty.
If you keep working with the same lender, the lender will tend to trust you more and make an exception to help you qualify.
Tip# 17 — Types of Property
For residential investment property mortgages, the properties should not be of more than 4 self-sustained units. The property should be insurable for fire insurable. Some lenders may ask for official municipal permits to see if the property is up-to-date as per the building code requirements.
The most lender would decline the application for the student rooming house properties without a municipal permit or license