With the housing market crash of 2008 a distant memory and home prices back on the rise, many investors are looking to real estate as a way to diversify their investment portfolios.
But let’s be honest -- investing in real estate is a big commitment, and it’s important to really understand the ins and outs before diving in.
With that in mind, today on the blog we’re sitting down with Andrew Chelton of F&M Mortgage to discuss what to expect when financing an investment property and some tips to make the process as smooth as possible.
Let’s jump right in!
Rob DeLucas: Generally speaking, if an investor is considering purchasing an investment property, either long-term rental or short-term rental property, what are the primary lending considerations they should be aware of -- and are there interest rate differences between investment and primary "owner-occupied" residences?
Andrew Chelton: Investment property rates are always going to be higher. With a 20% down payment, rates are over a full percent higher. However, with a 25% down payment, rates begin to get more favorable.
They are still higher than with a personal residence but typically drop by a half a percent or so if an investor is willing to put 25% down on a purchase.
RD: Should investors be ready for larger down payments for this type of investment?
AC: It helps for the reasons above. Also, 15% is the bare minimum an investor can put down to secure traditional lending. Sometimes, a local lender may be willing to “bend the rules” especially if the investor is solid and has other banking products with that particular lender.
RD: Are there any avenues for investors to bring cash to the table other than simply bringing cash to the table for the down payment? For example, can they borrow funds from another investor or relative for this type of transaction?
AC: A home equity line from your personal residence can work, however, no gifts are allowed. If you are using gift money, it has to be seasoned for 60 days. There have to be two full statements showing no “gift money” entering the account. Most lenders won’t go back further than two bank statements to track and source deposits.
RD: Is PMI a consideration in these purchases?
AC: Yes, if you put down between 15% and 19% of the purchase price, there is a rather expensive PMI payment on the loan. At 20% or greater, no PMI is typically required.
RD: In the event that two or more investors want to go on in a real estate purchase together, is it possible to get joint financing? Would both investors be on the loan together?
AC: Yes, you could have a borrower and co-borrower, but the credit reporting score would be based on the lower of the two borrower’s credit scores. It is important to make sure both borrowers maintain strong credit scores in order to secure the most favorable rates. There are title considerations in terms of the property itself, but both borrowers would be able to “co-borrow” on a loan.
RD: In the event of a short-term rental or Airbnb property, does this intended usage need to be disclosed on the front end?
AC: Yes, it needs to be disclosed. Condos can be trickier than traditional housing because there are more regulations and FANNIE MAE has strict stipulations when lending on condos.
Townhomes and single-unit housing is ok but needs to be disclosed during the lending process.
RD: How does this impact purchase? If it isn't originally disclosed, is there a statute of limitations on how long the loan needs to be in effect before there could be adverse consequences for not disclosing this?
AC: There is typically a document at closing that you would sign intending the property to be used as your primary residence for the first year of the loan. After 12-months, circumstances can change and it would be ok to use the property for Airbnb purposes. Loan terms would not need to be altered if the conversion happens after 12-months. There are a few extenuating circumstances, such as a move out of state which could alter the 12-month requirement.
RD: If an investor closes on a property (even an owner-occupied property), but within 6 months has moved out and started renting this out as an Airbnb investment, could the lender cancel the loan or force the sale of the property?
AC: If the lender finds out that an investor was dishonest when signing and changed usage of the property intentionally, it is considered mortgage fraud and is a federal crime. While it is difficult to be discovered, the punishments are severe and these actions are unacceptable. If disclosed to your lending agent, the agent should shut the process down because of liability.
RD: What are the biggest roadblocks you run into when working with an investor considering a rental property purchase?
AC: One of the biggest roadblocks is that the investor actually needs to have a certain amount of reserves in the bank even after the down payment has been made.
The amount of required reserves is based on the total number of properties the investor owns and can vary by lender, but on the purchase of a first rental property, typically the investor needs to have 2% of the unpaid aggregate principal balances available in reserves at the time of closing plus 6 months worth of total monthly payments on the loan.
Cash reserves are critical and most investors don’t factor this into consideration when seeking financing. FANNIE MAE only allows one investor to own 10 total mortgages at any time. A new purchase would require paying one mortgage off (typically a smaller balance) in order to qualify for another loan.
So, Is Real Estate Investing for You?
If you’re ready to take the next step toward owning an investment property -- before you begin to research properties in your area, reach out to Andrew and see how he can help.
Even if you don’t think you would currently qualify for a loan, he can tell you exactly why and guide you through the process of fixing any issues. Above that, the meeting is free -- so there’s really no reason not to take advantage of it.
Want to learn more? If you’re considering adding real estate to your investment portfolio but have a few questions before you’re ready to take the leap, just leave them in our comment section below and if we get enough of a response, we’ll ask Andrew to come back for round two.