If you plan on becoming a real estate investor, you’ll need to know mortgages like the back of your hand. Understanding everything about a mortgage for rental property is vital for investors, especially because this is an area where aspiring investors get confused and deterred by. To help out in this regard, this blog will provide you with all you need to know about a mortgage for rental property.
What Is a Mortgage?
A mortgage is a loan obtained from a lender used by real estate investors to purchase investment properties. Instead of paying for a property entirely in cash, an investor can use a mortgage to pay off most of the purchase. The part of the purchase the investor must cover is called the down payment. Over a number of years, the investor must repay the lender the amount of the loan, in addition to included interest.
Three Types of Mortgages
There are three types of mortgage loans. The loans are differentiated based on how the property will be used and the occupancies in the property.
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Owner-occupied mortgages
These mortgages are used for properties intended to be used as a primary residence. The buyer must move into the property within 60 days of closing the loan. Afterwards, the buyer must live in the property for at least a year. After that year, the buyer can choose to use the property as a rental. If the buyer decides to use the property as a rental, the loan terms will not change.
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Second-home mortgages
Second-home mortgages, as you could guess, are mortgages used to purchase properties used as second homes. This mortgage prevents using the property as a rental. If the property is used as a rental, the mortgage may be called due, which means that the investor would have to repay the loan in full.
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Non-owner occupied mortgages
This type of loan is used as a mortgage for rental property. If an investor chooses to convert the rental to a primary residence, they are free to do so. This will not change the terms of the loan.
Interest on Mortgages
A mortgage for rental property has higher interest rates compared to mortgages for homes. In fact, that’s why rentals under non-owner occupied mortgages can be converted to residences. This puts the lender at less risk. Rates of rental property mortgages are about 0.25% to 0.75% higher than those of home mortgages.
Interest rates for rental property mortgages have been relatively low in recent years. As of the time of this writing in May 2017, interest rates are in the low 4s. This may remain as it is or uptick as the year goes on.
Related: Paying Off Investment Property Mortgage Early: Pros, Cons, and Tips
Tax Status of a Mortgage for Rental Property
As a real estate investor, you could claim various expenses (which you can calculate with Mashvisor) in Schedule E of your tax forms. When it comes to mortgage for rental property, mortgage interest is tax deductible. The amount of mortgage interest paid during the taxable year is deducted from the rental income of the year. If the number is positive, the number is the investor’s income, which is taxable. If the number is negative, the number is loss, which reduces taxable income. This second scenario could vary depending on your income, so be sure to seek the help of a tax advisor.
How to Get a Mortgage for Rental Property
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Contact a Lender
You’ll need to find a suitable lender to get a mortgage for rental property. It’s recommended to get loans from local banks or lenders. Local lenders, rather than national ones, are more likely to ask for lower down payments. Also, chances of getting a loan from these lenders are higher, since they are usually more interested in investing locally.
It’s also recommended to work with a direct lender rather than a mortgage broker. A direct lender allows you to cut to the chase and get a mortgage for rental property directly. A mortgage broker, on the other hand, acts as a middleman between you and different lenders. By working with a direct lender, you’ll be in contact with the one who makes the head decisions.
This goes without saying, but you will need to research a lender before committing to one. Even once you’ve found a lender that suits you, don’t shy away from asking any questions about more mortgage that come to your mind.
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Requirements
There are a number of requirements you will need to be able to cover a mortgage for rental property. Having these requirements will make you a strong borrower to lenders.
Whether you plan on buying rental property or buying a car, you will need to have good credit. What if you have bad credit? Don’t worry, it’s still possible, here’s how.
Generally, if you are getting a mortgage loan for the first time, you will need a FICO credit score of at least 630. After you have received four loans, the credit requirement boosts to 720.
Credit isn’t the only thing you’ll need for a mortgage for rental property, you’ll still need some cash. Aside from the down payment, most lenders will require from you to have 6 months’ worth of the mortgage payment as cash reserves. You can find out the estimated monthly payments from the lender.
The amount you pay on the down payment will depend on how many times you’ve taken a loan and the property type. For single-family homes, the down payment is 20% for the first to the forth loan. From the fifth to the tenth, the down payment will increase to 25%. For multi-family homes, the down payment is 25% for the first to the forth loan. The down payment goes up to 30% after the forth loan.
Finally, lenders will want to see your W-2 income to see if you’ve been working for the last two years. If you are working independently, you will need two years of tax returns and a year-to-date profit and loss statement.
There, that’s all you need to know about a mortgage for rental property. If you’re ready to purchase a property, head over to Mashvisor to search for a property and assess its investment opportunity through the available investment property calculator!