The Basics of Investment Property Financing

Given the current real estate market, with an abundance of undervalued and distressed properties, looking into the purchase of an investment property might be a good idea.

Keeping in mind how these properties work from a finance perspective will help in the decision to purchase one.

What is The Strategy?

The three questions that a potential property investor should ask are:

  1. How much of a down payment is needed?
  2. How much of an investment will be required to get the property either rentable or resalable after purchase?
  3. What will the market bear in terms of either a rental rate or a sales price?

Getting Financed

Investors should expect to have a down payment of at least 25% when purchasing a property. Rates are from 0.5% to 1% higher than those charged to purchase a home used as a primary residence, and you should expect to have at least six months of mortgage payments in the bank as asset reserves for each investment property that you own.

However, if you purchase a two- to four-unit property and intend to live in one of the units, the property will be considered a primary residence and financed accordingly.  There are still premiums that apply for multiunit properties, but they are normally lower than those for investment properties.

On a mortgage application, rental income is typically calculated at 75% of the amount on the lease, to account for vacancies throughout the year.  This difference in income will be made up by your personal income. If you have less than two years of landlord experience, you will not be eligible to use the rental income on the mortgage application and will need to cover that amount with your personal income.

Essential Tips to Help Get the Best Mortgage

Whether purchasing or refinancing a mortgage, following a few simple steps will ensure that borrowers get the best mortgage for their situation.

The first questions that borrowers should ask themselves are how long they plan to own the property and what type of stability in payments are they looking for. If you plan on being in the property for only a few years, an adjustable-rate mortgage (ARM) or a balloon loan might be best for you, as the rates on these can be lower than that of a fixed-rate mortgage.

Finding the Best Mortgage

Getting in touch with one or more mortgage professionals is the next step in the process. You should explain your situation, then listen to what the professional has to say.  Mortgage brokers and banks are required by law to provide, in writing, to a potential borrower a good faith estimate, or GFE. The GFE will show a rate, costs and the amount of escrows that a borrower should expect to pay.

Good faith estimates can and should be compared to one another. If you want another opinion, you should speak to someone you trust and who is independent of the transaction, such as a real estate attorney.

You should also be asking how long you can expect the process to take. Longer turn times in periods of very low rates are to be expected. A good idea, especially in the case of a refinance, is to get prequalified in anticipation of low rates. The less processing that a lender needs to do with a file after the rate is locked, the lower the rate it is usually able to offer.