rental property mortgages | InvestingInProperties.com

Investment Mortgage Loan Costs

A tighter lending market

Property investors know that a rental mortgage is harder to obtain financing for, as well as costs more, than residential home mortgages. Why? The answer is simple:

lender risk. The greater the risk, the greater the financing costs for the bank. And likewise, the lower the risk, the lesser the cost structure. Lenders always look at their worst case scenario: that is, a property going into foreclosure if the monthly mortgage is not paid in a timely fashion. It is for this exact reason that lenders assign greater risk to investment mortgage loans.

Home purchases are highly emotional to borrowers. There is a natural human affinity to stay in one’s home – one’s own personal sanctuary. And a borrower will do all he can to keep his home, even when beset with personal financial difficulties. A homeowner is thus much more likely to attempt to hold onto his home and make payments on his mortgage in a timely manner than an investor would on a rental property. Investors look at balance sheets and income statements to determine if a property is worth sinking more money into and making mortgage payments in a timely manner. It is the concept of emotionalism and ties to a home that makes home buyers a safer risk than property investors.

The extra costs with an investment property mortgage

While there are daily fluctuations in rates globally, all real estate is local – and rates will differ from region to region. However, on average, rental home mortgage rates have

traditionally cost about half a point higher in mortgage financing costs relative to the residential home mortgage marketplace. Again, this is due to the increased inherent risk associated with non-owner occupied rental properties.

There are some discreet factors that ultimately affect the rate any investor will be able to obtain on their rental property. Some of the factors include the type of rental property – ie., a single family versus a multifamily, the loan-to-value ratio (the lower the LTV, the lower the mortgage rate, and vice-versa), the borrowers credit score, and of course, the current occupancy and rental cash flow of the property. The higher the occupancy rate, the lower the costs associated with the loan. Also, know that extra points can be shaved down by accepting a slightly higher interest rate on a rental mortgage.

The basics of rental property mortgage financing

While credit markets are much tighter for investment property, some generalities hold true when choosing from different rental property investment strategies. Occupancy rates help lower overall mortgage costs for rental property. Traditionally, 75% of current rent roll on a property can be used as an income qualifier for any given rental property. Loan-to-value ratios tend to start at 70% for investment property (while it’s 80% for home loans). Lower LTV’s (eg., down to 60% or 50% even) can substantially lower overall costs of the loan, including points and interest rate). In addition, when real estate investing, an excellent credit score (above 740) will also aid in reducing overall rental property financing costs. This can greatly expand what you can borrow, helping paint a brighter financial picture for your investment opportunities.

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The Ups And Downs Of Leverage

The seesaw swings both ways with leverage

Unlike other forms of investment, real estate investing affords property investors the innate ability to leverage their assets to obtain much greater returns over time. While this is a tried and true investing fundamental when purchasing real estate, there are also pitfalls one must be aware of before jumping headlong into the property acquisition process and obtaining any investment mortgage loan. To better protect yourself, here are the main pros and cons you’ll need to be very cognizant of when using leverage as you invest in rental property and take out investment property loans.

The main advantage of leverage

When utilizing leverage, the property investor is trying to use as little of their own investment dollars to act as a springboard to greater wealth. Return on investment (ROI) is traditionally much greater utilizing leverage than when only using one’s own

investment dollars to fund your projects. By obtaining a rental mortgage on one or all of your investment properties, you’re able to leverage the most amount of investment dollars while keeping the absolute amount of your own dollars sunk into investing to a minimum.

As an example, if a $100,000 rental property acquisition cost has a down payment of 30%, then you need only put up $30,000 of your own funds to lock up the property. If market appreciation is 4% a year, the property value in this example would increase to $104,000 on the rental real estate. But your ROI on it would be 13.3% ($4,000/30,000). And as you continue to grow your business, slowly adding properties, you can take out mortgages on each one, eventually using the equity in each prior one to help defray your new acquisition down payment costs.

The main drawback of using leverage

Traditionally, home values have remained quite stable over time. However, in periods of great flux or recession, they can decrease in value. And if you need to get out of the market at any given time, this can create a dangerous scenario for real estate investors. If, using the example from above, the $100,000 property decreases in value by the same 4% in a given year, the property would be worth only $96,000. And you, the property investor, still need to make interest and principal payments on the loaned amount (in this case, $70,000), regardless of the current market valuation. If you have leverage multiple properties, and we hit a bad real estate market all of a sudden, well…you can see the potential for financial destruction that could ensue.

Beware the dangerous housing “bubbles”

Luckily, these periods of “correction” or housing bubbles come few and far between.

But nevertheless, it is imperative when buying rental property that any prospective property investor understand the conceptual financial risks inherent when taking on investment property mortgages, thereby increasing their leverage. While leverage is one of the fundamentals of real estate investing, if you’re willing to take moderate risks, you’ll be able to manage using leverage to your advantage. However, always weigh the illiquidity of property investments, as well as the lack of diversification if you only acquire properties in, say, residential real estate and/or in one geographic area.

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The VA Rental Mortgage Loophole

The inside scoop on this legal trick

Of all the tricks and investment property financing tips I point out in my real estate investing articles, the VA mortgage loophole is one of the better ones. Veterans Administration (VA) mortgage loans, traditionally offering financing of 100% of the purchase price on a home for veterans, are designed specifically for homes – that is, owner–occupied houses. However, VA loans, like most FHA loans, allow for financing of 1-4 family homes as long as the purchaser will be an owner-occupant. So if you qualify for a VA loan, you would be able to purchase a two, three, or four family investment property, live in one unit, and rent out the other units in the building. All the while taking advantage of 100% financing provided by the VA, in a de facto rental mortgage loophole.

Qualifying veterans

As long as you are the owner-occupant at the time of the loan, you could qualify and take advantage of low rental home mortgage rates. But let’s say you do this, then decide to move after a period of time. The loan would stay in place, and in theory, you could look to repeat the procedure. Keep in mind that any veteran has an amount that he would be qualified to borrow without having to make a down payment on the property. If all of a veteran’s allowance is not used up on one property, he could utilize the remainder to obtain 100% financing on another property. In this way, you could start building up investment properties utilizing strictly VA loans.

Another investment mortgage loan possibility

The VA also offers another excellent choice of financing for veterans. It’s called the Interest Rate Reduction Refinance Loan (IRRRL). This program would allow a veteran to refinance a property that had been formerly bought with a mortgage from the VA. This would be done, ostensibly, to obtain a lower rate of interest on the loan. This Interest Rate Reduction Refinance Loan also has some unique provisions regarding owner-occupancy. For example, it does not require the owner to live at the property – only that he once lived at the property. This would offer a veteran the ability to buy a multi-family property, live in it, and then eventually obtain this IRRRL mortgage at some point in the future. In this scenario, one could then move out and purchase yet another multi-family under four units, live in one of them – and obtain yet another VA first mortgage with no money down. You can see how much leverage these types of investment mortgage loans can produce…and they’re not really investment mortgage loans per se.

Using your equity as leverage

Finally, a veteran would be able to utilize his equity in each succeeding investment property he acquires in order to leverage the acquisition of even more rental properties. He could use the IRRRL route of mortgage financing, or decide to utilize other forms of non-VA, traditional rental mortgage loans from banks or other lenders. Either way, he’d be substantially increasing his investment property acquisitions by wisely using leverage to its optimum advantage, simply by taking the accrued equity from each of his properties and plowing it back into other property investment purchases.

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Investment Property Loan Financing Tips

Understanding the psychology of lender risk

The reason investment property loans are more expensive, harder to obtain, and more restrictive than loans on personal homes, is that investment property mortgages are inherently riskier than home lending. Fannie Mae and Freddie Mac charge higher rates for investor property loans, much more than for primary home loans because of these higher risk factors. It’s a simple axiom – the greater the risk, the higher the cost. Of course, the opposite axiom is likewise the same – the lower the risk, the smaller the cost. For lenders, real estate investors are inherently more dangerous as a group to make loans to than are homeowners.

Thinking like a bank thinks…

Banks have to look objectively, and ruthlessly so, at their bottom line. What’s their worst case scenario in any lending situation? Naturally, a foreclosure. And in the case of those investing in rental property who are unable to make their monthly loan payments, since they have no emotional stake in the property, they will be more likely to walk away from their loan obligations in any worst-case scenario. Much more so than any homeowner would, since homeowners are emotionally grounded to their home – which is most probably their single greatest asset. This helps explain why total mortgage costs run higher for real estate investments, as well as why investment property mortgage rates are higher than homeowner rates.

Real estate investors understand that buying a rental property is simply a game of numbers. A homebuyer views their purchase decision in much more emotional ways – deciding what emotional benefits will accrue him if he buys a particular home. Conversely, this makes it much more difficult for the homebuyer to give up “his baby” so to speak. And this single reason is what makes lenders value the homebuyer as much less risk than anyone buying rental property.

Mortgage rate differentials

Regardless of the specific area of the U.S. you may look to buy in, real estate investments will have mortgages that will generally run about half a point greater than home loans on average. In addition, many fees tend to be added to loans on investment properties – many more than home mortgages. Thus, the overall cost of any rental property mortgage will be greater as well. Some of the factors involved in the overall costs associated with an investment property loan include the borrower’s current credit score, the loan-to-value ratio for the loan, the property character (ie. – single family, duplex, multi-family, multifamily with owner-occupying one unit) and the specific mortgage program being applied (FHA, Fannie Mae, Freddie Mac or no government-insured program).

LTV’s

In many instances, when in investing in real estate, lenders set up loan-to-value (LTV) ratios at higher overall amounts than home loans. The greater the amount you put down on the rental property you’re trying to finance, the less overall risk to the lender. Most lender these days have maximum loan-to-value ratios of 70% of the purchase price, where you, the buyer, must put down at least 30%. But if you put down 40%, or even 50%, you’ll find your interest rate and overall costs of the mortgage loan will come down substantially. This is also because you are helping to substantially lessen the lenders overall risk. (After all, it’s much harder to walk away from a property you have 50% down in equity than it is if you had only 30% down.)

Using rents as income qualifiers

Traditionally, banks will allow 75% of gross rents currently in place on units in any property you’re thinking of acquiring to help offset the monthly carrying cost of the loan. Keep in mind that this applies only to actual rentals…not hypothetical “market” rents. In addition, the tenants need to already be in place. Typically, the same 75% figure can be used to offset monthly loan costs in any refinance situation for your rental property.

Credit scores

You should also remember that lenders usually require those buying rental property to have better credit scores than their homebuyer counterparts. Lenders like to see scores of at least the low to mid-700’s before extending any rental property mortgage. (That’s not to say that it’s impossible to obtain a loan if your score is in the 600’s – but it will be more difficult, and certainly, it will come with a much higher interest rate. The bank, after all, is always looking to defray their risk.)

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The Current State of Investment Property Mortgages

It ain’t all that pretty…

If you are actively searching for investment real estate, it’s a good idea to be aware of the current state of the investment property mortgages market. While credit remains relatively much more difficult to obtain compared to several years ago, new banking regulations have made things even tighter in the mortgage arena since the beginning of the year. So you’ll need to have your creditworthiness all lined up before you try to close on any deal. You certainly don’t want to waste your time searching for a good investment property deal, only to find you can’t obtain the requisite financing.

Increased credit tightening

The most notable change in the credit markets this past year has been an intense scrutiny (and concomitant tightening of documentation) required on all residential investment property mortgages. Private investment from Wall Street has all but dried up completely for riskier loans, and as such, lending in most areas of the country will not allow for any form of “no documentation” (also known as “stated income” or “low documentation”) types of mortgage financing. Pejoratively, these loans have been called “liar loans,” mainly because one could lie about one’s income with impunity in order to qualify for the loan.

Currently, even stated income investment property mortgages that can be had allow lenders to audit your past federal tax returns (usually in case of default) to prove you were not truthful on your loan application. This further places more protection into the banking system to further avoid the wide use of fraud that contributed so strongly to the real estate collapse of the recent past.

Make your mortgage lender your ally

Armed with this investment property information, it is always advisable to discuss your financial situation with a mortgage lender before you start to locate your next investment property deal. This way, if you are self-employed, for example, you’ll be able to prepare in advance what documentation you’ll need for the future. You’ll know what amount of mortgage you can comfortably qualify for, and be able to plan for future financing as well. You can also get prequalified and preapproved for any investment property mortgage loan now, rather than waiting until you have a great deal in place, and then finding you don’t qualify. In that scenario, you could end up potentially losing out on the deal (and all the work you put in on it) since you couldn’t secure your financing in a timely manner.

So try to work with a local lender you’ve worked with before, get to know them, and let them advise you on your best plans of action for qualifying for your next investment property mortgage. Once you, do, you’ll be able to return to them, and cut through much red tape in the process for all subsequent investment property loans you will be trying to obtain.

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How To Leverage Rental Properties

Start by creating a long range plan

In creating a long range plan for investing in real estate, you should consider how best to leverage any and all rental properties you may acquire. After you successfully start with purchasing your first rental building (this assumes you are, and should be, in a positive cash flow position), you’ll want to utilize the equity from the first property to help with the acquisition of your second property.

This “rolling over” of your equity in your first property is what helps give real estate a distinct advantage over other forms of investments. Your ability to leverage each property you own to aid in the acquisition of the next property is crucial to successful real estate investing.

How to leverage successfully

By laying out a long range plan, complete with your property investment goals for a 5, 10, 15 and 20 year period, you can see on paper how often you’ll need to purchase a rental property. This timing pattern is important for you to feel comfortable with accomplishing. It also creates a written “agreement” with yourself to adhere to. As an ambitious, but simplistic example, let’s say you propose to acquire one rental property each year for the next 20 years. Each property must throw off positive cash flow. If they don’t, your plan will have to either be adjusted to a different acquisition timing structure, or you’ll need to sell off the underperforming (read: negative cash flow) properties as you learn more about why they’re underperforming.

Work with only one lender

Next, you’ll want to have a good working relationship with one mortgage broker/lender. Someone you can talk to about your plans ahead of time, and who will essentially become your partner over the long haul of property investing. Working with just one lender will create a kind of lovely business shorthand – one in which there’ll be no need to continually explain what you are trying to do with each refinance of your investment properties. You’ll also be able to create a long history with one lender – thus increasing your credit rating, trust and potentially yielding better long-term mortgage interest rates, as well as greater loan-to-value ratios than your lender’s norm. Never underestimate a bank’s desire to work with the same, consistent borrower over and over again. Many benefits will accrue to you over time by doing so.

In the above example, after you’ve purchased your first property, it will be time to acquire your next one in a year’s time. After you’ve located the next one (and have crunched your numbers as to what you feel it’s worth to you), go to your lender and discuss what equity you can reasonably pull out from your first property. Then back into the amount you’ll have to cover “out-of-pocket” to make the second rental building purchase a reality.

Long term progressions…

In the same way, by the time year three rolls around, and it’s time to purchase your next investment property, go back to your lender to discuss the possibility of “packaging” both your first two properties, pulling equity from both of them, either by refinancing both mortgages, or adding a new mortgage to just the second property. In this way you can help pull out more cash for the down payment on your third “installment” of your rental property long range plan: your third rental building purchase.

So by now you can start to see the progression this “rolling” of your properties is taking, as you and your lender are always re-evaluating what your current stable of properties will fetch in terms of equity. The fourth year, you do the same thing – locate your next purchase, go back to your lender, and see how much equity your “package” of investment properties will allow – either individually refinanced, or as a group. In this way you can determine how much you’ll have to put in to the next deal out-of-pocket.

After several years in this example, you can start to realize the ability to invest in properties without putting in any cash on your own . You’ll simply be leveraging the equity in each and all of your stable of investment properties, and utilizing that equity to enable you to acquire even more properties. In this way, you can build your own real estate mini-empire – at least one that may throw off a sizeable amount for you to some day retire on.

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