How To Get A Home Loan For A Rental Property: The Complete Guide

Purchasing an investment property and renting it out can be a great way to generate passive income. However financing the purchase of a rental property is different than getting a traditional mortgage to buy a primary residence. Lenders view investment properties as riskier so you’ll need to meet stricter requirements to qualify for a rental property loan.

In this comprehensive guide we’ll cover everything you need to know about getting a home loan for a rental property. including

• The differences between rental property loans and primary residence mortgages
• Loan qualifications and requirements
• Types of rental property loans
• Tips for getting approved
• Pros and cons of becoming a landlord

Let’s dive in!

How Rental Property Loans Differ From Primary Residence Mortgages

While the process of applying for a rental property loan is similar to getting a regular mortgage, there are some key differences to be aware of:

Down Payment Requirements

Most lenders require a minimum down payment of 15-20% for an investment property loan, compared to as low as 3% for a primary residence. This helps mitigate the risk for the lender

Debt-to-Income Ratio

Your debt-to-income ratio (DTI) measures your total monthly debt payments divided by your gross monthly income. For a rental property loan, your DTI generally needs to be below 45%. On a primary mortgage, you may qualify with a DTI up to 50%.

Rental Income Calculation

When applying for an investment property loan, lenders will consider 75% of expected rental income when calculating your DTI. They don’t count all of it because of the risk of vacancies.

Credit Score Requirements

You’ll typically need a minimum credit score of 620 to qualify for a rental property loan, while primary mortgages may only require a 580 score. The higher score requirements help offset the increased risk.

Loan Types

Certain loan programs for primary residences, like FHA and VA loans, cannot be used to purchase rental properties. Your main options are conventional, portfolio or alternative loans.

Rental Property Loan Requirements and Qualifications

Beyond the differences mentioned above, lenders will also evaluate these key factors when considering you for an investment property mortgage:

• Employment history – You’ll need at least 2 years of stable income history. Self-employed borrowers may need 4+ years.

• Cash reserves – Lenders want to see you have 3-6 months of mortgage payments available in reserve to cover costs if the property sits vacant.

• Credit history – At minimum, you’ll need a 620 credit score. But a 740+ score will get you better rates. Low balances and on-time payments are ideal.

• Down payment funds – You must document the source of your down payment, with many lenders requiring it to be from your own funds rather than a gift.

• Property management plan – First-time investors may need to provide a detailed plan for managing the property. Experience managing rentals helps.

• Existing properties – Lenders may limit the number of mortgaged properties you can have. Typical limits are 4-10 financed properties.

Meeting these requirements demonstrates you can handle the demands of being a landlord and reduces the lender’s risk.

Types of Loans Available for Rental Properties

While your financing options are more limited than with a primary residence, here are some common loan types to consider:

Conventional Loans

Conventional loans backed by Fannie Mae or Freddie Mac are the most popular option. You’ll need at least a 15-20% down payment and solid credit. Interest rates are typically higher than primary mortgages.

Pros

• Competitive interest rates
• Fixed or adjustable terms up to 30 years
• Lower down payments possible with good credit

Cons

• Stricter qualification standards
• Requires 20-25% down payment for multi-units
• Higher interest rates than primary mortgages

Portfolio Loans

Offered directly by banks and credit unions, these loans aren’t sold to the secondary market. Terms are flexible but interest rates tend to be higher.

Pros

• More flexible qualifying standards
• Lower down payments may be accepted

Cons

• Higher interest rates
• Large down payments still typical
• Less predictability in loan terms

Alternative Loans

Also called private or hard money loans, these come from individual investors or groups. Interest rates are high but they may accept lower credit scores.

Pros

• Down payments as low as 5-10%
• Fast funding possible

Cons

• Very high interest rates
• Large upfront fees
• Poor credit still makes approval difficult

FHA Loans

FHA loans can only be used if you’re buying a multi-unit property with 2-4 units and will live in one unit. At least one unit must be rented.

Pros

• Low down payments of just 3.5%
• More flexible credit and debt standards

Cons

• Must live on-site for at least one year
• Cannot use income from rented units to qualify
• Monthly mortgage insurance required

Overall, conventional loans tend to provide the best balance of rates, fees, qualifications, and flexibility for most rental property buyers. But shop around to find the best fit for your situation.

Tips for Getting Approved for a Rental Property Loan

Because lenders have higher standards for rental property loans, take these steps to improve your chances of getting approved:

• Aim for a 740+ credit score – The higher your score, the better your interest rate options. Pay down balances and correct any errors.

• Lower your DTI – Reduce recurring debts and avoid taking on new loans before applying. Getting below 36% DTI will boost approval odds.

• Make a larger down payment – Go above the minimum if possible, like 25-30%. This signals you’re financially stable.

• Have ample cash reserves – Have 6-12 months of reserves in your bank account, since vacancies can happen.

• Start small – If this is your first rental property, stick to a duplex or single family home before doing larger multi-units.

• Include a detailed management plan – First-time landlords should thoroughly explain how they’ll manage the property.

• Show strong self-employment income – If self-employed, have 2+ years of consistent, documented income from your business.

• Develop a relationship with the lender – Choose a lender you have an existing relationship with for simpler approval.

Meeting these tips will prove to lenders you can handle the demands of owning a successful rental property.

The Pros and Cons of Becoming a Landlord

Before diving in, carefully weigh the potential benefits and drawbacks of owning rental properties:

Potential Advantages

• Passive income – Rental income can provide ongoing money with minimal day-to-day management.

• Portfolio diversification – Real estate investing spreads out risk beyond just owning stocks and bonds.

• Leverage – You can buy a property using mostly borrowed funds and benefit from any appreciation.

• Tax advantages – Expenses can be deducted and you may qualify for tax breaks.

• Wealth building – If managed well, rentals can build long-term wealth as they pay down debt and grow in value.

Potential Disadvantages

• Property maintenance – As the owner, repairs and upkeep are your responsibility. These costs add up.

• Dealing with tenants – From screening to collecting rent to addressing complaints, tenants require oversight.

• Lower liquidity – It’s not easy to quickly sell real estate and access your cash.

• Risks from vacancies – Empty units lead to lost income and mortgage payment shortfalls.

• Lack of appreciation – Property values don’t always go up steadily, leading to less equity.

Key Takeaways

Owning rental properties can be a smart wealth-building strategy but also comes with headaches and risks. Entering the market with realistic expectations and solid preparation is key to success.

Wrapping Up

• Financing investment properties requires larger down payments, lower DTI, and higher credit scores than primary mortgages. Shop for conventional, portfolio, or alternative loans.

• To get approved, aim for great credit, ample reserves, low debts, and a detailed management plan. Start small if this is your first rental.

• Being a landlord provides passive income but also headaches from maintenance, vacancies, and tenants. Manage properties closely.

Getting an investment property loan requires jumping through more hoops than primary mortgages. But with proper planning and preparation, you can get approved and start building your rental real estate portfolio. Use this guide to navigate the process smoothly.