Getting Home Loans to Finance Your Rental Property Investments

Purchasing a rental property can be a great way to build long-term wealth. However, most investors need a home loan to finance the purchase of an investment property. While the process is similar to getting a mortgage for your primary residence, there are some key differences when it comes to home loans for rental properties.

Overview of Home Loans for Rental Properties

Just like with a primary mortgage, home loans for rental properties allow you to leverage the bank’s money to purchase the property This allows you to buy a more expensive rental than you may be able to with cash alone

The most common types of home loans for rental properties include

• Conventional loans – Offered by private lenders and not guaranteed by the government. Typically require a 20-25% down payment.
• Jumbo loans – For properties above the conforming loan limits set by Fannie Mae and Freddie Mac. Down payments of 20-25% are common.
• Portfolio loans – Offered by community banks and credit unions. May offer more flexible lending guidelines.
• FHA loans – Insured by the Federal Housing Administration. Allow down payments as low as 3.5% if you live in one unit.
• VA loans – Provided by the Department of Veterans Affairs. No down payment required for eligible veterans.
• USDA loans – From the U.S. Department of Agriculture for rural properties. 100% financing available.
• Home equity loan/line of credit – Uses your existing home’s equity as collateral for the rental property purchase.

The most affordable option is often an FHA, VA, or USDA loan if you qualify. However, you must live in the property for at least 12 months in most cases. After that, you can convert it to a rental.

Key Differences from Primary Home Loans

While home loans for rental properties follow the same basic process, there are some key differences:

• Higher down payments – Most lenders require 20-25% down for an investment property compared to as low as 3% on a primary residence. This helps mitigate their risk.

• Higher interest rates – Expect to pay 0.5 to 1% higher interest on a rental property loan. Lenders see it as riskier than your primary home.

• Shorter terms – Some lenders offer shorter repayment terms like 15 or 20 years for rental loans. Longer amortization increases the risk.

• Stricter debt-to-income ratios – Your DTI is calculated differently, with lenders wanting to see you can handle both mortgages.

• Fewer loan programs available – Government-backed loans like FHA are limited to owner-occupied properties, with a few exceptions.

• More documentation required – Expect to provide 3 years of tax returns, current rent rolls, vacancy history, etc.

Steps to Getting a Home Loan for a Rental Property

If you’re ready to move forward, follow these key steps:

1. Check your credit score and report – Lenders will want to see a minimum 620 FICO score in most cases. Fix any errors on your report.

2. Calculate your expenses and debt-to-income ratio – Factor in the new mortgage, insurance, property taxes, and maintenance costs for accurate numbers.

3. Gather your documentation – W-2s, paystubs, tax returns, bank statements, existing property records, etc. Be thorough.

4. Shop lenders and get pre-approved – Compare rates and fees from multiple lenders. Pre-approval shows sellers you’re serious.

5. Make an offer and apply for financing – Submit your final application with updated financial records once your offer is accepted.

6. Get an appraisal and inspection – The lender will require an appraisal to ensure the property is worth the loan amount. Inspect for any issues.

7. Close on time – Work closely with your lender, real estate agent, and title company or attorney to close on schedule.

The entire process normally takes 45-60 days on average. Having all your documentation ready can help speed things along.

Tips for Securing the Best Home Loan for Your Rental

Follow these tips when shopping for a rental property mortgage to get the best deal:

• Aim for 20-25% down – While some lenders may go as low as 15%, you’ll get better rates and terms with a larger down payment.

• Shop multiple lenders – Compare quotes from banks, credit unions, mortgage brokers, and online lenders. Look at both rates and total fees/costs.

• Ask about “blanket” mortgages – Some lenders offer a blanket mortgage to cover multiple rental properties under one loan. This can provide easier financing as you grow your portfolio.

• Consider a portfolio lender – Community banks and credit unions may offer more flexibility compared to big banks. Discuss your specific situation.

• Look for low caps on rate hikes – Adjustable-rate mortgages come with annual and lifetime caps on rate increases. Lower caps reduce future risk.

• Buy in your LLC’s name – If owning rentals in an LLC, some lenders can finance in the entity’s name directly to provide liability protection.

• Get pre-qualified – Pre-qualification from a lender shows sellers you can actually get financing. Aim for this before making offers.

Finding the right home loan takes some savvy shopping, but the effort can pay off with better terms and lower costs. Work with a knowledgeable loan officer who can explain all your options.

Is Now a Good Time to Get a Home Loan for a Rental?

With mortgage rates still near historic lows, now can be an opportune time to leverage financing to invest in rental properties.

Some key factors to consider:

• Low mortgage rates increase affordability and investment returns
• Strong rental demand reported nationwide
• Potential wave of foreclosures on the horizon, increasing renter pool
• Ongoing economic uncertainty makes alternative income appealing

On the flip side:

• Competition from institutional investors is high in some markets
• Appreciation has slowed in recent years in some areas
• Rising material and labor costs make renovations expensive
• Some markets have enacted stricter rental laws and regulations

As with any investment, thorough research and running the numbers for your target market are essential. It’s critical to factor in all expenses beyond just the mortgage payment.

Work closely with your lender, real estate agent, accountant and property manager to assess if the risks and rewards of rental property ownership make sense for your goals. But locking in a low fixed rate now could pay dividends for decades to come.

The Bottom Line

Financing rental properties is very similar to getting a traditional mortgage, but with a few key differences. While government-backed programs are more limited, there are still plenty of financing options available from banks, credit unions and online lenders.

Shopping multiple providers and asking the right questions can help investors find affordable home loans to build their rental portfolio over time. Paired with detailed market research, having the capital from a mortgage to purchase quality rental real estate could prove a sound long-term wealth-building strategy.