Investment Property Loans vs Primary Residence Loans: Key Differences You Should Know

When it comes to getting a mortgage one of the first things you’ll need to decide is whether the property will be your primary residence or an investment property that you’ll rent out. The loan terms requirements, and rates can vary significantly depending on how you plan to use the property. As you explore your home financing options, it’s important to understand the key differences between investment property loans and primary residence loans.

Overview of Investment Property Loans

An investment property is a property that is purchased with the intention of generating rental income, flipping for a profit, or earning returns another way. Investment property loans typically come with higher interest rates, larger down payments, and stricter requirements compared to primary residence loans.

Lenders view investment properties as riskier than primary residences for a few reasons:

• The borrower won’t be living in the home, so they may be less inclined to keep up with maintenance and repairs.

• If the borrower falls on hard times, they may be more likely to stop making payments on the investment property than their own home.

• There is the potential for vacancies which would stop incoming rental income.

To compensate for the increased risk, lenders charge higher rates and require larger down payments for investment property loans. Here are some quick facts about investment property loans:

• Interest rates are usually 0.25% – 1% higher than primary residence loans.

• Down payments tend to be 20% or higher. Some lenders may require 25-30%.

• Credit score requirements are higher, often 680 or above.

• Debt-to-income ratios must be lower, as lenders want to see you can handle both your personal debts and the mortgage.

• Reserves are often required to cover 6-12 months of the mortgage payments.

• Loan limits may be lower than what you could qualify for with a primary residence.

Overview of Primary Residence Loans

A primary residence is a home that you live in the majority of the year and consider your main home. Primary residence loans come with lower interest rates, smaller down payments, and less stringent requirements compared to investment property loans.

Lenders offer better terms on primary residence loans because they are seen as less risky:

• You will live in the home so are more likely to properly maintain it.

• Your own home is the last loan you would stop paying if money got tight.

• There is no risk of vacancies reducing income.

Here are some key features of primary residence loans:

• Interest rates are the lowest available as these are the least risky loans.

• Down payments can be as low as 3% with conventional loans and even 0% with VA and USDA programs.

• Credit scores requirements start in the mid 600s for government-backed loans.

• Debt-to-income ratios can be as high as 50% with some loan programs.

• Reserves are rarely required, outside of jumbo loan programs.

• Loan limits are the highest you could qualify for.

Comparing Loan Terms and Requirements

When getting financing for a property, it’s essential to be aware of how loan terms and requirements differ between investment and primary residence loans. Here is an overview of some of the key variances:

Interest rates

• Investment properties: Usually 0.25 – 1% higher
• Primary residences: The lowest rates available

Down payments

• Investment properties: Typically 20% or higher
• Primary residences: As low as 3% with conventional loans

Credit score requirements

• Investment properties: 680+ in most cases
• Primary residences: Mid 600s with government programs

Debt-to-income ratios

• Investment properties: Lower ratios required
• Primary residences: Can be as high as 50% with some loans

Loan-to-value limits

• Investment properties: 75% – 85% LTV depending on the lender
• Primary residences: Up to 97% LTV with some loan programs

Reserves required

• Investment properties: Often 6-12 months
• Primary residences: Rarely required

Occupancy timeline

• Investment properties: No requirement
• Primary residences: Must move in within 60 days of closing

Clearly understanding these key differences will help you choose the right loan product and improve your chances of getting approved.

Qualifying for Each Loan Type

The requirements to qualify for an investment property loan vs a primary residence loan can differ substantially. Here is an overview of key factors lenders evaluate with each occupancy type:

Qualifying for an Investment Property Loan

• Down payment amount – Typically need 20-30% down

• Loan-to-value ratio – Most lenders cap at 75-85% LTV

• Credit score – Usually require 680+

• Debt-to-income ratio – Want total DTI below 43% in most cases

• Cash flow – Income from rents must exceed PITI payments

• Reserves – 6-12 months of the mortgage payment may be required

• Experience – Some lenders want to see you have experience managing rental properties

Qualifying for a Primary Residence Loan

• Down payment amount – As low as 3% with conventional loans

• Loan-to-value ratio – Up to 97% LTV allowed with some loans

• Credit score – Available starting in the mid 600s

• Debt-to-income ratio – Allowable DTIs can be as high as 50%

• Reserves – Rarely required except on jumbo loans

• Occupancy timeline – Must move into the property within 60 days of closing

It’s much easier to qualify for a lower down payment loan on your primary residence. But investment property loans are certainly possible with good credit, income, and reserves.

Shopping for the Best Mortgage Rates

While investment property loans will have higher interest rates, it’s still important to shop different lenders to make sure you get the lowest rate possible. Compare options from banks, credit unions, and online lenders. Ask about both fixed and adjustable rate mortgages. Get pre-approved to identify the most competitive lenders. Here are some tips for landing the best possible rate:

• Check published rate sheets – Review lenders’ advertised daily rates for investment properties.

• Get personalized quotes – Apply with multiple lenders and compare custom rate quotes.

• Consider adjustable-rate mortgages (ARMs) – If you plan to hold the property short-term, an ARM with lower introductory rates could save money.

• Improve your credit – Work on increasing your score before applying to qualify for the best rates.

• Lower your debt-to-income ratio – Pay down debts so you can meet the lower DTI requirements.

• Make a larger down payment – Putting down 25% instead of 20% can help reduce rates.

Taking the time to shop around and improve your financial profile can help you lock in the most competitive rate on an investment property mortgage.

Pros and Cons of Investment Property Loans

If you’re considering purchasing a property as an investment, weighing the pros and cons of utilizing financing can help you decide if it’s the right move.

Potential Pros:

• Leverage – You can buy a more expensive property while putting down a smaller portion of the purchase price.

• Tax deductions – Interest, repairs, depreciation, and other expenses can lower your taxable income.

• Build equity – As the loan gets paid down, your equity share in the property grows.

• Potential appreciation – The property may increase in value over time, growing your net worth.

Potential Cons:

• Lower cash flow – Monthly mortgage payments reduce net rental income.

• Less ownership – You have to purchase a smaller share of the total property.

• Risk – Leverage amplifies both gains and losses on the investment.

• Less flexibility – It’s harder to tap into your equity or sell a mortgaged property.

The potential rewards of using financing for investment properties often outweigh the risks when approached cautiously. But utilize mortgage leverage only as part of a prudent investment strategy.

Alternatives to Investment Property Loans

Besides conventional mortgages, here are a few other financing options to consider for investment properties:

• Portfolio loans – Loans issued directly by banks or private lenders rather than sold to the secondary market. Often feature less stringent requirements.

• Hard money loans – Short-term loans issued by private investors and secured by the property. Interest rates are higher but easier to qualify.

• Home equity loan – If you have significant equity in your primary residence, a home equity loan or line of credit is an option.

• Private money – Raising capital from private investors is a way to fund purchases without bank financing.

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