Our in-house team of experts has compiled this list for you to very easily find out how close you are to getting that investment property. No fluff was added. Don’t miss out on the compiled FAQs at the bottom of the page to answer any leftover questions you may have.
1. Credit Score
One of the most important factors you have to consider when applying for an investment property loan–or any loan, for that matter–is your credit score. A credit score is a number between 300 and 850 that determines your creditworthiness in the eyes of a lender. In other words, it helps the mortgage lender decide how likely you are to repay the loan amount.
Lenders are more likely to approve and offer lower interest rates to applicants with higher credit scores. Inversely, a borrower may have trouble applying for a loan or acquiring one with a low-interest rate if they have poor credit.
Real estate lenders have varying credit score requirements but, in general, you may qualify for a conventional loan with a credit score of at least 620. However, having a credit score of 720 and above can help you get a better interest rate as well as better loan terms.
For reference, here are the minimum credit score requirements for different types of residential and investment property loans:
- FHA Loan: 500 to 580
- VA Loan: No minimum credit score
- USDA Loan: At least 580
- Hard Money Loan: Typically at least 620 but can vary
- Fannie Mae and Freddie Mac: At least 620 for fixed-rate mortgages
- Commercial Real Estate Lender: Varies, but typically higher (700 and above)
- Home Equity Line of Credit (HELOC): At least 680
2. Down Payment
Aside from the credit score, the biggest hurdle for many real estate investors is the down payment. A down payment is mainly used to buy real estate property, and it is a non-refundable initial payment you put down on a purchase to reduce the lender’s risk.
The down payment can be a big speed bump as it is a significant amount of cash that you need to have on hand. Real estate investment lenders require anywhere from 20% to 30% down payment to finance your loan. On the other hand, mortgage lenders often require at least 5% of the property’s value.
Private money loans may reduce the minimum down payment if your credit profile is good or if you have a shorter loan term. FHA and conventional investment property loans may also have low down payment options, depending on your credit score and other financial factors.
However, it is not always a good idea to put down the minimum amount of down payment. Why? Because the cost you offset at first will ultimately go to the rest of your loan. For example, if you pay only a 5% down payment on an investment property, the loan itself will likely be larger, and you may have higher mortgage rates because the lender is taking on more risk.
There is really no way to get around a down payment, and you can’t use a personal loan to cover it. You can, however, use a second mortgage on your primary residence (for example) to finance an investment property mortgage loan. Alternatively, you can use your IRA or 401(k), but these options will also come with risks.
If a 25% down payment is too steep to get the investment property mortgage rate you want, check out these investment property loans with only a 10% down payment.
3. Debt to Income Ratio
Your debt-to-income ratio is your monthly debt payments divided by your monthly income. It is a reflection of how much money you earn vs. how much you spend and gives lenders an idea of how well you can manage the loan.
Similar to credit scores and down payments, investment property loans have varying requirements for debt-to-income ratio (DTI). However, you would want to keep your DTI below 43% or even 35% if you really want to qualify for a good loan. Lenders also prefer that less than 28% to 35% of your DTI is going to a mortgage loan.
What’s the reasoning behind all this?
Well, a lower DTI indicates that you have more financial wiggle room to take on a new real estate investment loan, meaning there is less risk of you defaulting on the loan. In contrast, a high DTI shows the lender that you are stretching your resources too high, and have a higher risk of not being able to repay them.
So, what do you do if you have a high debt-to-income ratio?
Of course, the best course of action is to pay down your debts, but this isn’t always possible in such a short amount of time. Alternatively, you can:
- Increase your income with part-time jobs or freelance work
- Pay off your smallest debts first
- Add a co-borrower with a lower DTI
- Enlist a co-signer with a low DTI and a good financial profile
Our financial experts recommend against applying for an investment property loan before you lower your DTI. Otherwise, you might end up getting stuck with a too-high interest rate.
4. Mortgage Reserves
Mortgage reserves are liquid cash and other easily accessible assets you could use to pay your investment property loan. It’s another way for lenders to reduce their risk and reduce the chances of you defaulting on your payments.
These reserves do not include the cash for down payment and closing costs. Hence, it’s another significant financial factor you have to consider as a real estate investor.
Lenders measure mortgage reserves by months. For example, a lender may require you to have at least six months’ worth of mortgage payments on hand. However, investment property loans don’t require this for all borrowers–it will depend on your creditworthiness and the type of loan you’re applying for.
So, what assets can be considered as mortgage reserves? Most lenders that offer investment property loans will accept:
- Liquid cash
- Trust funds
- Certificate of deposits
- Stocks, bonds, mutual funds
- Vested funds in retirement accounts
On the other hand, assets don’t qualify as mortgage reserves if they are not easy to access. This can include:
- Unsecured loans
- Insurance funds that cannot be accessed until death or job loss
- Non-vested funds
- Money from cash-out refinancing
- Lender contributions
Borrowers with a good credit profile likely won’t have to show proof of mortgage reserves. However, you might need to prepare for this requirement if your credit score is less than 700, your DTI is high, and you are putting down a mortgage payment of less than 20%.
Furthermore, six months is not the minimum for all borrowers. For example, if you are making a significant down payment but have a score of less than 700, you might only need to have at least two months of mortgage reserves.
5. Documentation
If you meet all these requirements so far, the next thing you have to do is to gather documentation that you indeed meet these criteria. These documents will help the lender determine how much you can afford to borrow, how much you can repay with each monthly payment, and what type of investment property loan best suits your financial situation.
Expect lenders to ask for a long list of documentation. This might include:
- Copy of a valid ID
- W-2 forms from the last 2 years
- Pay stubs from the last 30 days
- Bank statements from the last 2 months or more
- Stocks, bonds, mutual funds, 401(k) from the last quarter
- Documents defining child support and alimony payments, if applicable
- Profit and loss statements from the last 12-24 months, if self-employed
- College transcripts, if graduated within the last 2 years
- Documentation of any deferred student payment loans, if applicable
- Gift letters if using gift funds
As for verifying your credit score, you won’t have to submit these documents yourself. Instead, your lender will ask for your permission to check your credit history. If you are getting pre-approval, the lender will do a soft pull, which won’t affect your credit. Most property sellers will ask for a pre-approval letter before negotiating with you because it will show if you can afford the property.
Many lenders offer pre-approvals for prospective buyers, such as Rocket Mortgage. You can ask potential lenders if they provide this kind of service before getting deeper into the conversation about investment property loans.
On the other hand, a lender will perform a hard pull when you officially apply for the loan. This can negatively affect your credit score but doesn’t usually last for long.
6. History of Property Management
Regular borrowers can stop at the last requirement, but if you’re a real estate investor, you might have to show the lender that you are capable of handling the investment property properly. Like the other requirements we’ve discussed, lenders do this to determine your ability to repay the loan.
For example, a lender that offers house flipper financing might ask to see documentation of your previous flips to assess your risk as a borrower. Of course, lenders will prefer to loan money to someone who has the experience and expertise to generate income on the investment they’re financing.
What about if you’re applying for a rental property loan?
Some investment property loans will require documentation of your experience as a landlord if you’re trying to finance a rental property, especially if it is a multi-family building. However, this is not always the case. Lenders usually ask for this supplemental information when you are applying for more expensive investment properties.
A lender may evaluate the following before financing your rental property:
- Rental income and expenses
- Ongoing construction
- Major leases
- Tenant delinquencies (non-payment)
- Property tax
These factors will help the lender determine if the property (and you, as the landlord or investor) is likely to meet loan obligations.
How Credit Suite Can Help You
Understanding these investment property loan requirements is a crucial part of due diligence. You wouldn’t want to bite off more than you can chew, and there are certainly a lot of things you have to prepare before applying for a loan.
Don’t want to go for a traditional investment loan for financing? Why not use an investment property line of credit instead? You can use a business credit card, hard money loans, HELOC, a flip loan, and even a portfolio line of credit to buy investment properties.
Whatever the case may be, Credit Suite can help you find alternative forms of financing to help you jumpstart your career as a full-fledged real estate investor!
FAQs
What is the 2% rule for rental property loans?
The 2% rule is a guideline used in real estate investing to evaluate the potential profitability of a rental property. It suggests that a property’s monthly rental income should be at least 2% of its total acquisition cost.
For instance, if a property costs $100,000 to purchase, it should generate a minimum of $2,000 in monthly rental income to meet the 2% rule. This rule helps investors quickly assess whether a property has the potential to generate sufficient cash flow relative to its purchase price. However, it’s important to consider other factors aside from investment property loans, such as expenses, location, and market conditions before financing an investment decision.
Is it harder to get a loan for an investment property?
Yes, obtaining a loan for a real estate investment property can be more challenging compared to getting a home loan (primary residence). Lenders typically consider investment properties riskier because they may involve higher default rates and lower occupancy rates.
Consequently, they often impose stricter eligibility criteria, such as higher down payment requirements, lower loan-to-value ratios, and higher mortgage rates. Lenders may also scrutinize the borrower’s financial stability and creditworthiness more closely. Additionally, investment property loans may require a demonstrated history of real estate investment experience. On the other hand, less formal financing like hard money loans may be less stringent.
What bank will loan me money for an investment property?
There are too many to mention! However, it all depends on your current financial profile, as banks will each have a unique set of requirements. Notable banks that offer investment property loans include Wells Fargo, Bank of America, Chase Bank, TD Bank, and Capital One.
Alternatively, you can consider hard money loans, mortgage lenders, credit unions, and online lenders that specialize in investment property financing. Compare mortgage rates, terms, fees, and eligibility requirements from multiple lenders to find the best loan options suited to your needs. Just remember that lenders will not finance your property if you plan to use it as a primary residence, so be sure to have your living arrangements sorted out before you start investing in real estate.
