Mortgages on Investment Properties

investment property

Investment properties, also known as non-owner occupied properties, can be very profitable for casual homeowners and real estate investors alike. While there is no guarantee that you’ll be successful, extensive research and the right timing could result in a tidy profit.

That said, it’s important to know the demographics for a particular neighborhood, and whether the market is set to improve or decline in the near and long term. It’s equally important to find a tenant to rent out your property to ensure you’ll achieve positive cash flow immediately and continuously.

Achieving Positive Cash Flow

While it’s not imperative, positive cash flow will allow you to invest in other properties by minimizing losses and out-of-pocket expenses, which will keep your DTI ratio low.  It’s also quite important if the property you buy isn’t expected to increase in value significantly.

Cash flow isn’t as important if the property is expected to surge in value, but finding a property on the cheap with the potential to appreciate is the ultimate goal.

Discovering that “hot property” is often the impetus for real estate investment. But always take your time to investigate before diving in. Certainly pay attention to local area rents to determine if buying makes more sense than renting.  If the price-to-rent ratio is considerably favorable, it could be a no-brainer.

And take special care when investing out of state, and especially out of the country. If you plan on buying an investment property in Mexico or Spain, do your research and make sure you’ve got a good understanding of the laws of the land. Ensure you’re working with a reputable broker or builder. Ask for references!

Obtaining Mortgage Financing on an Investment Property

Investment Property Number of Units Max LTV
Purchase 1 85%
Purchase 2-4 75%
Rate and Term Refinance 1-4 75%
Cash-Out Refinance 1 75%
Cash-Out Refinance 2-4 70%

 

The next hurdle is obtaining financing on an investment property. Even if you’re familiar with how mortgage works, it’s important to understand the restrictions tied to investment properties as they often differ from primary residences and second homes.

If you plan on buying an investment property, be prepared to put some money down, usually 20% or more. The days of 100% financing on investment properties is a thing of the past because banks and lenders incurred heavy losses from massive defaults and mortgage fraud.

All that speculation during the previous boom led to widespread strategic default, with investors cutting their losses on properties they had very little if anything invested in.

What Is the Minimum Down Payment on an Investment Property?

We’ve come a long way since 2006. And because lenders were hit with major losses during the housing crisis, they’ve adjusted their risk appetites significantly, especially when it comes to non-owner occupied properties.

Today, you may need to put 30% or more down on an investment property depending on your credit profile, documentation type, the number of units, and the value of the property.

For example, Fannie Mae (see chart above) limits the loan-to-value ratio (LTV) to 85% for the purchase of a one-unit investment property. That means you need at least a 15% down payment if you want to finance one. It drops to 75% LTV for a 2-4 unit non-owner occupied property. That increases your down payment to 25%!

But wait, it gets even more restrictive. If you want to take cash out on a 2-4 unit investment property, your max LTV drops to 70%. That means 30% equity is required, which might not leave a ton of cash available for extraction.

As you can see, the more complicated the loan scenario, the less you can finance. There’s also the issue of mortgage rates, which will generally rise as the LTV and number of units goes up. It can be a bit of a one-two punch and make qualifying that much more difficult.

Another hitch is that gifts for down payment are not allowed on an investment property, for obvious reasons. One way around this is to occupy the property first and then rent it out in the future.

In fact, that’s a great way to get started in real estate investment. You live in the house or condo for a period of time, and eventually rent it out and buy another property. Rinse and repeat. That way you know the ins and outs of the property, along with local area rents, and any other quirks. Ideally, you’ll also live close by if anything goes wrong.

Also note that many exotic mortgage programs such as option-arms and interest-only limit financing on investment properties to 80% or less for the most part, so be prepared to come in with more cash if you’re looking for an ultra-low start rate or some sort of negative amortization program.

Lender Restrictions on Non-Owner Occupied Homes

Now comes the trickier stuff. Most lenders don’t like to lend to investors with over 10 investment properties. And many lenders have a limit to how much they will finance, so if you’ve got two loans with a certain bank or investor, they may not be able to provide financing on a third property if you’re over their aggregate financing limit.

Additionally, if you plan on buying an investment property within a condominium complex, note that investor concentration usually cannot exceed 50 percent. This means at least half of the units need to be owner-occupied. And if it’s a new development, usually at least 50 percent needs to be sold and closed before many lenders will provide financing.

Most lenders also limit the total percentage of a complex owned to 10 percent by a single entity, so if there are only 10 units, you can typically buy just one.

Of course, these rules vary from bank to lender, and often developers will provide special financing on site to new investors. But these issues can and often do arise, preventing investors from obtaining favorable financing terms.

So do your financing homework and obtain pre-approvals before making an offer or jumping into a contract. And be prepared to show up to the signing table with a hefty down payment or you’ll likely be out of luck.

Investment Property Mortgage Rates

Lastly, an important note about mortgage rates. Many investors forgo mortgage financing entirely and simply purchase investment properties with cash. But not everyone has deep enough pockets to do that. And not everyone wants to lock up their hard-earned cash either.

If you do plan to finance your non-owner occ property with a mortgage, expect sizable pricing adjustments for both occupancy type and multiple units, if applicable.

Simply put, prepare to get saddled with a higher mortgage rate simply because it’s an investment property. And because rentals are often multi-unit as well, your wallet might get hit twice.

For example, if you purchase a NOO 4-unit property, expect your closing costs and/or mortgage rate to be significantly higher compared to an owner-occupied single-family residence.

That’s the price of uncertainty; investment properties inherently carry more risk than owner-occupied homes and are priced accordingly.  Yet another reason why most investors try to buy with cash instead.


6 Comments

  1. Mike Moore August 26, 2015 at 9:43 pm -

    Colin,

    Your explanation is very consistent with my own experience. Do you know of any lenders willing to do 25-30 year mortgages with a fixed rate (sub 5%) in today’s market when the borrower already has over 10 mortgages….?

    Sincerely,

    Mike

  2. Colin Robertson August 27, 2015 at 7:47 am -

    Mike,

    I think some of the newer non-QM lenders allow you to finance 10+ properties, but not sure if the rate will be below 5%.

  3. Ken August 28, 2015 at 12:14 pm -

    It’s definitely tricky to find financing for groups of condos. We own 22 condos in an older complex, and even though we’ve turned around the units since buying them in groups from tired investors, have renovated the units, have great tenants that all pay on time by ACH, and are making good money, the word “condo” seems to scare off bank and credit union loan officers. I’ve spoken with many loan officers and learned their institutions aren’t touching investment condos. Put those same units into an apartment building and financing is available all day long.

  4. Dani A. April 13, 2016 at 11:49 am -

    I own a property in NJ, my parents live in it. It has depreciated quite a bit. I owe about $370k. Its not my primary residence. Paying interest at almost 8%, tried to refinance but was rejected by current lender. What are my options?

  5. Colin Robertson April 18, 2016 at 10:27 am -

    Dani,

    If you think you can refinance if it’s a primary residence as opposed to an investment property, maybe move in with your parents and make it primary to get the rate down?

  6. John M. June 9, 2016 at 1:43 pm -

    I am buying a 2 family non owner occ. property, need a good low cost, low interest lender. cleveland, ohio and i already have a non owner condo.

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