The U.S. real estate market is still red hot, thanks in large part to low interest rates. If you’ve been thinking about getting into real estate investing, now could be a good time. You can take advantage of the low rate environment to buy an income-generating property that will likely grow in value over time.
Buying an investment property can be a great wealth-building move. But it is a different ballgame from buying a primary residence, as investment property mortgage rates are almost always higher than they are for a primary residence, and the borrower criteria for investment property loans are stricter, too.
That’s not to say you shouldn’t pursue an investment property. But it pays to know the costs and qualifications before you get into the real estate investment game.
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Investment loans are riskier than those for primary residences. From a mortgage lender’s perspective, a homeowner is less likely to default on the loan for the home in which they live.
“All interest rates have risk adjustments for things such as lower credit scores, less money down, if it’s a condo or if it’s a multiunit,” said Nicole Rueth, a senior vice president and branch manager at Fairway Independent Mortgage Corporation (Fairway owns Home.com). “There is also a risk adjustment for occupancy when it’s an investment. The risk is greater that, if pressed, you would default on an investment before your primary home since you personally live in your primary home.”
You might think of an investment property as creating more stability, since, in theory, rental income will cover the mortgage payment.
But an income stream is not guaranteed. You need to secure tenants for the property, and there’s always the chance that they will fall behind on what they owe you. Lenders need to ensure that you have enough cash available to make the mortgage payments even if that happens.
Rueth described these issues as “volatility risks.” The risk of vacancy or of rents going down aren’t something you can control for. To compensate, lenders charge higher interest rates on investment property loans.
Typically, investment rates are 0.5% higher than those for primary residences when you make a 25% down payment, and 1.5% higher if you put down 20%, according to Rueth.
The average current mortgage rate is about 3% according to Freddie Mac (though that number varies based on the type of loan you have, your lender, and your financial situation).
Based on that average, an investment property borrower with excellent credit who qualifies for the most competitive investment property rate might receive 3.5%. Someone who receives a rate at the higher end of the spectrum might get a rate of around 4.5%.
Of course, it’s always preferable to get a lower rate. But even 3.5% is still lower than rates have been for primary residences in recent years. Locking in an investment property mortgage rate under 4% before rates rise can create significant opportunities for growth and profit over time, particularly if the property is in an in-demand market where home values and rents are rising.
Buying an investment property now gives you a chance to earn rental income that, depending on rental rates in your local market, could cover your mortgage payment. Your tenants would effectively be paying your mortgage, while you build equity in the property.
The equity you build in this property can help you finance the next investment and the next one after that. So while your interest rate may be higher than on your primary home, the gains you make could far exceed what you pay.
Lenders want to make sure that you are financially able to pay the monthly mortgage and costs associated with the property, including property taxes, maintenance and upkeep, and normal costs associated with an investment property, such as advertising to attract tenants.
So not only are mortgage interest rates higher, but the financial requirements can be higher than they are for primary residence mortgages.
Lenders will likely want to see the following.
The absolute minimum credit score lenders will look for on an investment property transaction likely to be 620, the same credit score conventional primary residence loans require.
But here’s the kicker: 620 is the minimum credit score allowed for a conventional investment property loan. Some lenders may require a 640 or higher as their minimum, and you may need a 700 or higher to be eligible for more competitive interest rates.
Investment property mortgages also require a higher down payment than primary residence loans. Again, this is due to the increased risk.
If you are buying a vacation home for yourself, but you plan to rent it out when you’re not using it, most lenders will require at least 10% down.
But if you are buying a house, or a multifamily property, exclusively as an investment, you may need more than that.
For a conforming investment property loan, your lender may require 15% to buy a single-family home and up to 25% for a multifamily home with up to four units.
Putting down more than the minimum required can help you get a better rate, though.
“There is a significant rate drop at 25% down and again at 40% down,” Rueth said.
She added that the type of property you buy influences the rate as well. If you’re tight on cash, you may want to opt for a single-family property.
“Multiunits have better cash flow, but a single-family will have a better interest rate,” according to Rueth.
Lenders require cash reserves for investment loans — you guessed it, because of the higher risk.
Depending on the transaction and lender, you may also need to have a “Minimum Borrower Contribution” on your transaction. This means that you apply a certain percent of your own funds in the transaction before any gift funds or approved assistance or asset types are applied.
The amount you need depends on how many properties you are currently financing (in other words, how many properties you have a mortgage on). If you have six or fewer financed properties, you will need between two and six months’ worth of mortgage payments in reserves for each home financed.
If you have seven to 10 financed properties, you will need six months’ or more of mortgage payments in reserve for each home financed. The amount is based on your transaction and the amount of additional financed properties you own.
And “mortgage payments” are defined as total monthly expenses, not just principal and interest. Include insurance, property taxes, HOA dues, mortgage insurance, second mortgage payments, and any other required monthly expense when calculating the reserves you’ll need.
Your primary residence is included in these requirements.
The term “cash reserves” can be a little misleading, because you don’t need the total amount sitting in a checking or savings account, though you can use those funds to qualify.
Cash reserves can also be held in:
- Stocks, bonds, and mutual funds
- Trust funds
- Cash value of a life insurance policy
- Rent credits
- Gift funds
- Loan proceeds from another secured loan
- Proceeds from selling another property
- Real estate commissions
There are a number of other allowed forms of reserves as well, and your loan officer can explain which of your assets may be used to qualify based on the type of loan you’re using.
If you’re a first-time homebuyer, here’s a tip: If you are able, it could be financially wise to buy a multifamily property with up to four units with a no or low down payment loan. Live in one of the units as a primary residence and rent out the others. You can start earning income right away, but you’ll qualify for primary residence loan rates. Plus, the borrower requirements are less strict, so you can qualify with less money down.
Investment property mortgage rates aren’t just determined by the market. They also depend on your financial picture.
If you have a 650 credit score, for instance, you may qualify for an investment property loan. But a borrower who has a 750 credit score is likely going to get a better interest rate.
Your rate affects your monthly payments, so it’s important to get the lowest one possible. Here’s how to maximize your investment property mortgage rate.
- Work on your credit score. The most important step you can take to help your credit score is to pay your bills on time. Credit scores are based on your past financial behavior, and a history of late payments can impact it negatively. The second most important thing is to pay down existing debts and balances. This can help your credit utilization ratio (how much credit is available to you vs how much you owe), another big factor in your score
- Increase your down payment. More money down reduces your lender’s risk, so putting down more than the minimum can help you get a better rate
- Buying a multifamily property and living in one of the units. Owner-occupied mortgages (meaning you live in the home) are less risky than non-owner occupied loans. If you opt to live in a multifamily property, you may be eligible for a lower rate while also enjoying the benefits of earning rental income
- Buy a primary residence and rent it out after a year. Just because you live in a home today doesn’t mean you need to occupy it forever. You can buy a home now as a primary residence, and then rent it out once you’ve moved on to another place. In the meantime, you can house-hack by renting out a spare bedroom or basement suite on Airbnb or other short-term rental platforms
If you earn rental income from your investment property, you’ll owe taxes on that income.
But there are also a number of deductions you can take, including property taxes, repair costs, interest paid on the mortgage, and operating expenses.
Since the rental functions as a business, the IRS also allows you to deduct costs such as advertising fees, utilities, and insurance.
You can also depreciate the property on your taxes, which effectively gives you a tax break based on normal wear and tear that could lower the property’s value. Note that you can only depreciate an investment property. You cannot depreciate a primary residence.
If you plan to sell your investment property, capital gains taxes will apply. If you sell an investment property at a loss, you can deduct the loss.
Rueth noted that tax laws are changing, so it’s important to check with your certified public accountant (CPA) about the rules and guidelines. But she said there are ways to minimize the amount you, and your heirs, owe in capital gains taxes, keeping more of the wealth you earn in your family.
Tax obligations can get complicated when it comes to investment properties, so it’s best to consult a tax professional about your investment property deductions and what you owe.
Conventional loans allow you to purchase investment properties with up to four units. These are the most common types of investment financing, and you will need a credit score of 620 or higher to qualify. You’ll typically need at least 15% down, more if you want to buy a property with more than one unit.
The federal government insures several loan programs, including FHA loans and VA loans. No government loans may be used to purchase investment properties. However, you can use a 3.5% down FHA loan or 0% down VA loan to buy a multifamily property with up to four units. As long as one of the units is your primary residence, you can rent out the others.
A hard money loan is usually issued by an investor rather than a traditional lender. These loans typically have very high interest rates and short repayment terms (one to three years). That’s why they’re commonly used for house flips, in which the buyer wants to purchase and renovate the property, and then sell it quickly.
Portfolio loans can be an option if you have experienced financial difficulties, such as a bankruptcy or foreclosure, that may have negatively impacted your credit. The term “portfolio” loan refers to the fact that lenders keep these loans on their books, rather than selling them to mortgage brokers or servicers.
Because the lenders are not selling the loans, they can set their own terms and criteria, rather than adhering to external guidelines. This can mean higher interest rates to compensate for the risk.
Owner financing, as the term implies, means that the owner of the property agrees to finance your purchase, rather than going through a traditional lender. This method often requires the loan to be paid off after a relatively short term (for example, five years), either by a balloon payment (a large payment at the end of the term) or a refinance to a mortgage.
The advantage to you is that you don’t need to go through the traditional approval process, including a property appraisal. But the interest rates can be very high on owner financing loans, and balloon payments can be challenging to afford.
If you already own one home and have significant equity, you can use a cash-out refinance loan or home equity loan to borrow against that equity and use it to buy a second property.
But the debt you owe on the first house will increase with either of these options, so make sure you can afford the new payment plus the additional mortgage to avoid losing either home.
Investment property mortgage rates FAQs
A conventional mortgage offers the most flexibility for buying an investment property because there is no owner-occupancy requirement. However, you can use an FHA or VA loan to buy a multifamily property as long as you live in one of the units. The advantage there is that you may qualify for a lower interest rate and can buy with a lower down payment and credit score than you’d need for a conventional investment loan.
You may need at least 15% down to buy a single-family investment property. To buy a multifamily property with up to four units, you could be required to have up to a 25% down payment.
If you are eligible for a VA loan and have full entitlement benefit available, you may qualify for 100% financing on a home. You can buy a home with two to four units, live in one, and rent out the remaining units. You can also purchase a single-family residence with a VA loan with plans to convert into a rental a few years down the road.
An investment property can be a gateway toward wealth creation and building up new income streams.
But because investment property mortgage rates are higher than those for primary homes, and because the borrower requirements are stricter, it pays to work on your finances before you apply for an investment loan. That way, you give yourself the best chance at a great interest rate and a home loan that ultimately makes money for you.
*This advertisement does not constitute tax advice. Please consult a tax advisor regarding your specific situation.
Some references sourced within this article have not been prepared by Fairway and are distributed for educational purposes only. The information is not guaranteed to be accurate and may not entirely represent the opinions of Fairway.
Fairway is not affiliated with any government agencies. These materials are not from VA, HUD or FHA, and were not approved by VA, HUD or FHA, or any other government agency.