Getting a Mortgage for Rental Property
December 27, 2022 | Posted by: Alex Vinarski
Getting a Loan for Rental Property: The Requirements
Taking the first steps to become a landlord?
The road ahead can be exciting or excruciating depending on how you prepare. Owning rental properties is the dream of many but the reality of a few. That’s because every step to becoming a landlord is filled with challenges.
A vital aspect of the journey is getting a loan for your property. Access to funding is critical to helping you launch your property investment dreams. But there are some things you need to know about investment property loans.
The standard requirements for investment property loans
- Credit score and history
The first requirement is an acceptable credit score. Lenders may talk to you if your credit score is around 680, but the loan terms will be harder. For the most favorable terms, you need a credit score of 700 – 749. In addition to a good credit score, there should be no delinquencies in your credit history. However, even if you meet these two criteria but your credit history is insufficient, you may still be rejected.
- Proof of sizable income
An investment property means a second mortgage to pay; lenders want to see the financial capacity to handle these payments. Even though, in theory, you should be able to pay the second mortgage from the rent you collect on the property, this doesn’t always happen, as vacancies and bad tenants can prevent it. Lenders never use 100% of the rental income. You will need to show a job letter, pay stubs, and sometimes Notice of Assessment.
- Proof of sufficient savings
You also need to show proof that you have enough savings to make the down payment on the property, as well as, the closing cost of the mortgage. How much you are expected to have in your savings depends on the type of property you are buying. Down payment amounts range from 5-20% of the sales price of the property.
- Little to no indebtedness
You also need to be relatively debt-free. Lenders expect that no more than 35-45% of their monthly income should be spent on debt repayments. They will look at the loans you are carrying (student loans, credit cards, auto loans, and housing) and calculate the ratio of your gross monthly income that goes into paying them off. Before you apply for an investment property loan, work to reduce the amount of debt you have.
Property-specific loan requirements
The other set of requirements depend on the details of the property you are investing in. Rental properties are classified as commercial or residential.
- Residential properties
Buildings with 1-4 units are residential. The terms for these types of investment properties are only slightly more difficult than the terms for a primary mortgage.
- Commercial properties
These are buildings with 5 or more units. These require a commercial mortgage and generally, commercial mortgages are harder to get and more expensive.
In this article, we will limit ourselves to the loan requirements for residential properties (buildings with 1-4 units).
Loan requirements for residential properties
- Down payment requirements for residential properties
The down payment for a residential property will vary depending on the number of units in the building and whether the owner of the property (you, the investor) is going to live in the building or not.
Rental properties where the landlord plans to live on the premises attract easier loan terms. Here are the details of how this works:
- Owner-occupied properties with 1-2 units attract a down payment of 5%
- Properties with 1-2 units that are not owner-occupied attract a down payment of 20%
- Owner-occupied properties with 3-4 units attract a down payment of 10%
- Properties of 3-4 units that are not owner-occupied attract a down payment of 20%
In general, owner-occupants are expected to pay 5%-10% down on their properties, while, for non-owner occupants, the rate is always 20%.
But these rules only apply where the owner-occupied building costs no more than $500,000. For owner-occupied properties, the down payment on the first $500,000 is 5% (if the home has 1-2 units). For all amounts above that first $500,000, the investor is expected to pay 10% down.
Owner-occupier homes have better terms because of the lower risk they present to lenders. Mortgage providers know there is a reduced risk of mortgage default when a landlord lives in their property. But, there is also an advantage to investing as a non-owner occupied.
Although investors who do not live in their building will be forced to pay 20% down on the property, they are not required to buy mortgage default insurance. Any investment property where the investor makes a down payment of less than 20% always requires mortgage insurance.
