Want to Buy a Rental Property? Skip 3 Loan Roadblocks
Owning investment property can be a great way to add passive income to your earnings and create a long-term asset opportunity. But it doesn’t come cheap. Unless you’ve recently encountered a windfall, you'll likely need to get funding to purchase a rental property.
If you already own your own home, you know some mortgage basics. But financing for a rental property can be different than an owner-occupied home. Many real estate investor hopefuls aren’t aware of the differences, and it can cause them to lose out on a potential purchase.
3 Rental Property Loan Roadblocks to Overcome
Here are common roadblocks would-be landlords face when applying for an investment property loan – along with tips on how to overcome them.
1. The Problem: Inadequate Cash at Closing
You may have purchased your home with a minimal down payment. But rental property loans typically require you to bring more cash to the table than an owner-occupied home. Anticipate a requirement of at least:
- 15% down payment
- Six months of payments in reserves, including principal, interest, tax, insurance, and association dues (aka PITIA)
Having enough cash on hand can be tricky when you live in a hot real estate market.
The Solution: Buy Outside Your Market
If your local market has high prices, consider looking for properties outside of your locale.
Look for markets that have affordable rent (compare home prices to average income) while maintaining the revenue potential (compare average rent to anticipated mortgage cost). Military bases and high-quality schools can be good indicators of attractive rental neighborhoods.
You don’t have to do the search alone. Seek out real estate professionals and property management companies that cater to out-of-town owners. Be sure to do your research to find the right match.
“Successful remote investing is about the end-to-end experience, not just buying the property.”
Suresh Srinivasan, Chief Marketing Officer of Roofstock
Srinivasan recommends asking potential real estate professionals if they’ve been a buyer’s agent for out-of-area investment purchases and offer virtual tours and online document signings.
Finding a property manager in an unfamiliar area may be more challenging, advised Srinivasan. But due diligence is important.
“There’s a saying among real estate investors that you date your realtor, but you marry your property manager. Roofstock provides a list of vetted preferred property managers on our site because we understand that successful remote investing is about the end-to-end experience, not just buying the property,” said Srinivasan.1
2. The Problem: Using Gifted Funds for Closing Costs
Many lenders won’t consider gifted funds as an adequate cash source to cover your down payment and other closing costs. They want to see that you’re able to pay for these and other costs directly. It shows your long-term commitment to the investment property.
The Solution: Use Your Existing Equity
Do you already own a home? Consider tapping into accrued home equity to cover the costs of your down payment.
You can do this with a cash-out refinance. It’s a resourceful, legitimate option to maximize your assets to buy more property without clearing out your savings.
Here’s how a cash-out refinance works – you pay off your existing mortgage and replace it with a new loan that’s for more than you currently owe. The difference is paid to you, so you have the cash you need on hand.
Depending on your new rate, length of loan, and amount of equity you use, you may be able to get the money you need with just a slight change to your monthly mortgage payment.
3. The Problem: Your Debt-to-Income Ratio Is Too High
If you’re using your W2s for income documentation, it may look like you don’t bring in enough money to cover the additional debt of a real estate investment. This can be discouraging when you know there will be plenty of incoming cash once you rent out the property.
The Solution: Use a Rental Property Loan Program – DSCR
Seek out a lender that allows for market rental analysis with a debt service coverage ratio (DSCR) program. That’s industry lingo for a rental property loan.
DSCR is an income documentation method that uses the projected rental income of the property being purchased. It can help improve your debt-to-income ratio to qualify you for a better rate and terms for your investment property mortgage. It also helps to streamline the process and allows you to ditch the hassle of income documentation.
Avoid Additional Obstacles by Choosing the Right Lender
Loan requirements, rates, and terms vary from lender to lender. Take the time to find a lender that specializes in investment properties, like Axos Bank.
When shopping for the right lender, ask about loan types, qualifications (such as down payment, credit, LTV, and DTI requirements), and interest rate implications. Keep in mind that an investment property typically has a slightly higher interest rate than an owner-occupied property, so the rate may be more than what you received for your home.
You’ll also want to ask about title vesting. You can limit your personal liability and maintain privacy by choosing a lender that allows you to vest the property title in an entity like a trust, LLC, sub S corporation, or partnership.
Real Estate Investment Success Starts With a Plan
There’s a lot of income potential when it comes to real estate investments. Doing the proper research and planning up-front will increase your likelihood of success. So will arming yourself with a team of knowledgeable partners – tax, real estate, property management, and mortgage professionals.
Axos Bank is here to help with our expert team of mortgage specialists who can help you create a mortgage that works with your real estate investment goals. Our team takes a consultative approach to help you achieve your dream while maximizing your cash flow. Give the team a call at 888-546-2634 to get started.
Want to Buy a Rental Property? Skip 3 Loan Roadblocks
This blog was published by Axos Bank on June 1, 2022, and last updated on June 1, 2022.1. Roofstock is an Axos Bank marketing partner.