It’s a great time to buy a rental property. Most real estate investors finance their rental property purchases using home loans. But getting a loan for a home you plan to rent out isn’t quite the same as getting a loan for a home you plan to live in.
To get a loan to buy a rental property, you’re going to need a lot more money and a lot less debt. Lenders typically want larger down payments for rental property loans, and they want to see rock solid evidence of stability and cash reserves in borrowers seeking these types of loans. Here’s how to clean up your financial picture and meet the requirements of a rental property mortgage.
Improve Your Credit Score
In theory, you should be able to get a mortgage to buy a rental property with a credit score of just 620. But many lenders may want to see an even higher score, and you’ll get the best interest rates if your score is at least 740. Take steps to improve your credit score like paying down high balances, removing inaccurate items from your credit report, paying your bills on time, and limiting your hard inquiries.
Save a Big Down Payment
If you’re buying a home to live in yourself, you can get a loan with only three percent down from some lenders, depending on your credit score. But lenders want bigger down payments when you’re buying the house to rent out. Expect to put at least 20 percent down. To avoid having to carry private mortgage insurance, you may need to put a minimum of 25 percent down. The more you put down, though, the more equity you’ll have in your house from the beginning of the loan.
Now Save Even More
If you manage to get a mortgage to buy a rental property in Charlottesville, VA, you’re going to become somebody’s landlord, and that means you’ll have a financial responsibility to keep the home in good shape. You also have to prepare for the possibility that your new rental unit could sit empty for months before you find a tenant, and could sit empty again between tenants.
You can offset some of this risk by buying a quality rental unit in a desirable area where people want to live. But you’re going to need to show that you have enough savings to pay your mortgage and expenses in the lean times, when no rent is coming in. You’ll also need to show that you’re prepared for emergency repairs and financially responsible enough to handle regular maintenance and renovations for your rental property. Plan to save at least six months’ worth of operating expenses in addition to your down payment, inspection fees, and closing costs.
Minimize Your Debt
Minimize Your DebtOne important factor that lenders use to determine if you’re a lending risk or not is your debt-to-income (DTI) ratio. Your DTI is the percentage of your monthly income that goes right into paying off debt. The more consumer debt you have, the higher your DTI. The higher your DTI, the less capacity you have to take on new debts.
Mortgage lenders like to see a DTI of 36 to 45 percent for borrowers seeking a mortgage loan to buy a rental property. You can lower your DTI in one of two ways: pay off your consumer debt or increase your income. Sometimes, lenders will allow you to count up to 75 percent of your prospective rental income property as part of your income for purposes of calculating DTI. However, this option may not be available to you if you’re buying your first rental property, and some lenders may require all borrowers to get approved for the loan on the basis of their personal income.
Don’t Give Up
You might not find a lender willing to give you a mortgage loan for a rental property, at least not right away. That’s especially true if you’re buying your first rental property, or if your credit score is on the lower end, or if you have a high DTI ratio. Keep going to different lenders, and don’t be afraid to apply with non-bank lenders like credit unions, online mortgage lenders, and mortgage brokers. If you look around long enough, you’re bound to get some loan offers. And even if you’re not hurting for offers, it still pays to shop around and see what different interest rates and terms the different lenders are offering, so you can choose the best ones.
There’s never been a better time to buy rental property. Put your money into real estate, and protect your finances from the uncertain economic times ahead.
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