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How To Get A Mortgage For A Rental Property


I waited for five months to hear back from the bank that they financially accepted my offer on the rental property: $85K!

All of my paperwork was completed, the inspection came out better than expected and the bank was even giving me 2% toward closing costs. In that moment, it appeared as though the entire acquisition process was going to be a smooth ride, until…

A week into escrow, my mortgage broker called to break the news: the underwriter decided I was “too risky” to fund the mortgage. I was back to square one and needed to find a new lender.

The next week was a nightmare.

I shopped my financial profile around to 20-plus institutions and not one of them could guarantee an on-time escrow closing. Luckily, after speaking with dozens of lenders, I found one company (a direct lender) that could make the deal happen. I raced the clock to get all the paperwork submitted with the new lender and had to extend escrow two more times before finally closing on the property.

Having jumped through all of these hoops, I vowed that I would never make the same mistake twice. Before I made my next rental purchase, I did extensive research on mortgage financing and took the time to develop a relationship with a dependable local lender.

Looking back on this transaction, I wish someone had shared with me the lesser-known aspects of obtaining rental property loans. Getting a mortgage is rarely an easy process free of hiccups and headaches, but getting a loan for an investment property can be every trickier.

Considering investing in real estate? Here are some things to know before you apply for a loan for that new income property.

LENDING LIMITS

Fannie Mae currently allows each investor to carry 10 loans at once. (Bored? You can read all about Fannie Mae’s investment mortgage underwriting requirements.) If you are working with the right lender, they can help you strategize both a long-term and short-term plan to ensure that you are taking advantage of your 10-loan limit.

It’s worth noting that many lending institutions will only lend up to four loans (typically the bigger banks). You’ll likely have to do a little leg work to find a lender that will go up to the 10-loan limit.

INVESTOR-FRIENDLY LENDERS

When purchasing rental property, an important aspect of your long-term success is developing a strong, reliable team – and your lender is BIG part of that equation. When I first began real estate investing, I made the mistake of using a broker who didn’t understand the investing landscape. As a result, I spent a lot of time trying to explain my strategy and objective. In the end, I ended up receiving a lot of bad advice and it almost cost me several deals. I could have easily avoided this had I worked with the right lender from the get-go, mainly a direct lender.

There’s nothing wrong with working with a mortgage broker when you are in the market to by a primary residence, but if you’re trying to build a portfolio of rental properties, I recommend you work with a direct lender.

The main difference between a broker and a lender is that a broker shops around your financial profile to their selected list of lenders, where as a direct lender is the institution actually lending you the loan.

When you work with a broker, you give up control. The underwriter can change lending standards (often during escrow) or decide that they want to pull out of the deal at the last minute. When you work with a direct lender, you’re in closer contact with the decision makers from the get go.

Before working with a lender, here are a few good questions to ask:

  • Do you currently work with any active investors?
  • How many loans can you offer to any one investor?
  • Do you personally own any rental property?

CREDIT REQUIREMENTS

As I mentioned earlier, Fannie Mae currently allows up to 10 loans per investor. A little known fact is that there are two different credit-qualification guidelines for obtaining these loans. The first is for properties 1-4 and the second is for properties 5-10, listed below:

  • Loans 1-4: requires a credit score of at least 630
  • Loans 5-10: requires a credit score of at least 720

CASH RESERVES

In addition to the down payment, lenders will require you to have six months of cash reserves available per property.

This means that if you own a primary residence and you are going to acquire a rental, the lender will require you to have six months of mortgage payments (cash in the bank) for both your primary residence and your future rental.

Once you know the price point of the prospective rental you are considering, it’s a good idea to have a lender provide you with an estimated monthly payment so that you can save accordingly.

DOWN PAYMENT

Just like there are two sets of guidelines for your credit, there are also multiple sets of guidelines regarding down payments, listed below:

  • Loans 1-4 (Single family): 20% down
  • Loans 5-10 (single family): 25% down
  • Loans 1-10 (multi-family): 25% down (side note: many lenders will require you to pay 30% after loan 4)

W2 INCOME

Lenders will require a minimum of two solid years of w-2 income. They want to see that you’ve been at your job or working in the same industry for at least two years. The underwriter will calculate your annual income by averaging your past two years of gross income. For example, if this year you earned $100K and last year you earned $50K, your average annual income would be $75K.

If you are self-employed, you’ll need to provide two years of tax returns, a year-to-date profit and loss statement, and most likely a letter from your CPA confirming the validity of your previous tax returns. The calculation for your annual income is the same as the w-2 employee.

RECAP

Contrary to popular belief, now is a great time to buy rental property. Many markets that were over-priced during the housing bubble have over-corrected and property can now be purchased far below the cost to rebuild – which can mean substantial cash flow (even with the costs of property management).

I initially began purchasing rental property as a way to diversify my wealth-building strategy. After I acquired three houses, I noticed that over the course of six months, my rentals were far out-performing my IRA and 401(k). I decided to pull my money out of the financial markets and reinvest it into building a strong rental portfolio. I’m not saying that this is a strategy everyone should employ, but I will say that anyone looking to build wealth should at least review the real estate investment vehicle.

What about you? Have advice to share about getting a mortgage for rental properties? Are you trying to buy an investment property and have questions about getting financing? Share your comment or question here.

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Comments

  1. This is the single most useful blog post I have read in weeks. Absolutely awesome. Thanks!!!!!!

  2. Des,

    Thanks for taking the time to comment. Please let me know if you have any questions.

    Best,

    Arthur

  3. Do you still shop lenders after a few properties? Or do you tend to stick with one lender once you have a mortgage? If you stick with only letter, do you have have issues where they are concerned about how many loans you have out?

    • Hello Wayne,

      I feel pretty comfortable with the Lender I currently have in place and I don’t really shop around anymore. I’ve referred quite a few customers to them and have also done a fair amount of business of my own with them and as a result they treat me very well.

      At this point they usually pick up the cost of my “home inspection” or “home warranty”. In addition, I just don’t have the energy to re-submit all my documents to a new lender. It is a major pain in the ***. Plus I enjoy working with the same people. I don’t see that changing unless they drop the ball in some way.

      The nice thing about the Lender I work with is that they’ve help me set up a plan to get the maximum amount of loans possible. My wife and I don’t sign on each other’s loans, this allows us to buy multiple properties and maximize our leverage. Once we get to 20 loans that we’ll probably consider using hard money, buying in all cash or look into buying discounted “notes”.

      I hope that answered your questions. please let me know if I was not clear.

      thanks for taking the time to post a comment!

      AG

  4. Arthur another great blog this is great information for 1st time investors. Keep up the good work.

  5. Stephane says:

    Thanks for one of the most useful post I ever read on the topic !

  6. Very comprehensive. I am mostly an all cash guy..but at these rates – you can’t go wrong with mortgages either.

    Thanks Arthur,
    Ch.

    • Chuck,

      Always good to see your comments!

      I’m probably going to have to adopt a similar strategy as you this year. No one wants to give me money, so now I’m looking at lower price-point homes. I would rather leverage, but at the end of the day, it is about yield. If I can hit my numbers going in all cash, or doing an Owner Carry Back, then that is what I have to do.

      Thanks again for the comment!

      AG

  7. This is great information. Thank you. I have been looking at buying rental property and this is a great introduction to the process.

    • John,

      I’m glad you thought the post was useful.

      In addition to financing, make sure you have a good team (property mgr, lender, RE agent, etc) in place BEFORE you buy the property. This will make the whole thing go a lot smoother.

      Thanks for taking the time to comment!

      AG

  8. Fernando says:

    I’ve always wanted to invenst in a rental property but never knew where to begin. I have agreat credit and am sacing cash for a down payment. This article really helped but I still have some questions that come to mind.

    The lenders that you work with, are the private lenders or commercial lenders? Are they bigger corporations?

    Being a beginner I would assume to start off with something affordable that isn’t over the top? Am i correct?

    I have a ton of more questions I just dont know where to start!!!

    • Hey Fernando!

      Thanks for the comment. I’ve addressed your questions below:

      Lenders – For properties that have 1 – 4 units, you need a residential mortgage lender. Any property which contains 5 or more units is considered a commercial property.

      Buying a rental property – before spending a cent or looking at properties make sure you take time to educate yourself. You need to be very specific about your goals and investment strategy. Finding something “affordable” or something that isn’t “over the top” is too vague. You should be able to answer very specific questions, what is your target cash on cash return? Which zip codes do you buy in? Etc.

      In addition to this, you need to determine, what type of investor you are – passive/active and what model works best for your – flipping, wholesaling, buy and hold or note investing. I know this sounds overwhelming, and I am not trying to discourage you, I just don’t want you to jump in without understanding the asset class. RE isn’t like stocks or Bonds, once you buy it, you’re stuck. Which can be really good or really bad.

      There are many places to get information about RE investing – local real estate clubs, online forum communities like Biggerpockets, of course little blogs like mine ;) and don’t be afraid to spend a little money on books from Amazon.

      Please feel to email me any more questions and I’ll do my best to answer – Arthur @ TheBuyandHoldGuys.com

      Happy Investing!

      AG

  9. I am looking to get involved in a rental property with some partners. I would like to buy the property through an LLC. How does this effect the process of getting a mortgage?

    • Hey Matthew,

      If you plan on buying through an LLC you either have to buy in cash or get a commercial loan.

      However, you’re probably looking to buy a SFH or a small multi family, so I think your best bet is to buy it in you or your partner’s name and then put it into a “trust” where you and your partner are the beneficiaries. I would suggest you do your first deal as JV partnership, not an LLC. You’ll get better financing, tax shelter, and better cash flow. LLCs are expensive and usually not worth the effort or money unless you’re holding more than 500K in equity.

      If you are concerned about lawsuits – keep the property leveraged (w/debt), take out an umbrella policy, and hold the title in a “trust”.

      FYI – i write about Real Estate investing on my blog too,

      Good luck!

      AG
      AG

  10. bryan digger says:

    hi guys,

    i’m looking to get a house in the hopes that the gov’t will forgive mortgage debt like they did in iceland. currently, i am unemployed. I am 37 years old and haven’t had a job, well, since forever. If I go to the bank and show them my current assets, which are pretty expansive for my area (currently have 3 homemade trailers hooked up together, so one big one) would that be okay. I also collect welfare so I can use those payments to pay the house?

    Thanks,

    B. Diggs

  11. Hi, I came across your website by searching for information on “investment mortgage”. I am seriously thinking about purchasing a cabin in the mountains that is already in a turn key rental business. It’s fully furnished from silverware to sheets. What is the purpose of getting an investment loan verses a loan for a home, (mortgage)? I guess what I really want to know is why do I have to let the lender know that I am going to use it as a money maker?

    thanks
    LA

  12. mamunsultanpur says:

    Located in a turnkey rental desirable neighborhood, this property features huge open floor plan, rental properties finished basement, large back deck and wetbar in basement.

  13. I am interested in getting into rental property investments, however, I am retired and can not show employment salary right now. What issues will I have with a mortgage lender?? I can demonstrarte income from IRA disbursements and a pension, will that be enough????

  14. great article however you don’t mention where to get this type of loan?
    i know i can qualify any suggestions?
    thanks
    stephen

  15. Great information. Thank you. I was told the lender is required to do appraisal on each of the rentals for the 5-10 loans? Is this their new guidelines?
    Thanks,
    JT

  16. Do you have any advice on purchasing a rental property with a partner?