I waited for five months to hear back from the bank that they accepted my offer on a rental property: $85,000!
All of my paperwork was completed, the inspection came out better than expected, and the bank was even giving me 2% toward closing costs.
It seemed like the acquisition process was going to be a smooth ride, until a week into escrow, when 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 gave my financial profile 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 even trickier.
Have you considered investing in real estate? Here are some things to know before you apply for a loan.
What’s Ahead:
Know your (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’re working with the right lender, they can help you strategize both a long-term and short-term plan to ensure that you’re 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.
Look for 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 a 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. 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’re in the market for 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.
Related: Should You Use a Mortgage Broker or Bank Loan Officer?
When you work with a broker, the one thing to remember is that 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.
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?
It’s a good idea to browse online before taking out a loan. Funny enough, you can actually find some of the best rates out there without leaving your couch. A great site for comparing multiple mortgage rates and shopping around for mortgage loan offers at once is Fiona. You’ll simply enter a few items around mortgage search, such as the home’s purchase price, your down payment amount, and your credit range to get rates and offers from multiple mortgage lenders. You can also choose the type of mortgage products (e.g. 30 yr fixed, 15 yr fixed, etc.) for your quote.
Another great site for getting multiple loan offers at once is Credible. If any of the quotes are from lenders that handle rental properties, you’re gold. If not, you’ll still have the information necessary to comparison shop elsewhere.
Credible Operations, Inc. NMLS# 1681276, “Credible.” Not available in all states. www.nmlsconsumeraccess.org.” Credible Credit Disclosure - To check the rates and terms you qualify for, Credible or our partner lender(s) conduct a soft credit pull that will not affect your credit score. However, when you apply for credit, your full credit report from one or more consumer reporting agencies will be requested, which is considered a hard credit pull and will affect your credit.Check out a list of some of the top lenders on the market today.
The more loans you have, the stricter the 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
Make sure you’ve got plenty of cash
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’re 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’re considering, it’s a good idea to have a lender provide you with an estimated monthly payment so that you can save accordingly.
Related: What Percentage of Your Income Can You Afford for Mortgage Payments
The more loans you have, the more you have to pay upfront
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
- 5-10 (single family): 25% down
- 1-10 (multi-family): 25% down (Side note: many lenders will require you to pay 30% after loan four)
Use our Loan Payoff Calculator to see how different interest rates and payments affect your loan.
The lender will need to see the receipts (i.e. your W-2)
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 $100,000 and last year you earned $50,000, your average annual income would be $75,000.
If you’re 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.
Summary
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.