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What Is an Investment Property Mortgage?
If you’re looking for another source of income or want to start a side hustle as a home flipper, you may be considering the purchase of an investment property. Getting a mortgage loan for an investment property can be trickier than getting one for your primary residence, and obtaining a mortgage for investment property will require you to have a stronger financial picture than your typical mortgage loan would, too.
That doesn’t mean it’s impossible, though. Knowing your options when it comes to lending types, credit and financial criteria, and funding guidelines can help you navigate the process and ensure that you’re doing as much as you can to set yourself up for success.
What is an investment property mortgage?
An investment property mortgage is a loan that is used to purchase a property for either rental income or to flip and sell for a profit. Underwriting guidelines are more strict on investment property loans when compared to purchasing a home to live in or a vacation or secondary home.
Not all lenders offer investment property loans, as the risk of default is higher compared to lending money for a primary residence you plan to call home. That’s because you’re likely to continue paying your home mortgage payments in times of financial crisis. However, if rental income isn’t coming in for some reason, and you have to choose between paying your personal mortgage and your investment mortgage, you’re likely to pay to keep the roof over your head than pay on an investment property. This is also why mortgage interest rates are higher for investment properties vs. primary or secondary homes.
To get approved for a mortgage on an investment property, you must:
- Have a good or better credit score
- A down payment of 10% to 25%
- Cash reserves available
- Stable employment
What is an investment property?
An investment property is a unit that is purchased to provide a stream of income or to flip and sell for profit. This could be a single-family home or a multi-unit building with four or fewer units. Apartment and condo buildings with five or more units are considered commercial real estate and fall under separate guidelines.
Examples of an investment property can include:
- Single-family home
While many investors seek to gain a stream of income from renting their units out to tenants, others prefer to purchase a home to update or improve and then resell to make a profit. Either way, investment properties can be a lucrative source of income if you’re smart about your investment and are able to nail down an investment property loan for your purchase.
That doesn’t mean there aren’t risks, though. As with anything, there are pros and cons to owning rental properties as well as tax benefits that make purchasing investment properties an attractive way to make money. But with mortgages at historically low interest rates, buyers with the funds, credit and the desire to invest could consider an investment property a viable source of income.
Difference between investment property loan vs. regular mortgage
While you’ll choose from the same loan types — conventional, fixed, adjustable rate, government-backed — for both regular mortgages and investment property loans, the interest rates and lending requirements vary vastly from one to the other. From a lender’s standpoint, a mortgage loan for an investment property is riskier than for someone’s home, which is reflected in higher interest rates. The average interest rate can be as much as 0.75% more for investment property loans when compared to conventional mortgage loans.
On top of higher interest rates, lenders also have stricter guidelines to follow for investment property mortgages. For example, the real estate lending standards set by the FDIC limit the loan-to-value of an investment property at 85%, whereas the LTV of an owner-occupied residence can be as high as 100% depending on the loan type and lender.
While buyers who purchase a home with a regular mortgage can get away with a much lower down payment — in some cases as low as 3.5% with an FHA loan or 0% with a USDA loan — investment property lenders want more down on the property. Depending on the property, the lender and your credit, expect to pay between 10% and 30% down on the property.
Lenders also expect borrowers to prove they have at least six months worth of cash reserves available to pay for the mortgage, whether or not they have tenants lined up yet.
Requirements for an investment property mortgage
While lender requirements vary, some general requirements you can expect when applying for an investment property mortgage include:
- Low debt-to-income ratio. Freddie Mac’s investment property guidelines for DTI for is 45%. The lower your DTI, the better chance you have of getting a low interest rate on your loan and more lenders vying for your business.
- Significant amount of borrower funds. You’ll need a significant amount of cash that you can prove came from your savings or investments to get an investment property mortgage. Your down payment and closing costs may not include the use of gifted funds, so plan accordingly when sourcing cash if you don’t have the money saved and ready for use.
- Higher than average credit profile. You’ll need a relatively high credit score to qualify for an investment property loan. Most lenders will require a minimum credit score of 620 to qualify for an investment property mortgage, though some like Guaranteed Rate will go as low as 580 and others will require a much higher score to qualify. But even if you can find a lender who will work with a lower score, you may want a higher score before applying. Higher credit scores command better interest rates and lower down payments.
- Financial documents. As with a regular mortgage, you must provide pay stubs or other ways to show employment income, as well as your prior year’s tax returns and any other information or documentation that the lender requests.
Where to get an investment property mortgage
Though it’s riskier to lend money to investors, this likely won’t limit the lender options you have to choose from. While not all lenders offer investment property loans, there are a number of mortgage lender types to consider, including:
- Conventional banks
- Online lenders
- Credit unions
- Peer-to-peer lenders
Online lenders and credit unions may offer better interest rates or have more lenient guidelines than conventional banks, so these lenders are worth checking out. Credit unions are member-owned nonprofit financial institutions that require you to join as a member, but the application process is generally simple and can greatly benefit you in the form of lower rates, flexible lending parameters and other perks.
Private investors, known as peer-to-peer lenders, are also an option, though interest rates tend to be even higher with shorter repayment terms. These types of lenders also often charge more fees, including pre-payment penalties, to borrowers.
Another option is to do a cash-out refinance on your primary residence to pay for the investment property. Depending on the amount of equity you have available, you can pay for some or all of the cost without having to find an investment property lender. This isn’t always ideal though, since you’re essentially wiping out the equity in your home for a more risky investment.
Ultimately, the best way to find the right investment property mortgage is to shop around and see what different lenders offer. Each borrower has different needs and goals, so you may have to shop around to find a lender that’s a good fit for you. It’s smart to do that no matter what, though — as you should shop lenders in order to save money on rates and fees, too.
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