What You Need To Know
Whether this is your first revenue property purchase or your 5th, it’s always helpful to know what to expect when it comes to financing. This week, I’m going to briefly detail what you need to know about qualifying for a rental property mortgage. The below guidelines can apply to both a new purchase and a refinance of an existing rental property you already own. Do keep in mind this is only a brief introduction to financing revenue properties and it does not take the place of having a conversation with a mortgage specialist experienced in rental property financing.
How are you going to make the payments on your new mortgage? Yes, it is a rental property, so it’s assumed the tenants will be covering the mortgage payments, however, in the event the property becomes vacant, the lenders want the assurance you can still cover the payments without relying only on rental income. If you are self-employed, be prepared to show your most recent 2 years personal income tax documentation to determine the amount of income that can be used to qualify for the mortgage. If you can’t confirm sufficient business-for-self earnings through traditional means, you may be able to still qualify for a rental property mortgage, though a larger downpayment will most likely be required and the interest rate charged could be a bit higher too. If you are a salaried employee, your potential lender will request the usual supporting documentation to confirm your earnings used to support the mortgage.
If rental income from the property is required in order to qualify, be aware the allowable rental income that is recognized in the debt servicing varies with the different lenders. It seems the most common guideline followed is to add only 50% of the rental income to your employment earnings while including 100% of the costs related to the rental property under your debts. Other lenders may look at using an “offset” of 50-100% of the rental income which means they would only include the difference of the property costs if there is a shortfall in your total debt load. The second option is much easier to qualify for than the first one. A third way of qualifying some lenders will use is called a debt coverage ratio or “DCR”. This is where the rental income must cover the properties carrying costs by a minimum of 1.1 times.
The minimum downpayment required to purchase a rental property is 20% of the purchase price. Most often the downpayment funds must come from your own resources, though some lenders may still allow a borrowed or gifted downpayment source for the purchase of a revenue property. If you are unable to prove your income the traditional way, your minimum downpayment requirement may be 35% of the purchase price or more.
Don’t be surprised if you are asked to provide more documentation than if you were financing a personal residence. As a rental property mortgage comes with more risk to the lenders, the requirements are often more extensive and the specific document requirements will depend on your unique financial profile.
Other Properties Owned
If you already have rental properties in your portfolio totaling at least 4, your choice of lenders has shrunk. Majority of the lenders will not consider financing for a borrower who owns more than 5 properties including their personal residence. That doesn’t mean you don’t have options, just fewer. Working with a mortgage professional experienced in rental properties is important to ensure you’re getting access to all of the options available to you.
Some lenders offer best rates on rental property financing though there is usually little room for exceptions and the document requirements are very strict. If you’re willing to pay a bit of a higher interest rate, you will likely be afforded some wiggle room when it comes to document requirements and allowable downpayment sources.
This detail of the mortgage application is closely looked at when financing a revenue property. Most lenders like to see the potential borrower has a positive net worth in order to qualify for a rental property purchase, as this will ensure the borrower can support themselves and the mortgage in the event something happens with the tenant or property. If you do not have a positive net worth, the lender will be looking for a good downpayment, substantial employment income and an excellent credit rating.
The better your credit score, the easier it is to get financing, rental property or not. If your credit is bruised, there are alternative mortgage products to help, however, depending on the lender, this option could come at a higher rate, larger downpayment requirement and/or additional documentation requirements.
It’s not the first thing that comes to mind if you’re buying a place to owner occupy, however, when it comes to an investment property purchase, some borrowers prefer to own the properties under a company. A number of lenders allow this while others will only offer financing for rental properties under personal names. If you are buying under a company name, be prepared to provide ownership and financial documents for the corporation doing the purchasing.
Don’t underestimate the power of a preliminary consultation with a mortgage professional that has experience with rental property financing. Their skills could mean the difference between a rental property that positively cash-flows versus one that you’re paying for out of pocket every month. Owning and maintaining a rental property is not for the faint of heart so be sure you have done the research before committing to property ownership as an investment strategy. I recommend talking to not only a mortgage professional, but also to as many other people as you can who have experience in revenue properties, including but not limited to; a realtor, financial planner, current rental property owners and your lawyer.