How does an Investment Property Loan differ from Owner-Occupied Financing?
Investment property financing differs from owner-occupied financing in a few ways. You can expect to pay a little bit higher interest rate because it is a rental property. Remember that financing is priced according to perceived risk, and lenders consider loans on investment property to be a higher risk that owner-occupied property. Tenants may not always pay the rent, or the property may require more maintenance than an owner-occupied home. Owners may run into financial problems in these cases and may have a hard time making loan payments. The loan-to-value ratio will generally be lower that what is allowed for your residence.
There is a big difference in the underwriting requirements for investment property loans for 1-4 units and 5 units and above. For 1-4 units, the focus is still on the borrower
qualifying for the loan. The income and expenses for the subject property are taken into account but it is the borrower’s qualifications and ability to make the payments that are still the basis for underwriting the loan. Even if the property has a “negative cash flow”, where the owner has to add funds to cover expenses, the loan may still be approved if the borrower can prove adequate income to support the expenses.
For loans on 5 units and above, it is the property that must qualify for the loan. The income from the property must support the loan payments and other expenses. Underwriters use a “debt service factor”, which is a ratio of the income to the expenses, to determine what loan amount will be approved. Lenders require a “positive cash flow” where the income is greater than the expenses, or at least a “break-even cash flow”, where the income and expenses are approximately equal.
Whether you are buying a 1-4 unit rental property or 5 units and above, it is important to sit down with a loan officer before you start
looking for properties to buy. When you understand how the financing works, you will have a better idea of what type of investment property would be right for you.
