Financing Investment Properties

One’s primary residence is regarded as more than an investment—it represents a home, a sanctuary, and security. On the other hand, homes purchased for the purpose of renting to tenants are primarily purchased for the long term benefits of appreciation and income. For many years Americans have built their fortunes by acquiring prime income-producing real estate.

Homes purchased for the purpose of generating income are considered investment properties. As far as a lender is concerned, an investment property represents a greater risk of default. It stands to reason that home owners who are experiencing financial difficulty would take care of the payments on the home that represents their residence before focusing upon investment properties. For the potential investor, the stance of the lender means that financing for investment properties will have several hurdles:

The down payment will be larger. While primary residences can be procured with down payments of zero to ten percent, investment properties require a cash outlay of 10 to 30 percent of the value of the property. Fannie Mae and Freddie Mac, the agencies which purchase the vast majority of conventional mortgages in the nation, require 30 percent down.

Mortgage qualification standards are more stringent. For example, the seller may contribute three to six percent towards a purchaser’s closing costs on a owner occupied residence. For investment properties, the limitation is two percent.

The types of mortgages available will be more limited. Mortgages on investment properties with less than 30 percent down are more likely to be adjustables since lower down payment investor mortgages are more likely to be placed in portfolio by banks and other financial institutions. Fannie Mae and Freddie Mac offer only fixed rate investor mortgages and will not allow temporary buydowns.

Higher rates. The interest rates for investor mortgages will typically range .25% to .50% higher than mortgages for primary residences.

There are some exceptions to these rules for mortgaging investment properties. If you are trying to refinance an investment property and have a mortgage with FHA (Federal Housing Administration) or VA (Veterans Administration), then the new rate may be identical to owner occupied rates. FHA and VA will allow you to refinance these properties without income verification and without a property appraisal. These government agencies feel that those who have these loans should not be stuck with high interest rates regardless of present occupancy or financial status. Lowering these rates improve the payment streams of these mortgages and therefore present less risk.

There are some strategies that a potential investor can employ in order to limit the amount of cash required for the procurement of an income-producing property—

Switch residences. If the property you are considering is in the same price range as your residence, try renting out your present residence and then purchasing another low down payment for a primary residence. You will have to procure a lease for your primary residence before you go to settlement on the new property, unless you have the income to qualify for both property payments at once. In addition, if your present property is financed with an FHA mortgage, you will not be able to use FHA to finance your new home.

Equity line. If the property in which you live has a large amount of equity, take this equity out of your residence through a cash-out refinance in order to fund the down payment on an investment property.

Duplexes. Purchase a 2 to 4 unit property and live in one unit—agencies consider such it an owner occupied transaction. A veteran may be able to obtain a four unit property with no money down, though VA will require additional cash reserves after closing. Fannie Mae and Freddie Mac may require a 10 percent down payment, which is five percent more than single unit properties.

Assumptions. Assumptions of FHA/VA mortgages have been limited by the agencies. VA mortgages closed after 3/1/88 require VA credit approval to be assumed. FHA mortgages closed after 12/15/89 cannot be assumed by investors. Mortgages closed before that date must be assumed with at least 25% equity.

If you are considering purchasing an investment property, it is clearly to your advantage to review several financing alternatives which may affect your long term economic return…?

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