If you are investing in real estate it is likely you have already been through the mortgage process for your primary residence. Although you will be familiar with the basics, investment loans have unique characteristics that you'll need to keep in mind. Your bottom line will depend on how well you are prepared for investment financing.
In order to receive an investment loan on the residential mortgage side, you'll be limited to working with 1-4 unit properties. Properties with more units can only be financed with commercial loans. If this is your first investment purchase, I would strongly advise getting your feet wet on the residential side because the process is, in general, simpler and less expensive.
One fundamental to keep in mind about investment loans is that, to the bank, they are seen as riskier loans to make than the mortgage on your principle residence. The qualifying guidelines are therefore stricter regarding your credit history, debt-to-income ratios, down payment and cash reserves. Because of this, it is very important to sit down with a loan officer to determine what you can qualify for before you select a property.
In order to receive the best rates and lowest down payment requirements, you should have a very good credit score - ideally above 700. Follow the tips in the article Common Credit Problems and How to Fix Them to boost your scores. Qualifying for the program with the lowest interest rate is the key to maximizing your cash flow on the property.
Income and debts are a huge factor that banks consider on investment loans. The way they calculate what you can consider income, particularly with rental properties, can be counter-intuitive. This can be best explained by example.
Mr. Cash would like to purchase a 4-unit investment property. There are long-term tenants in the building who have recently signed 18-month leases. With the income from Mr. Cash's job, he cannot quite qualify for the additional expense of the new mortgage. However, the money he will make from rent on the property, after paying the new mortgage, not only makes it an attractive investment, but puts his income up high enough to qualify - or so he thinks.
The problem with Mr. Cash's scenario is that he has no experience managing property. Many loan programs require a property management track record in order to count the rental income in an applicant's file. The way the bank sees it is that Mr. Cash cannot prove he has the ability to reliably collect money from tenants or retain them. If Mr. Cash were to receive the loan and fail to collect money, or fail keep tenants in the property, it would affect his ability to keep up with his mortgage payment.
In this case, Mr. Cash has two options. He will either have to find a less expensive property so he can qualify just on the income from his job or he'll have to use a limited documentation loan program. The only problem with the limited documentation program is the higher interest rate that would affect his monthly cash flow.
Depending on how much you want to leverage your investment property, having the flexibility to make a smaller down payment can increase the cash you have on hand to do things like make property improvements. With a high enough credit score, a good debt-to-income ratio and enough cash reserves, you can qualify for investment loans with as little as 10% down. I have heard of some programs out there that don't require you to make a down payment at all on investment properties - but I would be careful. I'm sure these programs hedge against their risk with incredibly high interest rates and fees. While you can find 10% down programs, you will get the best interest rates possible if you have the ability to make a 20% down payment. Just make sure to compare all available options - your loan officer should be willing to come up with different scenarios.
Another item that is considered heavily on all investment loan applications is cash reserves. From the bank's perspective, you are taking on an investment that will require enough cash on hand to maintain the property and to bridge the gap if you have empty units for periods of time. Guidelines vary, but make sure you aren't spending all your money on the down payment - it is likely you can only qualify for a standard loan with at least a few months worth of reserves on hand.
Once you've been pre-qualified for your first investment loan, you should contact a Realtor to help you select the right property. They will have a lot of useful knowledge regarding hot neighborhoods and good buys. Purchasing investment property, especially multi-family units, is a lot different than looking for your dream home. Choose an agent who has worked with other investors and benefit as much as you can from their experience.
Your first investment purchase can be the beginning of a lucrative business - use your loan officer and Realtor as resources to plan for the future. Take the opportunity to talk with your loan officer about the prospect of buying more property down the road. If you need to develop experience as a property manager, find out how much. If you do repairs on your new property that will drastically increase your equity, ask your loan officer how to tap into that cash when the time comes to purchase again. As long as you want to grow your investment property business, your loan officer should be glad to help!
