What to Know Before Buying an Investment Property
While lenders generally charge similar interest rates for a primary- or a secondary-home loan, rates for jumbo mortgages issued on investment properties have stiffer qualification requirements, higher down payments and interest rates at least half a percentage point higher, says Bill Banfield, vice president of Quicken Loans, one of the nation’s largest lenders.
Would-be landlords also should keep in mind that when they apply for another mortgage, including a new primary residence, the lender will factor in mortgage payments for both the new loan and the existing investment loan when determining a borrower’s debt-to-income ratio (DTI), Mr. Banfield says. This percentage measures the borrower’s overall monthly debt payments relative to income—the lower the debt, the better. Under current federal laws, a borrower’s DTI must be 43% or lower to qualify for most mortgages.
Won’t rental income soften that blow? Not necessarily, if the property has only recently been rented or doesn’t have a history of reliable tenancy, says Norman Koenigsberg,president and CEO of East Brunswick, N.J.-based First Choice Loan Services. Many lenders also will factor in vacancy rates, assuming that the home may be unoccupied 25% to 30% of the year, he adds.
The reluctance of many lenders to include rent in loan qualification is attracting nontraditional lenders to the investment-home market. For example, on May 15, Greenville, S.C.-based Lima One Capital is planning to launch a 30-year, fixed-rate mortgage specifically developed for landlords who cannot qualify for loans from traditional lenders.
Borrowers pay higher interest rates for Lima One’s Rental 30, starting at 6.45% for loan amounts up to a 75% loan-to-value ratio, the amount of the loan as a percentage of the property’s appraised value. The loans can also be used to buy or refinance a single property or a real-estate portfolio, and borrowers can qualify with a minimum credit score of 630 and close the loan within two weeks or less, says John S. Warren, president of Lima One Capital, which lends in 27 states and the District of Columbia.
Homeowners who decide to rent out their existing vacation homes typically don’t face the same steep rates.
Anne Shattuck, a 51-year-old social-science researcher at the University of New Hampshire, and her husband bought a vacation home in Mount Desert, Maine, in 2005. For the next five years, the couple and their children spent summer vacations on their island getaway, enjoying cycling, hiking and other outdoor activities. “It’s a hidden treasure,” Ms. Shattuck says. “It’s not as crowded as Long Island or Cape Cod.”
A divorce in 2011 meant no more joint summer vacations, but Ms. Shattuck and her ex-husband decided to keep the three-bedroom log house, maintain their joint mortgage and rent it out during the summer. The rental income covers mortgage payments, helps pay for their daughter’s college tuition and means the couple can still enjoy it for some personal use, though separately.
As long as the borrowers’ initial intent was to live in a home, lenders typically won’t require them to refinance even if the home is now technically an investment property, says Mr. Koenigsberg. One-time payments and other mortgage rules must still be met, and the property must have been initially occupied as a primary or secondary home, he adds.
Here a few more considerations for borrowers considering a switch from a residence to a rental:
• Save your paperwork. Borrowers hoping to qualify for an investment loan can expect lenders to ask for proof of ongoing occupancy, such as a copy of the lease and evidence that a security deposit was collected, Mr. Koenigsberg says.
• Higher taxes. Non-primary residences aren’t eligible for homestead exemptions on local property taxes. Mortgage interest on investment homes isn’t deductible for federal income tax purposes.
States and local municipalities require vacation-property owners to collect and pay the same lodging taxes as hotels and charge stiff penalties to nonpayers, says Rob Stephens,CEO of HotSpot Tax, an online service that helps landlords identify and pay all required taxes. Many first-time landlords may miss this requirement because they think “this is just our second home we rent out to people,” he adds.
• More than a mortgage. Keeping up with loan payments is just one challenge landlords face. Others include covering maintenance and insurance costs, which will have higher rates than homeowner’s policies. Vacation rentals also require cleaning and marketing, which can be handled by a real-estate management company—at an additional cost.
Source: WSJ
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