When a first-time homebuyer applies for a mortgage, the process is relatively simple...or, as simple as the mortgage process gets, at least. The interest rates are low, the lenders are friendly(ish), and the whole process tends to be somewhat gentle. When you enter the world of real estate investment, that all changes. As you begin searching for the first property in your portfolio, you might find the mortgage process rather bumpier for one simple reason: you won’t be living in the property you’re buying.
Table of Contents - How Much Higher are Non-Owner-Occupied Mortgage Down Payments?
Most investors starting out in real estate start small, by purchasing single-home or small multi-unit buildings. When working at this level, investors will need to secure a residential mortgage, much like the one they got when they bought their first home. The only thing that will change during this process is the type of residential mortgage for which an investor qualifies.
There are two major types of residential mortgages: an owner-occupied mortgage and non-owner-occupied mortgages. So what’s the difference between the two, and how do the rates differ from one type of loan to another?
What does ‘non-owner occupied’ mean?
The term “non-owner-occupied” simply means that the owner (you) won’t be using the property as their primary residence. It sounds simple, and it is, but the distinction is blurrier than you might think. For example, your primary residence is considered owner-occupied (obviously). So, too, are any vacation homes you might have acquired, provided the property is outside your current county. The only time that the term non-owner-occupied pops up is when you’re buying property for investment. Therefore, the term non-owner-occupied is primarily intended to designate investment property.
When you apply for a mortgage on a property, you have to state to the best of your ability whether or not you will be living there. The answer to that question has an enormous impact on the amount of money required for a down payment.
Determining which answer is right for you could be challenging. For example, if you’re buying a new home that you intend to live in, but you’ll be using your old house as a rental property, you will likely qualify for an owner-occupied mortgage. That said, you will be required to pay taxes on the rental income.
What about multi-unit buildings?
One of the most popular options for investors hoping to purchase additional property is multi-unit buildings. A set of apartments can prove very lucrative for the right kind of investor. Investors wishing to buy a multi-unit building of up to four units can qualify for an owner-occupied mortgage (and save a bundle on the down payment) if they will be living in one of the units. If you’re not planning to occupy one of the four units, you will have to apply for a non-owner-occupied mortgage.
Once you set your sights on a multi-unit building with five or more units, all bets are off. Not only will you not qualify for an owner-occupied mortgage, but you also won’t be eligible for any kind of residential mortgage. You’ll have to go for a commercial loan, regardless of where you’re living.
The rates are the same
The one relief when you’re working to secure a non-owner-occupied mortgage is the rates at which the mortgages accrue interest. That is, they are often no higher than that of an owner-occupied mortgage. The one distinction is that most smaller lenders will not finance a non-owner-occupied mortgage. If they do, they will often tack on a surcharge that can vary greatly depending on the perceived risk.
As a result, when you want to secure the best non-owner-occupied mortgage rate, your best bet is to go with a larger financial institution. While the rates run the same regardless of which type of residential mortgage you choose, the down payment will range significantly.
The down payment difference
The most significant difference between an owner-occupied mortgage and a non-owner-occupied mortgage isn’t the rates, it’s the down payment. To secure a conventional owner-occupied mortgage, you can show up to the table with five percent of the home’s value as a down payment. When you’re searching for a non-owner-occupied mortgage, the down payment jumps to 20 percent.
In the case of multi-unit buildings with three-to-four apartments, the minimum allowable downpayment on an owner-occupied mortgage is 10 percent. Fortunately, the non-owner-occupied mortgage rate remains capped at 20 percent.
Why the distinction?
You might see the staggering difference in acceptable down payments, and ask yourself why an investment property is so much more. The answer is simple: increased risk. Mortgage lenders regard a primary residence as a much safer bet. Their thinking is this: when a buyer is living in the home or on the property they’re purchasing, they will tend to take better care of it. It’s about more than just feeling the sting of monthly mortgage payments, too. Lenders offer lower down payment rates on owner-occupied mortgage rates because they believe that the buyer will invest their time as well as their money keeping the property in good shape.
However, when you opt for a non-owner-occupied mortgage, the lender understands that the odds are good the property will see several tenants over the years. These tenants may not pay rent on time, or they may not treat the property like it should be treated. That neglect translates to financial liability that may leave you unable to pay your mortgage. While you certainly hope that won’t be the case, lenders set their rates playing the negatives, not the positives. That is a smart business decision for them, but it can frustrate would-be investors—significantly higher down payments make it harder to expand your portfolio.
If you’re just starting out as a real estate investor, knowing what to expect from non-owner-occupied mortgages is important—the better prepared you are for increased costs and financing issues, the easier it will be to find solutions.