Obtaining a loan for your investment property seems like a similar process for obtaining a loan for your personal property; however, it is much more stringent. Lenders want to know that they can trust you, so they set higher standards for investors to clear.
Table of Contents - Three Ways to Lower the Interest Rate on Your Mortgage for Your Rental Property
The interest rate for an investment property will always be higher than it is for a primary residence. If your investment property is only one unit, you can expect to pay 0.5 to 0.75 percentage points above the standard rate. If the property has two to four units, expect to pay 0.625 to 1 percentage points more.
To lower the interest rate on your mortgage for your rental property, you need to make the lender feel safe about their investment. Fortunately, there are three steps you can take to do just that.
Make a bigger down payment than required
The best way to show lenders that you’re serious about your investment is to put down a sizable down payment. First, it’s important to understand how down payments for investment properties work.
You are required to have a down payment of at least 20 percent to purchase an investment property. However, if you plan to live in one of the units of a multiplex, you don’t need a large down payment. Lenders feel that if you’ll be living in your investment property, then you’ll be less likely to sell the property in case of an economic downturn. They’ll reward this stability by asking for a lower down payment.
If your property has two to four units and you will occupy one of those units, you only need a 5 percent down payment. You’ll need a 10 percent down payment if the property has five or more units; however, a building of that size is likely to be zoned as commercial, which requires a different kind of financing.
If the property costs more than $500,000 and you plan to occupy one unit, you’ll need 5 percent down for the first $500,000 and an additional 10 percent of any amount over $500,000. If your owner-occupied investment property is $700,000, you’ll need at least $35,000 plus an additional $20,000 for a total down payment of $55,000. If you don’t plan to occupy the unit, you’ll need a down payment of $195,000.
Knowing how much you’ll need for a down payment will help you determine what kind of investment property you can afford. With a larger down payment, you can expect a lower interest rate.
Whip your finances into shape
If you won’t be living in the investment property, lenders will have stricter standards for you to meet to receive financing. Lenders will want to see higher credit scores, a better debt-to-income ratio and strong documentation that you have held a steady job with a solid income for the past couple of years. The last point makes it more difficult for the self-employed and retirees to obtaining financing for their investment properties.
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The biggest indicator of your trustworthiness for borrowing is your credit score. Your interest rate decreases as your credit score improves. If your credit score is only average, occupying one of the units can offset the hike in your interest rate as you build credit and earn equity in your property.
For example, if your credit score is 650 and you’d like to buy a home for $250,000, then with a 25 percent down payment you might expect an interest rate of 5.75 percent. Your monthly principal and interest payment would be $1,093. Boost your credit score to 720, and your interest rate decreases to 5.125 percent for a monthly payment of $1,020. That’s a $75 savings each month thanks to the credit score boost.
A credit score isn’t the only thing lenders will review. They’ll also evaluate your finances when calculating your rate. Your debt-to-income ratio compares your monthly debt obligations (things like an existing mortgage, car payment and minimum credit card payment) to your pre-tax monthly income. Lenders want to see how well you’re managing your current debt and whether you can afford your mortgage.
Lenders will also look at your gross debt service (GDS) and your total debt service (TDS). GDS compares your housing costs to your monthly household income. They want to see a number that is at or below 35 percent. TDS compares your total monthly household income to your housing costs plus any other debts. Lenders like to see TDS at or below 42 percent.
Lenders will also look at how much cash you currently have on hand. Ideally, you can comfortably cover your mortgage for a few months in case of loss of income. Lenders might lower your rate if they know you have a surplus of cash on hand.
Finally, lenders want to see a strong loan-to-value ratio on the investment property. The loan-to-value ratio compares the amount of the loan to the amount of the house. By making a higher down payment, your loan amount will be lower, and the ratio will be higher. Lenders are looking to decrease their risk, so less risk equals a lower interest rate.
Shop for the best mortgage
Regardless of the factors above – single-family or multiplex, owner-occupied or strictly investment – it’s always important to shop around for the best mortgage rate. Working with a mortgage broker will save you time and money on finding the best deals, including ones you may not have found on your own. You could save as much as $100 a month on your mortgage payment just by taking the time to do your research before committing to a lender. Remember that what worked for your primary residence may not work for your investment property, so you need to do your research.
Lowering your mortgage interest rate on your investment property is crucial for increasing your net profit. Give yourself the best rate possible by making a larger down payment, cleaning up your finances and shopping for the best deal before making your investment.
3 tips to guarantee you get the best mortgage interest rate
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