Investor Financing

Will You Pay a Higher Interest Rate on a Mortgage for a Rental Property?

Will You Pay a Higher Interest Rate on a Mortgage for a Rental Property?
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When you’re looking to buy an investment real estate property, you’ll find that the financing is different than when you applied for a home loan on your primary residence. Because lenders perceive investment properties to be riskier, financing for an investment property comes with a higher interest rate on your mortgage.

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While you’ll likely pay a higher interest rate on the mortgage for your property, how much higher depends on a few different factors. Key determinants affecting your interest rate include how many units the property has and whether you’ll occupy one of those units.

Although you should expect a slightly higher interest rate on your investment property, understanding how lenders set these rates and what you can do to lower them will put you in a stronger position for maximizing your investment.

What interest rate can I expect for my investment property?

Before you can worry about the interest rate, you need to make sure you have enough for a down payment. If you don’t plan to occupy your rental property, you must have a minimum down payment of 20 percent. If your property has one or two units and you will occupy one, you only need 5 percent, if it has three or four you will need 10 percent. You’ll need to put 10 percent down if the property has five or more units, assuming the building is still zoned residential. You may need an additional 10 percent for any amount over $500,000.

Once you meet the qualification criteria and can make the minimum down payment, you’ll need to secure financing for your investment property. Lenders are more hesitant to fund investment properties, which is why you’ll likely pay a slightly higher rate for your mortgage. Lenders assume that you are more likely to commit to being in your primary residence and will sell a rental property when needed, hence the higher rates.

Some small lenders do not offer loans for properties that are not owner-occupied. They do not work with investment properties unless you’ll be living in one of the units. If you do find a small lender who is willing to work with your situation, you may have to pay a premium on your rate.

Fees vary depending on many factors, but for a one-unit investment property, you can expect your interest rate to be 0.5 to 0.75 percent higher. For a property with two, three or four units, expect to pay anywhere from 0.625 to 1 percent more. Your situation will be different than these benchmark numbers. Talking to multiple lenders will help you secure the best deal.

You should expect to pay a higher interest rate for your rental, but there are a few steps you can take to ensure you get the best rate possible.

Make a larger down payment

The easiest way to pay less interest is to make a larger down payment. Although you can technically pay as little as 5 percent for an owner-occupied investment, putting down at least 20 percent helps you avoid extra costs like private mortgage insurance (PMI).

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Going further and putting down 25 percent can make a big difference in your interest rate. When lenders see that you can contribute that much cash, they know that you’re serious about your investment. More money from you gives the bank more security; if the investment isn’t successful, you’ll lose money before the bank does. They’ll reward you for this risk with a lower interest rate.

If you’re unable to put down 20 percent, you might consider borrowing against the equity in your current home to finance your investment property. This will give you more cash to make your down payment.

Improve your credit score

As with any conventional loan, it’s always best to show a strong credit score. Even a slight improvement can shave points off your interest rate. If your credit score is under 740, you may have to pay a fee to lock in a good interest rate. This can vary from one-quarter of a point to two points extra on your payment. Otherwise, you’ll have to pay a higher interest rate.

This difference adds up not only for your monthly payments but also for how much you’re able to charge for rent. If you’re looking for your tenant to cover the entire cost of your mortgage, you’ll need to charge a higher rent to cover your higher mortgage rate. Bringing up your credit score can be a $75 difference each month for your payment and your rent, making your investment more successful.

If you have poor credit, it may be better to wait to buy that investment property until it’s more financially feasible. Another option is to occupy one of the units in your investment property so that you don’t have to worry about housing costs while you improve your credit score.

Always do your research

When you comparison shop for lenders, you have a much better chance of getting a good rate. Evaluate offers from more than one lender before accepting a loan for any major purchase – whether for an investment property or otherwise. The lender you used for your last property purchase may not be right for your current situation. Compare offers from different lenders to make sure you have the right fit.

If you don’t have a large down payment, or if your credit score needs improving, you may have more luck with a local lender. Local lenders better understand your market and what you’re facing. They also have more flexibility with their products than a big bank does.

Using a mortgage broker for comparison shopping will save you time and money. Mortgage brokers have access to both traditional lenders and alternative sources and can shop your application to find you the best deal.

Rental properties have higher interest rates, but that shouldn’t discourage you from exploring this investment strategy. Learning more about the financing process and what lenders are looking for will put you in a strong position when it comes time to buy your rental property.

How Much Higher Are Investment Property Mortgage Rates?

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