With high rents, low mortgage interest rates and low real estate prices, today is a great time to consider purchasing investment property.
How is buying a rental different from buying a principal residence?
- You'll need a significant down payment -- at least 20 percent but in many markets it may be 25 percent to 35 percent.
- Your credit rating must be excellent, with most lenders setting the bar at 700 to 740.
- You can use some of the income (or potential income) of the property to qualify.
- Your appraisal costs more.
- The loan fees are higher.
When you buy income property, the value is derived from its income. Appraisers use an income approach when valuing the home, not just a sales comparison method. After all, the income is why you're buying it, right? So, the appraiser will create a rent schedule, comparing your property to other rental nearby and coming up with a figure that you could expect to get in rent.
If the property has tenants, that figure is of primary importance in coming up with this number.The appraiser then takes this number and works backward to come up with a property value based on the building's earnings and condition.
Next, underwriters subtract a vacancy factor of 25 percent of the income, and that's the amount of income you get to use for qualifying purposes.
Finally, your loan fees are adjusted to account for the additional risks of default associated with income property. For example, Fannie Mae adds three points to your fees for an 80 percent loan on an investment property. Plus an additional point if it's a duplex, tri-plex, or four-plex.
Finance a rental for less
You can finance a rental property with a 96.5 percent FHA mortgage and pay no extra fees. The catch is that it would have to be a multi-unit property, and you'd need to live in one of the units. But if you're a renter now, you could use an FHA loan to become a homeowner and a landlord in one shot.