How to Get a Conventional Loan for an Investment Property

Learn about the investment loan and down payment guidelines.

Two family investment propertyI'll assume you have given some thought about purchasing an investment property and are seeking some preliminary information regarding the minimum down payment, credit score and other requirements.

Some private lenders provide investment property (rental housing) financing in addition to Freddie Mac and Fannie Mae.

Fannie and Freddie are corporations that provide funding to banks and large mortgage companies. These two companies are supported by the federal government against default. Fannie Mae and Freddie Mac do not loan money directly to the borrower, but work with approved lenders who disburse the mortgage money. Lenders are required to underwrite loans according to the lending guidelines of Freddie Mac and Fannie Mae.

What is an investment property?

An investment property is a residence that you purchase with the intention of renting it out to generate income. Your primary residence (the house where you live) is not considered an investment property. A rental property can be a single family home, townhome, manufactured home, condo, or apartment building. It can also be a room or part of a room in your home that you rent out. If you want to purchase a rental property, you may be able to use a standard mortgage loan or a specialized loan just for rental properties.

Any home that you rent out or buy to fix up and sell for a profit is considered an investment property. Even if you live in your condo, apartment, manufactured home, or house for part of the year, it can still be a rental property. Most of the time, when people talk about investment properties, they mean single-family homes with one to four units, not commercial properties like apartment complexes and shopping centers.

Automated Underwriting for Loan Approval

Both Fannie Mae and Freddie Mac analyze mortgage applications using sophisticated technologies. The analysis takes into account the borrower's credit score, liquid assets, almost liquid assets, job, and income. Fannie Mae's underwriting software is called Desktop Underwriter. Freddie Mac makes use of a loan prospector program.

Unlike other loan programs, there are no definitive guidelines laid out in a manual. The software informs the lender if the loan application is approved, and under what conditions. The following offers a general understanding about the approval guidelines for an investment property loan.

How Much is the Down Payment for an Investment Property

Investment property loans include higher down payments and tougher lending conditions.

You must pay at least 15% or 20% down on a single family home if you want to finance it with an investment property loan. Your lender may allow you to take advantage of the lower 15% down payment amount if you have decent credit.

1 unit - 15%
2 - 4 units - 25%

Using a Home Equity Loan for the Down Payment

You can use the value of your primary residence as security for a loan to buy a rental property. But you have to show that you have enough cash on hand to pay back the loan if something comes up.

A HELOC is a sort of revolving credit that allows you to borrow money against the value of your house. A home equity loan is a long-term loan with a set interest rate that is secured by the value of your property. You may also receive a loan or line of credit to purchase a rental property using the value of your house.

By taking out a home equity loan, you can keep your first mortgage and its low interest rate. But the home equity loan means you have to make another payment.

Using a Cash Out Refinance For the Down Payment

A cash out refinance is also a choice. With a cash-out refinancing, you pay off your current mortgage and cash for the down payment and closing fees. A cash-out refinance would have a fixed rate, but it could make your current mortgage last longer. If the loan term is longer, the interest on the main home could be higher. That would have to be weighed against how much money an investment property is expected to make.

Seller Concessions for Investment Properties

If you are buying an investment property, the seller can only give you up to 2% of the price, no matter how much you put down.

Minimum Credit Score for a Investment Property Loan

You can apply for an investment loan with a 620 credit score with Fannie Mae, but the preferred minimum credit score is 680.

Your credit score is a key factor in investment property loan eligibility.

Credit scores are based on how much you owe, what you've paid off in the past, and how long your credit history is.

If you have a low credit score, you may need to put more cash into an emergency fund to cover the risk of defaulting on a loan.

Your best bet to qualify for a lower interest rate is to have a good credit score. If you need a jumbo loan, you may have to get it with a higher interest rate.

Higher-income borrowers can get a more expensive loan with better credit.

Fannie Mae requires a 680 minimum credit score with a 15% down payment for a single family property.

Debt to Income Ratio for an Investment Property

The debt to income ratio for Freddie Mac is 45%. If you are not familiar with the term, debt to income is a ratio calculation between the monthly debt and monthly GROSS income. Simply divide all monthly debt payments (i.e., car payments, credit cards, etc.) by the gross monthly income to determine the debt ratio.

Investment Property Mortgage Insurance

Just like a home loan, private mortgage insurance is required with a down payment less than 20%; and, the PMI cost is higher than on an owner occupied property due to the default risk. If the mortgagor is facing a financial crisis, he is more likely to go delinquent on his investment property than on his home mortgage. Consequently, the private mortgage rate is higher to offset the risk.

Financing options for rental properties

The conventional mortgage is the most common financing option for rental properties. To qualify for a conventional mortgage, you must have a credit score of at least 680, earn a substantial amount of income, have the money for a down payment, and have the ability to repay the loan. Even if you have a high income, you may need a larger down payment if your credit score is low. You may also need to prove that you have saved enough money to cover the closing costs and ongoing expenses. Specialized financing for rental properties often has higher interest rates and requires a larger down payment than a conventional mortgage.

Investment Property Loan Requirements

A conventional loan is the most common type of financing for an investment property. However, you must meet certain criteria to qualify for a standard mortgage loan. To get approved, you must demonstrate that you have the ability to repay the loan with a steady source of income and sufficient cash reserves. Loan officers use credit scores, debt-to-income ratios, and cash reserves to decide if you qualify for a loan and what interest rate you get. If you have a low credit score or low cash reserves, you may need to get a jumbo loan or an alternative loan for investment properties.

Cash Reserves for an Investment Property

The lender will almost certainly insist that you have enough money in savings after settlement to make the mortgage payment if there is an unforeseen occurrence. The automated software program determines the total amount of money in reserves. With well-qualified investment purchasers, two months' cash reserves is normal. Six months of payment reserves are not uncommon.

Multiple Properties Financed

If the borrower has other financed properties besides the subject property and the borrower's main home, extra reserves must be calculated and verified. Applying a certain percentage to the total unpaid principal balance (UPB) for mortgages and HELOCs is the way to figure out the amount of reserves for other financed properties.

Percentages are based on financed properties. The reserve requirement for the subject property can range from two to six percent of the unpaid balance of the other financed investment properties.
See Fannie Mae Minimum Reserve Requirements 

Rotating question markFrequently Asked Questions (FAQs)

Q. Can rental income qualify for a property investment loan?
A. This varies by lender. Some lenders won't let you disclose rental income unless you've been a landlord previously. Others ignore rental income. If your lender allows rental revenue, it's usually restricted at 75% of market rate.

Q. How many investment mortgages can I have?
A. Fannie Mae permits 10 investment mortgages.

Q. Are the interest rates higher with investment mortgages?
A. Interest rates for investment properties are 50% to 85% higher than owner-occupied mortgages. Interest rates for investment properties are more expensive than owner-occupied loans.

Q. How long does it take for a loan to be approved?
A. If you give your lender all the information and paperwork they need, you can expect to be approved for a loan in a few weeks.

Q. What happens when your income goes up and down?
A. You can show that your income is reliable and consistent by using a cash flow statement or an income and expenses worksheet.

Conclusion

Rental properties are an excellent way to increase your income, diversify your portfolio, and build equity in the long term. You must be financially prepared to handle the added responsibility of maintaining the property, paying the mortgage, and managing tenants. A conventional loan is the most common type of financing for an investment property.

You must have a high income, a good credit score, and sufficient cash reserves to qualify for this loan. If you have a low credit score, you may need to take out a jumbo loan or get a home equity loan. A home equity loan lets you borrow money against the value of your primary residence, while a jumbo loan is offered to borrowers purchasing investment properties with a high loan amount.