Mortgages for Rental Properties
Until the market crash in 2008, mortgages for buy-to-let properties were numerous and often involved minimal expenses and very little underwriting. Since the market crash things have changed very quickly and mortgages for investment property have become more scarce and expensive. Government sponsored Freddie Mac and Fannie Mae still buy investment property mortgages from banks, and Fannie Mae allows investors to have mortgages on up to 10 properties. The problem with the loans comes with the originating banks as many require investors to have down payments of 25 or 30 percent of the purchase price. The reason the down payments requirements are so high is because mortgage insurers do not want to insure mortgages for non-primary homes. During the last few years many people have walked away from family homes so the likelihood is that foreclosures on rental properties will be even higher.
The best approach is to do your homework beforehand and find out the down payment requirements. In some of the hardest hit markets like Florida, Nevada and Arizona, down payments are higher than in other parts of the country. Additionally, in some parts of Florida, loans for condominiums require down payments of 50 percent. Insurers refuse to cover the over-built properties, and banks are so concerned about further price depreciation that they will only commit themselves to lend half of the going price for a condo. Finding an available property is easy but producing enough cash for a big down payment is a problem for a lot of would be investors. Some banks who hold the loans in their own portfolios, and do not sell them to Freddie Mac, allow smaller down payments but much higher origination fees and rates that are generally two percent higher than the going average.
Once prospective buyers have found an affordable property and sufficient funds for a down payment, there are several other issues to contend with. Mortgage rates are much higher on rental properties because they are priced partly on risk. People are less likely to default on a primary residence than on a rental property so consequently rates on rentals are generally at least one percent higher than on other loans.
Debt-to-income (DTI) ratios used to qualify people for mortgages are generally capped at 41 percent. Someone earning $5,000 a month with a mortgage of $1,500, a car payment of $500, and no other debt would have a DTI ratio of 40 percent. If they bought a rental home with a mortgage of $1,000 a month but rented it out for $1,500 a month their DTI ratio would be 46 percent, which would be too high to qualify for the loan. Even though they would have a $500 profit every month from the rental, they would not meet the underwriting guidelines.
Another consideration on rentals is property tax. Many states have lower property tax rates for a primary home than a rental and once taxes are added to an escrow mortgage payment, the property owner may end up paying much more for each monthly payment than they thought they would when just looking at the interest rate based payment estimates. People should seek advice on buy to let mortgages from financial professionals before making any decisions that prove to be much more costly than they imagined.
Fannie Mae Guidelines
HSH Library: Down Payments
Rain City Guide: Investment Property