Guide to investment property loans
Investment property loans are a lot like ‘standard’ mortgages, provided you want to buy a home with 1-4 units.
The application and approval processes work the same way, and mortgage rates are usually less than 1% higher than for a standard mortgage.
However, the rules are a little stricter for an investment property loan than for a mortgage on your primary home. For instance, you likely need 15-20% down instead of 3-5%. And your credit score will need to be in the high 600s or 700s.
If you’re planning to buy an investment property in the near future, here’s what you need to know.
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What is an investment property?
An investment property is a home that is not your primary residence, and that you buy with the intention to generate rental income or sell for profit. Most commonly, these include one- to four-unit rental homes or houses that you buy to fix and flip. For the purposes of this article, we are not including commercial investment properties like apartments or office buildings.
How are investment properties different from second homes?
It’s important to distinguish between investment properties and second homes because mortgage rules and interest rates are different for each type of property. The biggest difference between the two is that you must occupy a second home for at least part of the year, while you — the owner — don’t live in an investment property.
A second home or vacation home might count as an investment property if you intend to rent it out even for short periods. However, lender policies vary over this.
For example, Fannie Mae lets you rent out a second home provided you occupy it yourself for a period each year, retain exclusive control of the home, and don’t rely on your anticipated rental income when you apply. Lenders will also expect a second home to be in a tourist area for a vacation home or a certain distance from your main house if you plan to use it as an occasional residence.
>Related: Second home vs. investment property mortgage rates
Investment property loan options
There are three main loan types used to finance investment properties:
- Conforming loans: By far the most common option
- Jumbo loans: Used when the loan exceeds conforming loan limits
- Government-backed loans: Used only when you occupy one unit yourself and rent out the others (not considered ‘true’ investment properties)
Most of those seeking investment property loans will require conventional mortgages. The majority of these are ‘conforming mortgages,’ meaning they conform to lending rules set by Fannie Mae and Freddie Mac. (More information below.)
It’s a condition of all government-backed loans (FHA, VA, and USDA loans) that the borrower occupies the home as their primary residence. So these are not good sources for investment property loans.
However, there is one exception. You can use a government-backed FHA or VA loan to buy a multifamily dwelling with two, three, or four units. And, provided you live in one of those, you can rent out the other(s).
Other ways to finance an investment property
Many investment property buyers use one of the three mainstream mortgage programs listed above. But other options include:
- Home equity: A home equity loan or home equity line of credit (HELOC) on your current home
- Private loans: Real estate investors will sometimes fund a purchase of rental property
- Seller financing: Occasionally, a seller who owns a home outright may trade the lump sum she would normally receive for a continuing income stream
- “Hard money loans”: These short-term loans can sometimes work well for house flippers
But most buying investment properties turn to mainstream mortgage lenders, including banks. You can find some through our website using the Request a Quote service. You’ll soon find a question that asks whether you want the loan for investment purposes.
The investment property loan process
If you plan to finance your investment property with a mainstream home loan (likely a conforming loan), the process will look very similar to any other home purchase. You will:
- Get preapproved for financing
- Find a home and make an offer
- Apply for the loan
- Lock an interest rate
- Go through the underwriting process
- Sign final papers on closing day
As when buying a home for yourself, it’s a good idea to get preapproved for a mortgage before you begin house hunting. That way, you’ll know how much home you can afford. And, more importantly, the seller and seller’s real estate agent will know you’re making a serious offer.
Before you settle on a lender, make sure to comparison shop for the very best mortgage rate you can find. Investment property mortgage rates are often 0.50 to 0.75% (sometimes 0.875%) higher than those for standard mortgages. And the lower your rate, the higher your profit margin on the property will be.
Is it hard to find investment property loans?
As a rule, it gets easier to find an investment property mortgage when the economy’s doing well and more difficult when it’s struggling. That’s because lenders see investment property loans as riskier than primary home loans. And they may restrict access to moderate their risk level in tough times.
For example, when the Covid-19 pandemic choked the economy, many lenders made qualifying for one of these loans very tough.
So how easily you’re going to find the loan you want will depend on the economic environment when you apply. But, during normal and good times, there are usually plenty of lenders willing to help out.
Investment property mortgage requirements
Mortgage lenders get to set their own requirements. And the guidelines for investment property loans are usually stricter than for a primary residence.
Though rules vary by lender, here are the broad guidelines you can usually expect to see for an investment property mortgage.
- Minimum down payment: Often 15%, though some lenders still require 20%. You’ll get better rates with 25% down
- Minimum credit score: 680 with a 15% down payment; 620 with 25% down
- Maximum DTI: This is your debt-to-income ratio. Typically, your non-housing debts should be no greater than 28% of your gross monthly income. And your total debts plus housing costs shouldn’t exceed 36%. But some lenders are less strict, often allowing 36% and 45% respectively
- Cash reserves: Many lenders want you to have cash reserves (or easily liquefied assets) that are sufficient for you to cope for six months without rental income
- Loan limits: Government-backed mortgages and conforming mortgages have limits on the amount you can borrow. These vary according to local home prices
- Documentation: Expect lenders to request two years of tax returns, two years of W-2s, and two months of bank statements at a minimum
In addition to your finances, mortgage lenders will also evaluate the property you hope to buy.
Lenders will typically lend on any mainstream property: a condo, apartment, manufactured home, single-family house, or multifamily house. But there may be rules about condition, safeness, year-round habitability, accessibility, and so on. An appraiser will establish whether the home is mortgageable.
Investment property loan rates
Lenders know that investment property loans are riskier than loans for owner-occupied homes. That’s because if a borrower gets into financial trouble, they’ll prioritize paying their main mortgage over their investment property mortgage.
As a result, lenders charge a higher interest rate for investment property loans than for ordinary mortgages as well as setting higher barriers to qualifying.
As we’ve already mentioned, these rates are often 0.50 to 0.75% (sometimes 0.875%) higher. That will vary by lender as well as your down payment, credit score, cash reserves, and DTI. You’ll get the best interest rate on an investment property with a down payment of at least 25%.
To find out more, read: Investment and rental property mortgage rates.
Special mortgage rules for investment properties
One of the advantages of buying an investment property is that you can typically add your anticipated rental income to your existing income when you apply. That will help you prove you can comfortably afford your new mortgage payments.
However, don’t assume your lender will count all that extra income, nor that it will take your word for how much it will be.
Lenders typically allow 75% of the future rental income to count toward your qualifying income. And they require either a current lease agreement or a rental schedule, which will use the appraiser’s view of your likely rental income based on local comparisons with similar rental properties.
You’ll likely need that extra income to qualify. Because your lender will want to be sure you can afford payments on your existing mortgage (assuming you have one) as well as your new loan.
When you’re budgeting, also keep in mind that investment properties typically offer much more generous tax breaks than owner-occupied ones. So speak to your professional tax adviser to discover what those might mean to you.
Investment property loan FAQ
That depends on your lender’s rules and the type of mortgage you want. Often 15 percent down is enough for a conventional loan. And for multifamily dwellings where you occupy one unit, you could put down 3.5 percent (FHA loans), 3 percent (conforming loans), or even 0 percent (VA loans), although these are not considered ‘true’ investment properties.
You cannot put 3 percent down on a ‘true’ investment property. But, as discussed above, a mortgage from Fannie Mae or Freddie Mac has a minimum 3 percent down payment for a multifamily dwelling where you live in one unit. So you can buy with one of these loans and still generate rental income from the additional units in your home.
Absolutely! Most borrowers do.
Many banks, mortgage lenders, and other lenders are happy to lend on investment properties as long as you meet lending criteria, which are stricter than for your main home. In addition, investment property loans are easier to find when the economy’s doing well. You might have a harder time finding investment property loans during economic downturns, like when the Covid pandemic was at its peak.
That depends on the rules of the program(s) of which you’re a member. But most financial advisers warn against touching your retirement funds for any investment that’s even a bit risky. A better way to fund your investment property purchase might be with equity from your current home, via a cash-out refinance or second mortgage.
A ‘true’ investment property is one you do not live in. But your home may be considered an investment property if you buy a multifamily property, live in one unit, and rent the other(s) out. Indeed, this can be one of the most affordable ways to buy a rental property and start earning income from it.
That depends on whether your chosen mortgage has loan limits. In theory, you could borrow millions with a jumbo loan, providing you can afford the monthly payments, have a big down payment, and are highly creditworthy.