Finding the perfect rental property is a thrill, but securing the right rental property loans can make or break the deal. Don’t let financing hurdles derail your investment dreams. This guide provides actionable steps to confidently secure rental loans, covering everything from property evaluations and credit score essentials to navigating cash reserves. We’ll empower you to get the financing you need for your next rental property, so you can achieve your investment goals.
While hunting for your deal, it is best to be initiative-taking and reach out to investment property lenders or hard money lenders, ones that underwrite, or qualify the loan, to the rental property’s income and offer a 15–30-year term. When doing so, there are numerous criteria to be mindful of that may affect your ability to get a rental property loan, we will cover some of the big-ticket items below.
Understanding Your Rental Market
To be confident that you will be able to finance your rental property, you should stick to markets that have sales & rental comps within 1-5 miles of the property. You should also make sure that those comps are as recent as possible, but a good rule of thumb is there within 90-120 days. This ensures that the appraisal report, which is one of the most important aspects of the loan underwriting process, will be satisfactory to the investment property lender.
Also, be mindful of acquiring a rental property: (i) in a town or city with a low population count (less than 10,000 people), (ii) that is located on a gravel or dirt road, or (iii) one that sits on more than 2-5 acres of land. These are factors that if present may be hurdles to financing. They also may signal that the property is in a rural area and avoiding rural areas is more than ideal.
That is not to say obtaining a rental property loan in what may be considered a market is impossible. Every scenario is unique, and exceptions can be made but if too many of the above negative factors are associated with the rental property loan request then it may be an uphill battle for financing.
Key Takeaways
- Get pre-approved for financing: Connecting with lenders early in your property search can help you move quickly when you find the right deal and avoid missing out due to financing delays. Knowing your budget beforehand allows you to confidently make offers.
- Assess market conditions and property potential: Research comparable properties and rental rates in the area to determine a realistic investment strategy. A property in good condition, located in a desirable rental market, increases your chances of securing financing and achieving positive cash flow.
- Demonstrate financial readiness: Lenders look for borrowers with a solid credit history, sufficient cash reserves, and a clear source of down payment. Preparing your finances in advance streamlines the loan process and positions you as a reliable borrower.
Evaluating Rental Property Condition
In order to be eligible for a long-term, 15-30 year, rental property loan, the property must be in good condition. That is a little vague but to delve deeper: the rental property, in the condition, that you are purchasing it, should value within the neighborhood’s price range and should rent for a monthly amount that is in line with market rents.
Also, it should be free of any sort of defects or conditions that would affect marketability or its livability to a prospective tenant. If the property needs repairs to get it up to market standards (for both value and rental income) then it would not be suited for a rental property loan (it would be a bridge or hard money loan instead, where rehab/renovation is being funded).
Analyzing Rental Income and Cash Flow
If you are buying a rental property from a seller that’s owner occupying it or a seller that’s a fellow real estate investor/landlord but there’s a lack of rental income history or it’s been rented at below-market rental rates, that’s fine.
When you run your analysis, it is your job as the buyer/real estate investor to determine what the market rent is for that rental property. You obtain this through looking at comps in the area. You provide that market rent figure to the investment property lender you’re thinking of working with and they would figure out what the Debt Service Coverage Ratio (“DSCR”) is for that rental property.
The DSCR determines how strong of an income-producing rental property you’re looking at buying or refinancing. DSCR is calculated by taking the Gross Monthly Rental Income and dividing it by the monthly loan payment, which includes Principal, Interest, Taxes, and Insurance, as well as HOA dues (if applicable) (this is also known as “PITIA”).
The DSCR should come out to a 1.2 or above, which means your residual income after paying PITIA is 20% of the gross rent. But you still may be able to get financing if this number is at or below a 1.0, it just depends on the lenders’ requirements. If you are at or below a 1.0, that means the property’s income, more specifically the gross monthly rent, does not cover the monthly PITIA, so after paying the loan you’re not netting anything or you’re coming out of pocket to cover some of the loan payment each month.
This is not ideal and may signal that either the purchase price is too high, the property is in poor or below market condition and unable to command market rent, or that the rental market is saturated, and rents are low.
The 1% Rule and Other Rules of Thumb
How to Calculate the 1% Rule
The 1% rule is a quick way to estimate if a property’s rental income might cover your mortgage. It suggests that the monthly rent should be at least 1% of the property’s total purchase and repair costs. For example, if you buy a property for $150,000 and plan to spend $10,000 on repairs, your total investment is $160,000. Using the 1% rule, you should aim for a monthly rent of at least $1,600. This rule can be helpful when you’re first evaluating a potential investment property. It gives you a quick benchmark to compare against other properties and helps you narrow down your search.
However, keep in mind that it’s just a starting point. You’ll need to do a more thorough analysis to determine the property’s true profitability. A more in-depth analysis would include calculating key metrics like the debt service coverage ratio (DSCR) and net operating income (NOI) to assess the property’s financial performance.
Limitations of the 1% Rule
While the 1% rule can be a useful initial screening tool, it has some limitations. It doesn’t account for all of your expenses, such as property taxes, insurance, and ongoing maintenance. These costs can significantly impact your cash flow, so it’s crucial to factor them into your calculations. For a more comprehensive understanding of your potential expenses and income, consider creating a detailed rental property analysis.
Additionally, the 1% rule doesn’t consider variations in local markets. In some areas, rents may be significantly higher or lower than 1% of the purchase price. Always research the local rental market to understand what rents are realistic for comparable properties. Sites like Zillow can provide valuable data on average rents in specific areas. Don’t hesitate to connect with local real estate professionals for insights into market conditions and rental rates.
Importance of Cash Reserves
Having sufficient cash reserves is essential for any real estate investor. Lenders often require borrowers to have several months of mortgage payments in reserve. This demonstrates your ability to handle financial obligations even if your rental income is disrupted. Investment property loans often have stricter requirements than primary residence loans, so adequate reserves are even more critical. This is especially true when securing financing for bridge loans, which often require a higher level of financial stability.
Beyond meeting lender requirements, cash reserves provide a safety net for unexpected expenses. Repairs, vacancies, and legal issues can arise unexpectedly, putting a strain on your finances. Having 6-12 months of liquid cash reserves, as some experts recommend, can help you weather these storms without jeopardizing your investment. This includes not only mortgage payments but also funds for potential closing costs, property taxes, insurance, and other unforeseen expenses. If you’re considering a commercial loan, having substantial cash reserves can strengthen your application and provide a buffer for unexpected market fluctuations.
How Much Cash Do You Need for a Rental Property Loan?
To be eligible for a rental property loan, you must demonstrate to your lender that you have the requisite liquid assets in reserves. This applies to both when you are looking to get a loan to purchase a rental property and when you’re applying for a rental property loan to refinance your rental property.
There are certain types of accounts that rental property lenders will consider to be liquid. This may vary slightly from lender to lender, but most are in line with each other as there are industry standards. Here is some guidance on what is considered to be liquid:
- Personal bank accounts
- Stocks/bonds/mutual funds, 100% of the account(s) value is usually considered liquid
- Vested retirement accounts (example: IRA, 401k, Keogh, 403b) will be counted at 60-70% of the vested balance/value
- Business accounts may be considered for assets as long as you can demonstrate through documentary evidence that you are an owner of the business
- Cash value of a life insurance policy (100% of the cash value may be considered liquid).
- Cryptocurrencies, but best to assume that this will be limited to more “mainstream” crypto such as Bitcoin and Ethereum (and of course if you’re using this as a down payment, you’ll have to liquidate and deposit it into a US bank account)
For a purchase of a rental property, you’ll need to demonstrate that you have enough to cover the down payment and closing costs, plus 6 months of PITIA and you do this by providing the 2 most recent statements for any account listed above. Any large deposits in those 2 months will need to be sourced.
If you’re refinancing a rental property and getting a loan for that then you’ll just need to show you have 6 months of PITIA (loan payments) in liquid assets. It’s just as important to note what cannot be used for liquidity support when getting a rental property loan for a purchase or refinance:
- Seller second lien covering the down payment
- A gift of equity: where a seller lowers the purchase price below market value
- Equity from another rental property cannot be considered towards your liquidity unless you do a cash-out refinance of that rental property
- Gift funds from family or friends may not be counted or if it is counted it may only be a certain percentage of your down payment or liquid reserves (for rental property purchases most will want to see that the majority of the down payment is coming from you the real estate investor)
- Another loan, secured or unsecured, that’s procured for the purpose of being, or covering, a down payment, or the liquid reserve requirement, on a rental property, may be an ineligible source of funds for a rental loan against this new rental property
The real estate investor’s liquidity position is an important part of underwriting. Proof of funds or other sources of liquidity is needed to be able to determine the real estate investor’s ability to cover required expenses for the loan and rental property.
Down Payment Considerations
When financing a rental property, the down payment significantly influences your loan terms and overall investment strategy. A 20% down payment is generally recommended for conventional loans, often leading to lower interest rates and better loan conditions. As U.S. Bank explains, “A larger down payment (20% or more) often gets you a lower interest rate” (U.S. Bank).
However, some lenders offer options with lower down payments, such as 5% or 15%, but these may come with higher interest rates. A Reddit thread provides further insights into the varying perspectives and experiences of investors regarding down payment requirements.
Sufficient cash reserves are also essential. Visio Lending recommends that investors have 6-12 months of liquid cash reserves to cover mortgage payments, closing costs, and other expenses. This liquidity not only helps secure the loan but also provides a safety net for unexpected costs or vacancies.
While a 20% down payment is often ideal for favorable loan terms, exploring lower down payment options might be suitable depending on your situation. Just be prepared for potentially higher costs and risks. Ensure you have adequate cash reserves to support your investment and maintain financial flexibility. For flexible financing options, explore programs like bridge loans and rental loans offered by companies like MoFin Lending.
Credit Score Requirements for Rental Loans
Credit history and credit score play a key role when you are trying to get a rental property loan. Most rental property lenders do not look at your personal income, net worth, or tax returns and thus have limited info to work off.
The credit report is one of the reports involved in the underwriting process that gives rental property lenders the most insight into your creditworthiness as a borrower. Therefore, a big emphasis is placed on your credit score and your credit history. It is important to maintain making timely payments on all credit/debt obligations to demonstrate an ability to repay and keep your score up.
If your score is below 680, or you have a pattern of missed or past due payments, that may be looked at negatively and affect your borrowing potential. Make sure to monitor your scores and all your accounts so that when you do go for a rental property loan you can make your rental property lender aware of any potential issues.
Minimum Loan Amounts and Property Values
As a rental property investor, you are looking for the best return on your dollar. Your aim is to go after cash-flowing rental properties. For example, you find a single-family residence that can be bought for $60,000 – $80,000 in cash and rents at $800 – $1,100 a month, annual taxes are low, and the annual insurance cost is even lower.
Your monthly net and the return-on-investment for this deal is above average. But this may be a refinance risk. The reason being is that most rental property lenders have minimum loan amount and minimum property value requirements for rental property loans. That varies between lender, but most have a minimum loan amount requirement of $75,000 – $100,000 and there a fewer that set the minimum to $50,000 or $150,000.
It is best to assume that rental properties with a purchase price, or value if you’re refinancing, that’s below $120,000 will not be looked upon as favorably. Lower valued properties pose more risk for rental property lenders.
Getting Your Rental Loan Application Approved
With everything covered in this article, you should have a general idea of how to attack the financing piece of the puzzle. To apply to get a rental property loan should be straightforward and easy. You do not need to provide a detailed analysis of the rental property you are looking to buy or refinance. There are simple items to present to your rental property lender.
For purchases:
- Property Address:
- Property Type:
- Number of Units:
- Sq Ft:
- Purchase Price:
- Monthly Rent (current in-place, if applicable):
- Annual Taxes:
- Annual Insurance:
- Monthly HOA (if applicable):
- Your Estimated Credit Score:
- Source of your Down Payment:
- How many rentals do you currently own:
Refinances are a little different, the information needed varies slightly:
- Property Address:
- Property Type:
- Number of Units:
- Sq Ft:
- Date of Purchase:
- Purchase Price:
- Rehab Costs Invested to Date:
- Current Debt Owed:
- Current Estimated Value:
- Monthly Rent (in-place):
- Annual Taxes:
- Annual Insurance:
- Monthly HOA (if applicable):
- Your Credit Score:
- How much do you have in liquid assets/reserves:
- How many rentals do you currently own:
With the above information, your lender should be able to ask any follow-up questions or provide you with a quote and breakdown of terms, including your rate, monthly payment, and an estimate of the closing costs. From there you can determine whether or not the deal makes sense.
Types of Rental Property Loans
Navigating the world of rental property financing can feel overwhelming, but understanding your options is the first step. Let’s break down the different types of loans available:
Conventional Loans
Conventional loans are a popular choice for experienced investors. These loans typically require a larger down payment (often 20%) and a strong credit score. While the qualification criteria are stricter than some other options, conventional loans often offer competitive interest rates and predictable monthly payments. They’re a solid choice if you have a proven track record and substantial capital.
FHA Loans
Backed by the Federal Housing Administration, FHA loans are designed to make homeownership more accessible. For rental properties, FHA loans allow for smaller down payments, sometimes as low as 3.5%. However, there’s a catch: you typically need to live in the property for at least a year if it’s a one-to-four-unit property. This makes them a good option for “house hacking,” which we’ll discuss later.
VA Loans
For eligible veterans and active-duty military members, VA loans offer incredible benefits, including the possibility of 0% down payment. Similar to FHA loans, VA loans often require owner-occupancy, meaning you’ll need to live in one of the units if you’re purchasing a multi-unit property.
Non-QM Loans
Non-Qualified Mortgage (Non-QM) loans cater to borrowers who don’t fit the traditional lending box. Perhaps you’re self-employed or have a non-traditional income stream. While Non-QM loans offer more flexibility, they typically come with higher interest rates and fees. They’re a good option to explore if you have a unique financial situation. For more traditional financing options for investment properties, explore resources like MoFin Lending’s rental loans.
Owner Financing
With owner financing, the seller of the property acts as the lender. This can be a win-win, offering flexibility for both parties. However, owner-financed deals often involve a large balloon payment at the end of the loan term, so it’s crucial to understand the terms and long-term implications.
Home Equity Loans/HELOCs
If you own a home, you can leverage its equity to finance a rental property purchase. A home equity loan provides a lump sum, while a HELOC (Home Equity Line of Credit) acts like a credit card, allowing you to borrow against your equity as needed. Keep in mind that you’re putting your primary residence at risk if you default on these loans.
Cash-Out Refinance
Similar to home equity loans and HELOCs, a cash-out refinance allows you to tap into your home’s equity. You refinance your existing mortgage for a larger amount, receiving the difference in cash. This can be a good option if you want to consolidate debt or access funds for a down payment on a rental property.
Hard Money Loans
Hard money loans are short-term, high-interest loans from private lenders. They’re often used by house flippers who need quick access to capital for renovations. Due to the higher costs, hard money loans are best suited for short-term projects with a clear exit strategy. For longer-term financing solutions, consider options like bridge loans which can offer more flexibility than traditional hard money loans.
Portfolio Loans
Portfolio loans are held by the lender rather than sold on the secondary market. This gives lenders more flexibility in setting terms and underwriting criteria. Portfolio loans can be a good option for experienced investors with complex financial situations. Direct lenders like MoFin Lending often offer commercial loans that function similarly to portfolio loans, providing more personalized service.
Private Money Loans
Similar to hard money loans, private money loans come from private individuals or groups. They often have less stringent requirements than traditional loans, making them a potential option for borrowers who may not qualify for conventional financing. However, it’s essential to carefully vet private lenders and understand the terms and conditions.
DSCR Loans
Debt Service Coverage Ratio (DSCR) loans are specifically designed for investors. These loans are underwritten based on the property’s cash flow rather than your personal income. A DSCR of 1.25 or higher is generally required, meaning the property’s net operating income should be at least 125% of the debt service (mortgage payments). MoFin Lending offers DSCR loan programs tailored to investors looking for flexible financing options.
Additional Tips for Securing a Rental Property Loan
Getting approved for a rental property loan requires more than just choosing the right loan type. Here are some additional tips to strengthen your application:
Property Management History
Demonstrating experience in managing rental properties can give lenders confidence in your ability to handle the investment. If you have a history of successful property management, be sure to highlight it in your application.
Thorough Property Research
Don’t rush into a purchase. Thoroughly research the property and the local rental market. Consider factors like location, property size, amenities, and potential rental income. A well-researched investment demonstrates your commitment and understanding of the market.
Seeking Professional Advice
Connect with experienced professionals, such as real estate agents, mortgage brokers, and financial advisors. They can provide valuable insights and guidance throughout the process. For tailored advice on financing your investment, consider reaching out to a lender specializing in investment properties, like MoFin Lending.
Investment Property Loan Rates
Be prepared for potentially higher interest rates compared to conventional mortgages for primary residences. Shop around and compare rates from different lenders to secure the best possible terms. Understanding how APR works is crucial for comparing loan offers effectively.
Using an LLC
Holding your rental property within an LLC can offer liability protection and potential tax advantages. Consult with a legal and tax professional to determine if this strategy is right for you.
House Hacking
House hacking involves purchasing a multi-unit property, living in one unit, and renting out the others. This strategy can help offset your mortgage costs and build equity faster. FHA and VA loans can be particularly beneficial for house hacking. Learn more about house hacking strategies to see if it’s a good fit for you.
Creative Financing/Seller Financing
Explore creative financing options, such as seller financing or lease options, to potentially reduce your upfront costs or secure more favorable terms. Creative financing can open up opportunities for investors with limited capital.
Understanding the Loan Process
Familiarize yourself with the loan process, from application to closing. Understanding the steps involved can help you prepare and avoid potential delays. Resources like the Consumer Financial Protection Bureau offer helpful information on the mortgage process.
Loan Approval Factors
Your credit score and down payment significantly impact your loan approval and interest rate. Maintain a good credit score and save for a substantial down payment to strengthen your application. Improving your credit score before applying can significantly increase your chances of approval.
Importance of Understanding Loan Types
Each loan type has its own set of advantages and disadvantages. Carefully consider your financial situation, investment goals, and risk tolerance when choosing a loan type. Speaking with a financial advisor can help you make an informed decision.
Cross-Default Provisions
If you’re using multiple lenders, be aware of cross-default provisions. These clauses stipulate that defaulting on one loan can trigger a default on other loans. Carefully review loan agreements to understand the potential implications.
Related Articles
- Smart Strategies for Rental Property Financing – MoFin
- How to Get a Loan for a Rental Property – MoFin
- Long-Term Financing for Rental Properties – MoFin
- DSCR Loan Guide for Real Estate Investors – MoFin
Frequently Asked Questions
What are the most important factors lenders consider for a rental property loan? Lenders primarily focus on the property’s potential rental income, its condition, and your creditworthiness. They want to see that the property can generate enough income to cover the mortgage payments (a good DSCR) and that you have a history of responsible financial management. The location and condition of the property also play a role, as lenders want to ensure the property is marketable and holds its value.
How much cash do I realistically need to get a rental property loan? You’ll need enough for your down payment and closing costs, plus typically six months of principal, interest, taxes, insurance, and HOA fees (PITIA) in reserve. Lenders consider liquid assets like bank accounts, stocks, and some retirement accounts. They generally won’t accept borrowed money or gifts as reserves.
My credit score isn’t perfect. Can I still qualify for a rental property loan? While a higher credit score is always better, some lenders may still work with you if your score is below the ideal range. However, a lower credit score might mean a higher interest rate or stricter loan terms. It’s best to discuss your specific situation with a lender to understand your options.
Are there any loan programs specifically for investors who don’t fit traditional lending criteria? Yes, options like Non-QM loans, portfolio loans, private money loans, and DSCR loans cater to investors with unique circumstances. These loans may offer more flexibility but often come with higher interest rates and fees. Direct lenders like MoFin Lending can be a good resource for exploring these options.
What’s the best way to prepare for the rental property loan application process? Start by thoroughly researching the property and the local rental market. Gather all necessary financial documents, including bank statements, tax returns, and credit reports. Connect with a lender early in the process to discuss your financing options and get pre-approved. This will give you a clear understanding of what you can afford and strengthen your position when making an offer on a property.