It is important as a real estate investor to realize that finding a good cash-flowing rental property is just one piece of the puzzle. The financing aspect is just as important. It is not ideal to be in a situation where you are under contract to purchase a rental property that you either will not be able to finance the acquisition of or have limited options, which leaves you with purchasing in cash or borrowing at unattractive terms. You also do not want to buy in cash and have difficulty doing a cash-out refinance in the future. Cash is king and having it tied up in your investment property can hold you back from growing.
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.
The Market You are Investing In
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.
Property Condition of the Rental Property
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).
Rental Property Income & Debt Service Coverage Ratio (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.
Required Liquidity to Purchase
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.
Credit History and Credit Score
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 Amount and Value
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.
What Information to Provide for a Purchase to Get a Rental Property Loan
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.