Investing in rental property isn't like financing a home. Lenders know losing a rental house isn't as disastrous as losing your personal residence, which makes it easier for you to walk away. Neither you nor your tenants may show as much care for the property as you would for a personal residence that you live in and own. As a result, the requirements for buying are tougher.
When you buy a home, you often have to buy mortgage insurance, which protects lenders against losses if you default. Mortgage insurance isn't available on rental homes, so lenders want a bigger down payment, at least 20 percent. Interest rates can be as much as 1 percent higher than on a personal home of the same value. If you make at least a 25 percent down payment, that can get you a better rate.
In the home-buying market, you need a minimum score of 640 to 660 to get a good interest rate. As a rental-property buyer, the good rates start at a 740 score. If you go below that, your interest goes up. An alternative to paying higher interest over the life of the loan is to pay more points -- prepaid interest -- at closing. Depending on your situation and credit, this could take anywhere from .25 to 2 points.
Lenders require property buyers take out insurance so that the collateral for the mortgage -- the house -- is protected against disaster. On a rental property, that's going to cost you anywhere from an extra $100 to $500 a year compared to a similar private home. This varies according to location, and how much coverage you want. Beyond having enough coverage to rebuild your home, you may want to take out extra liability coverage to protect against a renter injuring himself.
Second Home Mortgage
Second-home mortgages fall somewhere between rental and primary-home mortgages. You may need a larger down payment than your first home, but the terms are usually better than for a rental. If you're buying a second home you intend to rent out part-time, the costs go up. A lender may insist you sign a rider guaranteeing you won't rent the property out or the company will base your mortgage on the assumption you will turn it into a rental.
- Bankrate: Five Tips for Financing Investment Property
- New York Times: Rental Investment May Seem Safer Than It Really Is
- Fox Business: Six Things to Do Before Buying a Home
- Bankrate: Renting Out a Home? Get the Right Insurance
- Nolo: What Is the Difference Between an Investment Property and a Second Home?
A Durham, NC resident, Fraser has written about law, starting a business, balancing your budget and fighting evictions, among other legal and financial topics.