Most investors find that financing their first rental property is easy. They use a conventional loan, and the process is similar to buying an owner-occupied home.
However, as you begin to scale up an investment portfolio and buy more property, financing multiple rental properties becomes more of a challenge.
What to Expect When Financing Multiple Rental Properties
With a good personal credit score and income, and an existing rental property portfolio with solid cash flow, investors will find that there are plenty of lenders willing to loan money. However, the terms and conditions may be different from what you’re used to.
Here are some of the things to expect when you apply for more than one rental property loan:
1. More hoops to jump through
- Down payment of 20% - 25% or higher
- Cash reserve account equal to six months for each mortgage
- Debt-to-Income ratio (DTI) below 36% to get the best loan terms
- Credit score of +720 to get better rates and terms
2. Higher interest rates
Interest rates are a measure of risk. That’s why a debt instrument like the 10-Year Treasury Note backed by the full faith and credit of the U.S. Government pays an extremely low rate, and why unsecured revolving credit card debt has an interest rate of 20% or more.
Real estate investors financing multiple rental properties should plan on paying a slightly higher interest rate to compensate the lender for additional risk.
While the exact rate will vary based on the lender and the loan terms and conditions, interest rates on rental property normally run between 0.5% and 1.0% more than an owner-occupied loan. So, if the going interest rate for a 30-year fixed rate mortgage on a primary residence is 3.5%, rental property loan interest rates will likely range between 4.0% to 4.5% or more.
No private mortgage insurance payments
Private mortgage insurance – or PMI – protects the lender from borrower payment default. However, the good news is that because you’re putting more than 20% down to finance your rental property, the requirement for PMI goes away.
Not having to pay for PMI also helps to offset the cost of a higher interest rate. That’s because an average PMI fee runs between 0.5% and 1.0% of your total loan amount. On a $100,000 investment property the annual PMI fee could be up to $1,000, adding about $83 per month to your mortgage payment.
Without the extra cost of PMI, cash flow increases and your DTI (debt-to-income) ratio decreases, helping to make it easier to get an additional rental property loan.
3. Rental property must “fit the mold”
According to Quicken Loans, in order to get a loan on an investment property it must be used as a rental or to generate income and meet one of the following characteristics:
- Single-family unit
- Multifamily unit
There are still ways for real estate investors interested in fixing-and-flipping or wholesaling to obtain financing for their projects, and we’ll discuss some creative options later in this article. But first, let’s look at multiple loans on rental property from the eyes of a lender.
Why Lenders View Multiple Loans as Higher Risk
Successful real estate investors know they should think of their rental property as a business, not a place they’re going to live. While this makes good business sense for the investor, lenders know that a borrower is much less emotionally attached to the property.
Risk of default
One of the biggest concerns that lenders have when making multiple rental property loans is the risk of borrower default.
Mortgage brokers and lenders know from experience that a home occupied by an owner is the least likely to go into default. An investor is much more likely to walk away from a rental property for personal or business reasons.
Risk of over-leveraging
Rental property investors use leverage or OPM – Other People’s Money – to boost returns and diversify risk.
To the lender, leverage is a two way street. If a borrower uses too much leverage across multiple properties, the odds of default are increased if the market cycles downward or cash flow is lower than projected.
High-risk red flags that a borrower may be over-leveraging include:
- Believing that property values always go up
- Having a mortgage payment so high that rental income barely covers the mortgage and operating expenses
- Using low interest rates to buy bad property because it’s “cheap”
- Forgetting to focus on cash flow
Borrower Information That Lenders Require
With one exception, the paperwork and documents that lenders require for multiple rental property loans are the same from loan to loan:
- Tax returns from the last two years
- W-2s or 1099s for proof of personal income
- Bank statements and information on other personal assets such as IRAs and brokerage accounts
- Credit history and credit score
- Financial statements on your current rental properties, including P&L, balance sheet, tenant rent history, and appraisal (if required by the lender)
So, what’s the one exception?
If you’re borrowing to buy additional rental property it means that you’re doing very well with the investments you already own. Develop a presentation to explain to the lender just how well you’ve done, and how well you will do with your new rental property.
Hot buttons that a lender might look for include details on your investment strategy, your property vacancy rate and cap rate compared to the market rates, and a biography of your real estate team members.
Options for Financing Multiple Rental Properties
One of the nice things about investing in rental real estate is that there’s almost always money available. You just need to be creative and know where to look.
Mortgage lender vs. broker
Mortgage lender: a traditional direct lender such as a local, regional or national bank, or a savings and loan. Direct lenders follow the guidelines set by Fannie Mae and Freddie Mac so that they can sell the loan after it closes instead of keeping it on their balance sheet.
Mortgage broker: acts as a middle-man to help real estate investors find the best sources and terms for multiple rental property loans. Working with a mortgage broker can also help save time. Instead of approaching numerous direct lenders, a mortgage broker will help determine the best type of loan and assist with your loan application.
Show me the money
Here’s a list of the best options for financing multiple rental properties, ranging from the traditional to choices for the creative, think-outside-of-the-box investor:
- Conventional mortgages offered by direct lenders that follow Fannie Mae and Freddie Mac investment property guidelines can be the easiest to obtain and offer the best terms and rates. However, most direct lenders won’t loan on more than a few properties owned by the same investor.
- Portfolio lenders keep loans on their own balance sheets instead of reselling them like a direct lender does. Qualification requirements and loan terms and conditions can be more easily customized for individual investor needs, although fees and interest rates will usually be higher.
- Blanket loans are a single mortgage used for multiple properties. One big advantage of using a blanket loan is that only one set of closing costs is paid if all property is purchased at the same time. On the downside, rates and fees may be higher to compensate the lender for risk and selling one of the group of properties “under the blanket” may require a special release from the lender.
- 203K loans are fixer-upper loans for property needing significant repairs. Be prepared to work with an FHA-approved lender and meet the borrower requirements and have a detailed work schedule included as part of your loan application documents.
- Hard money loans are usually structured as short-term loans with higher fees and interest rates. This type of loan can be used as an alternative to a 203K loan or as fast financing to acquire a property from a motivated seller until a more permanent loan solution is arranged.
- Private money loans are a softer form of a hard money loan and are offered by investors looking for return over the long term. Because private money loans don’t come from traditional lenders, they can be perfect for investors looking for creative financing.
- Seller financing – also known as an owner carryback - is perfect for property that’s owned free and clear. Buyer and seller can avoid the seemingly endless paperwork of applying for a mortgage and the seller may be able to conduct a 1031 exchange to defer paying capital gains tax.
- Home equity loans and lines of credit can be used to free-up accrued equity in existing investment properties to buy more. When using this option, be sure to keep an eye on your overall debt-to-income ratio and the change in cash flow.
- Joint ventures are a great way to raise capital for a higher down payment and increase the capital reserve account. Because there may be multiple borrowers in a JV, lenders may be more relaxed in their loan terms and offer better interest rates in exchange for the reduced risk.
Cash-out refinancing can be an attractive option for raising additional investment capital from property with untapped equity, especially with today’s low interest rates.
Some investors prefer to keep their equity intact, with a low loan balance and solid cash flow. Other rental property owners turn accrued equity into capital with cash-out refinancing, using those funds to purchase additional rental units and scale up the portfolio.
Requirements for investment property cash-out refinancing vary from lender to lender. In general, a lender will allow a mortgage of up to 75% of the property’s value. Note that from the lender’s viewpoint, that’s the same thing as receiving a 25% down payment on the new mortgage.
If you’ve owned existing rental property over the past few years, the odds are you’ve built up a significant amount of equity from rising market values.
As an example, let’s say you purchased a single-family rental house five years ago with a $100,000 loan amount. Today, thanks to rapidly rising market values, your property has an appraised value of $150,000 and your existing loan balance has been paid down to $80,000.
Your cash-out refinancing would yield: $150,000 current value x 75% new mortgage = $112,500 - $80,000 existing loan balance payoff = $32,500 in available capital for additional real estate investments.
Tips for Financing Multiple Rental Properties
At first glance, financing multiple rental properties may seem like an impossible dream. But with a little creativity and advanced preparation, it’s easy to make that dream come true.
In closing, here are some of the best tips for getting loans on multiple rental homes:
- Make a large down payment to keep overall LTV (loan-to-value) and DTI ratios low and cash flow high.
- Aim for a personal credit score of at least 720 to increase your ability to qualify for more than one mortgage and to obtain the most favorable interest rate and loan terms possible.
- Be a credible borrower by having personal information and financial performance reports of your current rental property prepared ahead of time.
- Develop a presentation on your current investment business for the lender, including investment strategy, past and current property financials, and a biography for each member of your real estate team.
- Shop around for a lender the same way you would shop around for an investment property, and offer to bring your lender repeat business and referrals as you continue to grow your rental property portfolio.