Many beginning real estate investors believe that rental property loans are difficult to find. While financing a rental property does require some time and effort, there are a surprising number of mortgage options available.
In this article, we’ll discuss where to find single-family rental (SFR) loans, how to qualify for a rental loan, and highlight some financing options that many investors overlook.
Key Takeaways
- Single-family rental loans generally require a larger down payment and a higher credit score.
- Options for financing a rental property include conventional loans, portfolio and blanket mortgages, and a self-directed IRA for real estate.
- Borrowers should focus on other rental property loan terms in addition to interest rate, such as prepayment penalty, loan term, and amortization.
How to Qualify For a Single-Family Rental Loan
The process for qualifying for an SFR loan is similar to applying for a mortgage for your primary residence. However, because a rental property is used as an investment and is not owner-occupied, lenders view loans on rental property as having a slightly higher level of risk.
For example, banks know from experience that if the economy begins to decline and demand for rental property tapers off, some investors may give the keys back to the bank and walk away from the property.
With that in mind, here are some of the criteria to expect when you apply for a single-family rental loan:
- Credit score of at least 620, although some lenders may look for a minimum FICO score of 680 or above.
- Borrower debt-to-income ratio (DTI) of no more than 36%, which means if a borrower’s gross monthly income is $10,000 the total monthly debt payments can not exceed $3,600.
- Down payment of around 25% so that there is sufficient equity in the property in the event the real estate prices begin to decline.
- Because the down payment on a single-family rental loan is larger, private mortgage insurance (PMI) doesn’t apply provided the loan-to-value ratio (LTV) is less than 80%.
- Interest rates and loan fees are generally higher on single-family rental loans to compensate the lender for the additional risk of financing an investment property.
- Investors must have sufficient liquid cash reserves equal to up to 12 months’ worth of mortgage payments to allow for lower than expected cash flow from the home.
- Property types that qualify for rental property loans are single-family, small multifamily property with four units or less, townhomes, and condominiums.
Options for SFR Loans
There are several options to consider when looking for a single-family rental loan, and some lenders may be a little more flexible than others.
A good place to begin shopping for a loan on an investment property is through Roofstock’s lending partners portal. Investors can connect with a lender online to receive a rate quote for refinancing an investment property or obtaining a new mortgage on a single-family rental.
As you research the choices for a single-family rental loan, here are the main types of investment property mortgage categories to examine:
Conventional / Conforming Loans
- Down payment is generally a minimum of 25% of the property appraised value.
- Lower interest rates and fees based on the borrower’s credit score and down payment amount.
- Offered by traditional lenders such as national, regional, and local banks, and credit unions.
- Guaranteed by Fannie Mae and Freddie Mac, with loans required to meet established guidelines.
- Potential for up to 10 rental loans, although many lenders place a cap of four loans per borrower.
FHA Financing
- Multifamily loan may be used by a borrower who claims one unit as a primary residence.
- Down payment and interest rate may be lower than conventional loans, based on the borrower's credit score.
- Offered by traditional lenders and mortgage brokers.
- Guaranteed by the Federal Fair Housing Administration (FHA).
- May be used for purchases, property requiring significant updating, or new construction.
VA Financing
- Multifamily loan used by borrowers who live in one of the units as their primary residence.
- No minimum down payment or credit score.
- Offered by mortgage brokers and traditional lenders.
- Guaranteed by the U.S. Department of Veterans Affairs (VA).
- Available to veterans, active-duty service members, and eligible spouses.
Blanket Mortgage Loans
- Used to finance multiple rental properties under a single loan.
- Down payment, interest rate, and loan terms vary based on the property type and lender.
- Offered by mortgage brokers and private lenders.
- Ability to refinance multiple individual mortgages under one blanket loan.
- Properties financed using a blanket loan may serve as collateral for one another.
- Borrowers may negotiate a release clause that allows one property to be sold without refinancing the entire blanket loan.
Portfolio Mortgages
- May be used to finance a single-family rental or multiple homes with the same lender.
- Down payment, interest rate, and loan terms vary and may be customized to meet the investment objectives of the lender and borrower.
- Offered by mortgage brokers and private lenders for borrowers seeking creative financing.
- Flexible loan terms may also mean higher interest rates and fees, prepayment penalties, and shorter loan terms requiring a balloon payment at the end of the loan.
Private Money Lending
- Financing may be offered by any type of real estate.
- Down payment, interest rate, and other loan terms fully customized to meet the objectives of the lender and borrower.
- Private money lenders are often real estate investors who invest in debt instead of equity.
- Good option for funding future investments based on the performance of current properties being financed.
- Private money lenders sometimes actively participate in a deal by taking a share of the recurring cash flow or profit in exchange for lower interest rates or fees.
Self-Directed IRA
- Type of retirement account structured like a traditional or Roth IRA.
- Funds must be directed from a current IRA to a custodian who works with self-directed IRA (SDIRA) accounts.
- Investors then have direct control over how retirement funds are invested.
- Income must be kept within the self-directed IRA, and the IRA must have sufficient cash to pay for operating expenses and capital improvements.
Home Equity Loan and HELOCs
- Home equity loan is a type of second mortgage used to pull equity out of an existing property and is paid to the borrower in one lump sum.
- HELOC (home equity line of credit) is a credit line against the equity of an existing property that the borrower may draw on at any time.
- Interest rate and fees may be higher compared to long-term, cash-out refinancing.
- Both home equity loans and HELOCs are repaid monthly to the lender, usually at a fixed interest rate and specific loan term.
- Up to 75% of the accrued equity may be borrowed, depending on the qualifications of the borrower and the lender.
Seller Financing
- Offered by sellers who own a property free and clear.
- Seller financing is used by owners to earn interest income from the buyer by acting as the lender.
- Also known as owner financing, purchase-money mortgage, or a seller carryback.
- Down payment, interest rate, and other loan terms may be negotiated to meet the investment objectives of the seller and buyer.
- Seller financing may be used as a strategy to reduce the lump sum capital gains tax payment by paying the tax as part of each borrower payment received, as an alternative to a traditional 1031 tax-deferred exchange.
Single-Family Rental Loan Terms
Regardless of what type of single-family rental loan you apply for, all investment property mortgages have the following key elements:
Down Payment: Single-family rental loans require a minimum down payment of 25% of the property’s appraised value. So, if a home appraises for $200,000 the required down payment would be $50,000 ($200,000 x 25%) and the loan amount would be $150,000.
There are some potential advantages to making a larger down payment. First, there is a larger equity cushion in the property at the time the home is financed. Secondly, because the loan-to-value (LTV) is lower, less cash flow is required to service the debt and make the monthly interest payments.
Interest Rate: Investment property loans generally have slightly higher interest rates than a mortgage on a primary residence, although rates may vary from one lender to the next.
Although many investors focus on finding the lowest loan rate, keep in mind that some lenders offset a lower interest rate with extensive fees or terms that are lender-friendly such as a prepayment penalty.
Application Fees: Some banks offer fixed application and loan origination fees, while others based application fees on the dollar amount of the mortgage.
Depending on the size of your loan, mortgage fees on a rental property loan could run into thousands of dollars. Be sure to understand how much upfront money the lender is requiring, and ask if your application fee is refundable if your purchase transaction falls through.
Points: Mortgage points are a form of prepaid interest used to reduce the loan rate. One point generally equals 1% of the loan amount and typically lowers the interest rate by 0.25%.
So, if you are applying for a single-family rental loan of $150,000 and the normal interest rate is 4%, by paying $1,500 for one point the loan rate would be reduced to 3.75% over the term of the loan.
Term: Conventional fixed-rate loans generally have loan terms of 30, 20, or 15 years. The monthly mortgage payment is the same each month, and at the end of the term the mortgage will be paid off and the home will be owned free and clear.
Using the example above, the monthly mortgage payment (principal and interest, or P&I) on a $150,000 loan at 3.75% interest would be $694 per month amortized over 30 years. As the term progresses, more of the payment is applied to the principal because there is less of a loan balance to charge interest on.
However, some non-conventional lenders such as blanket and portfolio lenders may offer a longer amortization rate but a shorter loan term.
Amortization: When the loan term does not match the amortization rate a balloon payment is due at the end of the term. For example, a lender may offer a borrower a $150,000 loan at a 3.75% interest rate amortized over 30 years with a term of 5 years.
So, even though the monthly payment is still $694 per month (P&I), after 60 months of payments the borrower would need to pay off the remaining loan balance of $131,562 by paying the lender cash, refinancing the loan, or selling the property before the end of the loan term.
Adjustable Rate: ARMs (adjustable-rate mortgages) have an interest rate that periodically resets. Some lenders will offer a low “teaser rate” then adjust the interest rate upward after a limited period of time.
For example, a 3/1 ARM has a fixed interest rate for the first three years. After three years, the interest rate can adjust once every year over the term of the loan. Private lenders (such as portfolio and blanket lenders, and sellers offering financing) may negotiate with the borrower to adjust the interest rate on an ARM after only a few months.
Both Freddie Mac and The Federal Reserve Board publish valuable information on adjustable-rate mortgages for borrowers.
Prepayment Penalty: When lenders offer a low interest rate on a single-family rental loan, they will sometimes include a prepayment penalty as one of terms and conditions of receiving the loan.
A prepayment penalty compensates the lender in part for lost interest income if the rental property loan is paid off early, such as when the property is sold or refinanced. Generally, the longer the original loan is held the lower the prepayment penalty is.
Underwriting: Property appraisal, physical inspection, title report, and verification of the borrower’s loan documents are all part of the underwriting process. Oftentimes when underwriting begins, a borrower will be asked for additional information or documents from the seller to help the lender approve the loan.
Closing: When shopping around for an SFR loan it’s important to ask the lender when the loan will close and fund. In today’s sellers markets, many property owners are looking for a buyer who can close fast with reasonable contract contingencies.
If one lender can’t commit to funding the loan by the scheduled closing date in the purchase contract, it may be better to try and find a lender who can close fast instead of asking the seller to extend the closing date.
How to Keep Rental Loan Costs Lower
SFR loans may be more expensive than a mortgage for a primary residence, but there are several things an investor can do to help keep costs for an investment property loan lower:
- Make a down payment of at least 25% for a lower loan-to-value (LTV).
- Maintain a good credit score of 740 or higher.
- Shop around for the best single-family rental loan terms and conditions.
- Consider creative financing options such as private lenders or a self-directed IRA for real estate.
- Document the financial performance of any existing rental property owned to demonstrate to the lender a track record of success.
- Prepare your loan application documents ahead of time to show the lender you are serious about obtaining the loan.
Wrapping Up
Although single-family rental loans require more time and effort to obtain, there are a variety of options for financing when an investor knows where to look. In addition to conventional loans from banks and credit unions, portfolio loans and private equity lenders are two of the many options for creatively financing a rental property loan. Because loans for income property generally have higher rates and fees, it can pay to shop around and compare terms from different lenders.
