Financing Residential Investment Property

One of the concerns that a lender has is the risk of payment default is higher on investment property than on the purchase of a home. The perception of greater risk leads to higher interest rates on investment properties than one would receive for owner occupied property.

So what does the underwriter look at to approve the loan?

I. Your credit – You need to have paid your other financial obligations as agreed. This usually means a middle credit score of at least 660. It is possible to get financing if your credit score is lower, but expect substantially more documentation to explain any negatives on your credit report, significantly higher rates and a larger up-front equity investment in the property.

II. Your experience as a property investor –

a) Lenders generally look for at least 2 years of “property management” experience. If you haven’t
filed a Schedule E, you will be considered a “first time” investor.

b) Experienced investors can have a lower credit score than a “first time” investor.

c) A “first time” investor must have enough income to cover the entire PITI for the subject rental
property with no credit for any income received.

d) Most lenders will limit the number of properties to 5 per investor, including your primary residence.

III) The loan application process –

The application process is complicated and takes longer than buying a home. Specifically:

a) It is a TEAM EFFORT – you need a realtor and lender who understand the unique aspects of the investment property market.

b) Closing timeframes generally run around 45 days or more.

c) Appraisal costs are double home loans, $600 - $700 vs. $350 because the lender requires a
Small Residential Income Appraisal Report. This report is an important document that
establishes for both you and the lender information about the realistic rental income you can
expect to receive from the subject property and the sales of comparable properties.

d) The lender will limit seller paid costs, known as concessions, to no more than 2% in most cases.

e)  Be prepared to put up a minimum of 25 - 30% equity.

f) Lenders require at least six months of cash reserves. Cash balances in checking, savings and
money market accounts are all considered cash reserves. The cash reserves are what the lender relies on in the event that their analysis of the property’s cash flows show negative cash flow. Reserves = PITI X 6mos.

g) Analyzing cash flow from a property – Several methods exist to analyze cash flows, but ultimately
the one that will determine your loan approval is how the lender looks at cash flow. The following
chart outlines differences in the methods. Because the lenders have the money, their analysis is
the one that will be decisive in the loan process.

Analyzing Cash Flow - Lender vs. Your View