Managing a rental property is like any other business; a business's primary focus is to generate profit. To generate profit from your rental home, the revenue generated by the rental income needs to be greater than the operating costs for the property. This is why securing a rental property's best possible mortgage rates and not just the lowest possible purchase price is so important. If your interest rates are lower, your monthly payments will be lower, which means you can generate more cash flow throughout the lifetime of the investment property.
Understanding the Importance of Finding the Best Mortgage Rates
While managing a rental property has a lot of moving parts with a variety of costs, the basic premise is that if your costs are “x” and your revenue is “y,” then you need ‘y” to be equal to or greater than “x.” The viability of the business model depends on the ability of your rental property to generate revenue that covers all of your operating costs while also creating a positive cash flow. The mortgage payment, including the interest rate, will be a massive part of your operating costs. If there is any way to reduce the total amount of your mortgage payment, it will significantly impact your operational costs and cash flow.
Obtaining a mortgage for a rental property differs from obtaining a mortgage for a primary residence. Mortgage rates for rental properties are typically higher than those for a primary residence. This is because banks see mortgages for a rental property as a greater risk. Landlords buying a rental property will rely on the revenue from the property to pay the mortgage payment, while a homebuyer who plans to live in a home will typically be paying their mortgage out of their personal income. Because banks are more reluctant to give out loans for rental homes, you’ll have to shop around to find the best mortgage rates.
When you’re buying a home, you’re dealing with large numbers. This means that one or two points off a mortgage rate can significantly impact how much you own the bank and how large your mortgage payment is. The less you owe in interest, the quicker you will build equity on the rental home. This will allow for more financial flexibility in growing your business and positive cash flow.
Researching Mortgage Rates for Rental Properties
There are several ways to obtain a mortgage for an investment property. One place to start is the internet. You can research local and national banks and see what options are available to you. Before going anywhere, you may want to speak with friends and family to see if they have any recommendations, especially if you know someone who owns an investment property. Another good place to start is a bank with which you already have an account. If you don’t know where to start and nobody you trust can give you any good advice, you can always seek out the help of a mortgage broker. A mortgage broker will act as an intermediary between you and lenders, which could increase your overall costs.
Lenders are typically less willing to loan money for rental properties and will limit the number and amount they are ready to lend. For this reason, you may spend a lot of time finding a willing lender. National banks are more inclined to lend money to individuals who don’t bank with them, which is their main advantage. Another advantage of national banks is they have a much larger staff, and you’ll have access to 24-hour assistance. On the flip side, if you struggle with getting a mortgage from a national bank, a local bank may be more willing to lend you money if you already have an account with them.
While national and local banks may advertise interest rates online, this doesn’t mean that is the interest rate you will get. Several factors will have an impact on your interest rate. They may be advertising interest rates for primary residences and not rental properties. Since interest rates for rental homes are typically higher, those advertised rates likely won’t apply to you. Remember to consider all costs like origination fees and other closing costs with your mortgage. If the fees and closing costs are high, you may offset some of the benefits of a lower interest rate.
Factors That Affect Investment Property Mortgage Rates
Different lenders wills will consider different factors regarding how they issue loans. For example, when applying for a FHA loan, a lender will look at the person applying for the loan and their income. They’ll look at their tax returns, debt-to-income ration, credit score, and credit history, similar to an individual applying for a loan for their primary residence. These FHA loans can have a reliable 30-year fixed-rate mortgage, but it can be challenging to obtain one of these loans for a rental property. You also can’t use an LLC with these FHA loans, meaning it must be in your name.
One way to get around this for real estate investors is to go to a local lender like a local credit union. These local credit unions will offer a similar fixed-rate mortgage as an FHA loan and allow you to use an LLC. Most of the qualifications they consider for the loan will be the same as an FHA loan, which means the rental income from the property likely won’t be considered.
There is another type of lender to consider if you are relying on the business model to obtain a loan, and that is a portfolio lender. A portfolio lender isn’t interested in the individual as much as they are interested in the actual business that is being proposed. You will need a sufficient credit score to show you are reliable, but they want to know whether the property will perform as a business. Single-family homes don’t see substantial returns, so they may be less likely to lend money for a single-family home purchase.
Your interest rate with a lender will largely depend on the loan-to-value ratio. This is the difference between the cost of the home and the down payment, which is the total loan amount. The more you can put down on the property, the lower your interest rate will be.
There are market forces that will determine the willingness of lenders to lend money to borrowers. If interest rates are low, they are more likely to lend money to investors, while investors are more likely to seek loans. Portfolio investors will likely consider other factors as well. If local zoning restrictions make it unlikely that supply will be able to meet the demand for housing in the region, a lender is far more likely to approve a mortgage. If supply is low and demand is high, property values and rent will increase rapidly, making the investment much more attractive for lenders.
Strategies for Securing the Best Mortgage Rates
Improving your credit score is crucial when obtaining lower interest rates on a mortgage. Here are some tips for improving your credit score:
Check your credit score regularly.
Your credit score may increase or decrease depending on your spending and payments, and keeping track of those increases will help you limit any actions that may lower your credit score. It will also help you track any sudden and drastic decreases in your credit score that might indicate identity theft.
Keep track of your credit utilization.
The best way to maintain a high credit score is to ensure you never use more than 30% of your credit limit. This means that if your limit on a credit card is $1,000, you will want to ensure you’re never in debt for more than $300 on that account.
Pay your bills on time.
This sounds obvious, but people often forget to pay their bills on time despite having the money. The best way to avoid late payments is to set up an automatic payment that will at least pay the minimum just in case you forget. You’re busy, and there is nothing wrong with automating some of your busy work.
Pay off past-due accounts.
If you have outstanding debt on old accounts, pay those off immediately. You can set up a payment plan with the creditor to ensure payments aren’t taking up too much of your income.
Limit hard credit inquiries.
If you apply for credit or credit increases regularly, it will hurt your credit score. This is especially true if you make several inquiries in a short period. Avoid applying for credit cards at each store and gas station you use. While these stores are a great place to start when you first want to establish a credit history, they can harm your credit score if you are already set.
If your credit score is high enough and you are ready to shop around for mortgages for a rental property, do your due diligence. You may need to move quickly once you find your ideal property, so it may be best to research the best mortgage rates before searching for a rental home. Remember, this is a business, so you should treat it like a business and always try to find the best bargain.
Creating a solid financial record for investing in real estate is essential. Lenders will be far more likely to lend at low interest rates to an investor with a solid credit history, employment history, and track record as an investor. Just having money in the bank isn’t enough. They want to know your income is reliable and not just a one-time cash accumulation.
Working with Mortgage Lenders
Lenders are crucial for the rental market industry. While people think of landlords as cash-rich, most landlords still use mortgages to finance their investments, even if they have a lot of cash flow and cash reserves. Using debt to invest in new properties allows landlords and investors to put their money into new investments and maintain a cash reserve for emergency repairs and renovations.
Lenders experienced with rental properties are more willing to invest in the business model and the market as they understand the risks and the benefits based on market analysis. They aren’t as concerned about the individual finances of the person running the company. What they want to know is what the market forces are and if the person running the business understands the business itself.
Some factors are more important than interest rates alone regarding loan terms for a rental home. For example, an interest rate may be lower than another, but you may be restricted when paying the loan off early. When searching for a lone, you want to find one with an acceptable interest rate and the type of flexibility for payments and exiting the loan best suited for your business.
Negotiating Mortgage Rates for Investment Properties
When negotiating mortgage rates for an investment property, there isn’t much that can be done. If you are familiar with a lender and have done business with them before, you may be able to go to them and ask for the best possible mortgage rate they can provide and see if it fits your needs, but beyond that, there isn’t much that can be done.
This is why shopping around is so important. If you find a better rate with similar terms from another lender, you can go to a lender you’re familiar with and ask them to match or beat the interest rate from the competing lender. If you can prove to lenders you’re financially stable, and your business model is sound, lenders are more likely to compete for your business. If they are more likely to compete for your business, it increases the odds of them matching competing offers.
Considering Mortgage Rate Locks
A mortgage rate lock is essential for securing a preferable interest rate for your rental property mortgage. A mortgage rate lock locks in an interest rate for some time while everything gets approved. This is a valuable tool when interest rates increase as they have been since the pandemic.
Mortgage rate locks can be done for different time lengths and extended to fit your needs. They can be 30 days, 45 days, 90 days, and so on. The benefit of using this tool is to lock in a lower interest rate at a time when rates can increase daily. The downside is that this can increase your closing costs and becomes more expensive the longer you use it.
If you think you may be closing on a rental property in the next 30 days and interest rates have been steadily increasing, using a mortgage rate lock to secure a lower rate when you close the rental property would be beneficial.
Refinancing Rental Property Mortgages
Another reason you may need to shop for a mortgage is to refinance. There are various reasons why you may want or need to refinance. One reason is you may want cash to pay off debt or to invest elsewhere. You may also need to buy out an investor. Another reason to refinance is to obtain a lower interest rate.
Ideally, you will refinance to decrease your monthly mortgage payment and increase your cash flow. The best time to do this is when interest rates are decreasing. Unfortunately, with high inflation, those rates have been steadily increasing and are unlikely ever to reach the low rates of the Great Recession era. However, as inflation slows, interest rates will likely go down. This means if you obtained a loan during this period of high interest rates, it might be worth it to refinance.
Refinancing an investment property is similar to refinancing a primary residence. The big difference between finding a mortgage when purchasing a rental property and finding one when refinancing is you have more time to find what you are looking for. You can wait until interest rates have bottomed out before refinancing. If you have already taken out a home equity line of credit, it may be difficult to refinance.
Loan Options for Investment Properties
FHA loans are available for investment properties, but they come with downsides and are typically used for first-time buyers. These are the typical mortgages found with Fannie Mae and Freddie Mac. You will be unable to use an LLC when obtaining an FHA loan. Conventional mortgages, non-government-backed loans, are also an option and can be competitive with FHA loans. Using these loans will allow a buyer to get a mortgage with your LLC. VA loans don’t help when purchasing investment properties unless a homeowner plans on making it their primary residence before converting it into a rental and transferring the VA loan to a new purchase. VA loans require applicants to use the home as a primary residence, and they can only have one VA loan at a time. While a VA loan does require the home to be owner-occupied for a certain period of time, once those requirements are met, it can be rented out.
As mentioned, another option is to seek out portfolio investors who specifically invest in the business, not your personal finances. Every real estate investor has their own needs, and the best lender depends on your finances and what fits your business model.
You’ll also need to choose between a fixed-rate mortgage and an adjustable-rate mortgage. The differences are self-explanatory. A fixed-rate mortgage is one where the interest rates never change, while an ARM will have interest that fluctuates with the market after a set period. Typically, an ARM is tied to One-year treasury bills, the 11th district cost of index funds, or the secured overnight financing rate. The interest rates will adjust with whatever index it is tied to. The benefit of an ARM is you will typically have a lower interest rate to start, and there is the possibility it could always go down over time. The downside is that your interest rate can increase substantially depending on the economy.
Everyone’s business and personal finances are different, so there is no answer to the correct way to do business. Some people are more significant risk-takers, while others are more risk-averse. Some people have more cash flow, while others are on a shoestring budget. Your needs may grow as your business grows, so constantly assess your needs before making any significant decision.
Maximizing Cash Flow and Rental Income
A rental property business's main goal is to minimize operating costs and maximize cash flow. This is why getting the best possible interest rate is so important. It’s one way to reduce your operating costs every single month for the duration of the investment. Operating costs can stack quickly. You have your mortgage payment, property taxes, insurance, and repairs, to name a few. There is very little a landlord can do to keep some operating costs down, but one decision you can make is to find the best possible mortgage rate for your rental property.
Finding a reasonable mortgage rate is one of the best ways to create flexibility regarding how much you can charge for rent. Since this is how you generate revenue, an economic downturn will be easier to survive if you have more flexibility with how much you can charge.
Conclusion:
There is no silver bullet or simple solution to finding a reasonable mortgage rate. It would be nice if there was one simple trick and potential real estate investors didn’t need to shop around, but even the most experienced investors still need to shop around for new lenders and the best offers. It’s part of the job. It’s also an essential part of the job. It’s how you maximize your profit with each investment and grow your portfolio. When searching for the best mortgage rate, make sure you are thorough and find help from experts.
Mortgages Rates FAQs:
1. How does my credit score impact the mortgage rates I can get for my rental property?
Your credit score will significantly impact your mortgage rate if it is an FHA or conventional loan. Portfolio investors want to ensure your credit score is higher than a certain threshold and will likely impact the mortgage rate less. As a rule of thumb, a higher credit score means lower loan rates. On the flip side, a lower credit score means higher interest rates and possibly being denied a mortgage loan.
2. Can I refinance my rental property mortgage to lower the interest rate?
If interest rates go down, it is possible to refinance a rental property with a lower interest rate. There are no guarantees interest rates will go down significantly, and it likely isn’t a good idea to make it a part of your business plan.
3. What is the typical down payment required for an investment property loan?
Investment properties typically require higher down payments than an FHA loan for a primary or conventional residence. Usually, they will want a 15% to 20% down payment to secure a mortgage. The higher upfront costs make the barrier of entry difficult.
4. Can I use rental income to qualify for an investment property mortgage?
It depends on the type of loan. FHA loans won’t allow it. Conventional and portfolio lenders may allow up to 75% of the market rate to qualify for the loan.
5. What is the difference between an investment property loan and a loan for a primary residence?
Generally speaking, it is more challenging to get a loan for an investment property than it is for a primary residence. The government backs specific types of loans to help make homeownership more feasible, which allows lenders to loan money to more people. Because FHA loans aren’t designed for investment properties, access to lenders is more limited. You’ll also need a higher down payment for an investment property.