Whether it is a vacation rental or long term rental, buying rental property could be a big step towards financial freedom. According to the National Association of Realtors, buying a rental or investment property actually accounts for approximately 20% of purchase transactions lately. A benefit for investors that are able to buy rentals is that there is a huge need for quality rental properties.
The amount of renters is continuing to grow.
A major reason for the large number of renters is because the prices or values of properties are increasing above a comfort level for first time buyers. The millennial generation has proven to be a little slower on moving from tenants to homeowners. You can’t blame many as they grew up during the mortgage meltdown / great recession and saw the pain of their parents going through tough times. Plus many are straddled with student loan debt.
Although there are great programs for first time and other buyers, there is a great opportunity for investors. Recent relaxing of guidelines have made it easier to qualify for rental properties as well. This includes higher debt ratios allowed, just one year of tax returns for self employed buyers, and other helpful areas.
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Rental Property Qualifying Tip
It can be tough for buyers to qualify for a mortgage with multiple properties. But when it comes to buying a long term rental, we should be able to count 75% of the market rent for the property. The market rent comes from the appraisal report. The appraiser will complete a rental comparable schedule which will determine the market rent for the property. For example, let’s say the market rent is $2000 per month and the total mortgage payment with taxes and insurance is $1500. For qualifying purposes, we would multiply the market rent of $2000 times 75% which equals $1500. Since the total mortgage payment would be $1500, the market rent would cover the full payment. In other words, buying this property would not hurt a buyer’s debt ratio! How about that!?
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Buying a Vacation Rental Property
Many have seen the HGTV programs that show how investors may buy vacation homes where the rental income may cover all or a large portion of the property expenses. That would be quite the arrangement! To be able to enjoy a vacation property while rentals cover a large portion of the expenses would be nice, wouldn’t it? Buying a vacation rental has a few differences compared to long term rentals.
Buying a Vacation Rental Property Using Market Rent
As mentioned above, the market rent could be used towards qualifying a borrower. This includes buying a vacation rental property. There is even the possibility of using documentation from the last 12 months from the rental agency to prove market rent.
Existing Vacation Rental Property Agreements
When buying a vacation home, especially in peak season, there is a good chance there is a vacation rental agreement in place. Buyers would need to honor existing rental agreements as tenants are typically protected in case of a sale. Keep in mind that an existing vacation rental in place could cause an issue with a buyer meeting occupancy requirements as a primary or secondary home. But, buying as a rental would give the new owner rental income that is already in place! Not too bad! Then, if desired, the owner can personally use the home during vacant weeks during the off season and even possible during a peak season week.
Long Term Rentals Versus Vacation Rentals – Which is Better?
So you want to buy a rental property but maybe can’t decide which one to buy? There are benefits of long term versus short term rentals.
[av_table purpose=’tabular’ caption=’Comparison of pros and cons for long term and short term rentals’ responsive_styling=’avia_responsive_table’] [av_row row_style=’avia-heading-row’][av_cell col_style=”]Characteristics / Features[/av_cell][av_cell col_style=”]Vacation Rental Properties[/av_cell][av_cell col_style=”]Long Term Rentals[/av_cell][/av_row] [av_row row_style=”][av_cell col_style=”]Furnished[/av_cell][av_cell col_style=”]Comes furnished [/av_cell][av_cell col_style=”]Usually not furnished[/av_cell][/av_row] [av_row row_style=”][av_cell col_style=”]Owner Use[/av_cell][av_cell col_style=”]Between Rentals[/av_cell][av_cell col_style=”]Rarely[/av_cell][/av_row] [av_row row_style=”][av_cell col_style=”]Rent Amount[/av_cell][av_cell col_style=”]May Charge More Peak Season[/av_cell][av_cell col_style=”]Consistent Amount[/av_cell][/av_row] [av_row row_style=”][av_cell col_style=”]Management Fees[/av_cell][av_cell col_style=”]Higher [/av_cell][av_cell col_style=”]Lower Fees[/av_cell][/av_row] [av_row row_style=”][av_cell col_style=”]Income Consistency[/av_cell][av_cell col_style=”]Usually Fluctuates[/av_cell][av_cell col_style=”]Level Amount[/av_cell][/av_row] [av_row row_style=”][av_cell col_style=”]Utilities[/av_cell][av_cell col_style=”]Paid By Owner[/av_cell][av_cell col_style=”]Typically by Tenant[/av_cell][/av_row] [av_row row_style=”][av_cell col_style=”]Upkeep[/av_cell][av_cell col_style=”]Higher to Keep Rented[/av_cell][av_cell col_style=”]Less Often[/av_cell][/av_row] [/av_table]
Furthermore, in order to make the right decision, you should involve a Realtor that is very knowledgeable with the area as well as real estate as an investment. Realtors may prepare a market analysis for value as well as rental income projections.
Not Everyone Wants to be a Homeowner
A big reason to purchase a rental property is because not everyone wants to be a homeowner. So buying real estate as an investment not only serves the owner, but also the rental community. There could be many reasons someone may choose to rent rather than buy. Someone may have some credit issues, making sure they want to live in the area first, or just saving up money for now. It could even be the person or family may not want to incur potential repair expenses of a home. Therefore buying an investment property could serve these needs of the rental population. There are so many ways to get into real estate investing which we explain in a recent article “How to Get Into Real Estate Investing and Build Wealth“. So check out this article for some ideas you many not have thought of!
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Build wealth through rental properties
How Much Down Payment for Rental Property?
So if you are going to purchase investment property, then you will need to know how much down payment is required. Actually it is possible to put down as little as 15% on a rental purchase. Keep in mind though that it will be the most expensive option in rate and mortgage insurance. The lending agencies charge based on risk which include property type and level of down payment. Since the home is not a primary residence and if times get tough, the owner would likely let the rental go before his/her own primary residence. Additionally if the buyer of a rental puts down the minimum funds, that increases risk as well. Therefore, rentals have some of the highest risk, thus why the rates are higher.
Even though 15% down is allowed on rentals, the most common down payments are 20% and 25% down. Just like above, the more risk then the more the cost / rate. So 20% down would cost a little more than 25% down. There are some additional requirements for investment property purchases. First of all, the whole down payment must be from the borrower’s own funds. For instance, down payment may not be a gift. Although, it could be from a home equity line or borrowed against other qualified assets. Lastly, the seller may contribute towards buyer closing costs but the maximum is 2% of the sales price.
A Few More Points About Investment Properties
Rental property mortgages are available only through conventional financing such as a Fannie Mae or Freddie Mac mortgage. Therefore USDA, FHA, and VA are not available to purchase rental or even 2nd home properties. As far as credit requirements go, it helps tremendously to have higher credit scores to qualify. Additionally this aids in getting a better rate. Although higher scores help a lot, it is not absolutely necessary to have high scores as even a 640 score is possible for rentals.
What if you don’t have access to the down payment required on a rental? What if you called it a primary residence to get around the requirements? Then read below and think again!
Occupancy Fraud: Don’t Lie on Your Mortgage Application!
Calling a rental property a primary or vacation home is one of the most common types of mortgage fraud. Some buyers purposely try to skirt guidelines, while others innocently look for the best terms. So a mortgage lender question is typically posed like this, “Will this purchase be for a primary, secondary, or rental property?”. A common, but wrong answer from many applicants is “The one that gives the best rate and lowest down payment!”. This may not sound bad, but it is the start to a very bad path that a buyer should not take. Some are bold enough to ask “How would anyone know what we do after closing?”. Well, there are some very high tech resources that lenders and agencies use to determine occupancy fraud. If the loan was indeed misrepresented, then it may be discovered. Plus the lender or lending agency such as HUD, VA, or Fannie Mae have many remedies including:
- Call the full mortgage balance due and payable
- Turn over the file to the FBI
- Large financial penalties and fines
So, if you are buying an investment property, do the right thing and call it an investment or rental property! If you have a loan officer telling you to lie on the application, drop that lender immediately. Your life isn’t worth it! The same is true with loan officers as they should not want to lose their license over a mortgage lie.
Call Us for Rental Property Purchases!
Contact our offices for buying or refinancing a rental property. We will help you find the right option for your financial future.