How Does Investment Property Affect My Qualifying for a New Mortgage?

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When housing markets turn down, investors typically jump in and buy up foreclosed and short sale properties at rock bottom costs. These homes are being held as income-producing rental properties. Many of these property owners are renting to folks who must rent because they were foreclosed on, and are still in a rocky financial period due to the continuing job shortage and resulting financial devastation. It becomes a vicious circle. Those who own investment properties may be finding it a problem to prove positive income on investment properties in order to get new financing for their own personal home.

High Risk

  • Owning investment properties raises the flag of risk to lenders, particularly during a period of high foreclosures. Typically, when investors own several properties and get into personal financial difficulties, saving their personal home is the first thing on the list of priorities. When property values decrease, having rental homes in need of repairs combined with the homes sitting vacant, may have an investor so stretched financially that he may have very little cash flow. Lenders will look hard to see if the borrower has liquid assets. If he is buying an investment property, he will likely need to be able to put 25 percent of the purchase price as down payment. If the home is for personal use, he will have to prove that it is actually for his personal use and may be required to put 20 percent down, depending on the state in which he is buying. This is because some areas in some states, and some entire states, are not eligible for private mortgage insurance, or PMI, coverage. All conventional loans (Fannie Mae or Freddie Mac) require PMI on any loan that is over 80 percent of the purchase price. For a truly owner-occupied purchase, the investor may want to consider an FHA loan, since qualifying standards are more lenient, and the minimum required down payment is only 3.5 percent of the purchase amount.

Provable Income

  • In applying for a new mortgage, the investor must prove that his rental properties have produced income for a period of two full years; this must also be reported on his past two years of tax returns. His bottom line adjusted gross income for the year should show that he has positive income. The lender will add back any depreciation to the adjusted gross income, and see if there is sufficient income to qualify the borrower for a new mortgage. Fannie Mae allows for a 25 percent vacancy factor, so whatever the home rents for per month, 75 percent of that income can be used against the monthly cost of principal, interest, taxes and insurance payment on a new purchase. For example: An investment property rents for $1,200 per month X 75 percent = $900 allowable income. If the investor's total mortgage payment is $700 per month, he will show a $200 positive cash flow, and it can be used as income. If this investment property has a mortgage payment of $1,000, however, then the lender must add $100 to the investor's monthly debts, which will effect his debt ratios. This may prove to be a "catch 22" for the investor/borrower.

Debt Level

  • If the investor passes this "test" of positive income on his tax returns, the lender looks for new accounts on his credit report. These accounts may have been opened to use for repairs on the rental homes, thus creating extra debt and added monthly payments. New credit accounts such as Lowe's, Home Depot or credit cards may be indicators of a shortage of cash flow. High balances on newly created credit cards indicate that the funds may have been used for the rental homes, and are creating an increase in the borrowers debt ratios, which will be scrutinized by the lender.

Credit

  • If the investor has created new accounts or has high balances on his credit cards, his scores will be effected. This could affect an investor's ability to get a new housing loan.

Reserves

  • An approval of a mortgage for an investor will depend on the level of reserves he has left after his closing of the new mortgage. He will be required to prove that he has six months of mortgage payments (principal, interest, taxes and insurance) in a bank with which to make payments in case of emergency. If he has five rental properties, for example, with a total payment of $700 per unit, 6 (months) X $700 = $4,200; $4200 X 5 (properties) = $21,000 that he must have on hand in order to qualify for a new mortgage. (An exception to this is when the investor has equity of 30 percent in the property, and is able to prove it).

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