Lending Requirements for Rental Properties
Though the process of financing a rental property is similar to the process of financing a primary residence, financial institutions have tougher lending requirements for rental property loans. This is due to the default rate on rental property loans being higher than on primary residences. Before seeking a loan to buy a rental property, investors should understand what lenders are looking for from borrowers and be prepared to meet these requirements.
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Credit Score
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A borrower's credit score is one of the key determinants of both loan approval and loan terms. For a rental property loan, borrowers should have a credit score of about 740 for standard loan terms. Credit scores below this will result in higher interest rates and may make a borrower ineligible for the loan from traditional lenders. Before applying for a loan, borrowers should request a copy of their credit reports and check them for accuracy to maximize their credit scores.
Property Equity
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Lenders will generally require at least 20 percent equity in the rental property before approving a loan. This means that the borrower will have to have a down payment of 20 percent of the property's selling price. By putting down more than 20 percent, borrowers will experience an easier loan approval process. Borrowers with large down payments will generally receive better interest rates, and the additional equity reduces the lender's risk. Before putting down all available cash for a down payment, borrowers need to keep in mind any expected repairs or improvements that the property will require.
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Financial Reserves
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In addition to the down payment, lenders often require rental property borrowers to have financial reserves on hand to cover the costs of the rental property mortgage and the borrower's other financial obligations, especially other rental property mortgages. Lenders want to see that the borrower can pay the mortgage even if the rental property is slow to produce a cash flow. Typically, lenders want borrowers to have six months' worth of expenses in savings or other readily available accounts.
Other Assets
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If a borrower has difficulty qualifying for a rental property loan, the lender may also look at other assets to use as collateral. This may include the equity in the borrower's primary residence or other real estate holdings. Before agreeing to use other properties as collateral for a rental property loan, borrowers should understand the risks. A borrower who defaults on a loan for rental property who uses other collateral may lose both the rental property and the property used as collateral. As this greatly increases the risk to the borrower, borrowers should avoid using additional properties as collateral, if possible.
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References
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