If you’re thinking about investing in real estate, or you’re fairly new to the process, then understanding investment property mortgage loans and rates is essential. This guide will help you to make the best decisions based on your situation, beginning with the types of loans available.
Rates for investment property mortgage loans can be either fixed or adjustable, depending on the lender and the borrower’s preference. Fixed-rate mortgages offer the same interest rate for the entire duration of the loan, which can range from 5 to 30 years. This stability can provide more certainty to borrowers, making it easier to budget for their monthly mortgage payments, depending on whether the loan is personal or commercial.
On the other hand, adjustable-rate mortgages have interest rates that are subject to change over time, based on fluctuations in a benchmark index. This means that borrowers can start off with lower interest rates in the beginning, but the rates can increase later on, which can lead to higher monthly mortgage payments. Adjustable-rate mortgages are typically offered with initial fixed-rate terms that range from 3 to 10 years, after which the rate becomes adjustable.
The terms for investment property mortgage loans generally vary depending on the lender, the borrower’s financial profile, and the property’s location and value. However, some typical terms/lengths for investment property mortgage loans include:
- Loan amounts: Investment property mortgage loans usually have higher loan amounts compared to traditional home mortgages, ranging from $100,000 to $500,000 or more.
- Down payments: Most investment property mortgage loans require a higher down payment than traditional home mortgages, which can range from 15% to 25% or more.
- Loan-to-value ratio (LTV): Lenders generally require a lower LTV for investment property mortgage loans compared to traditional home mortgages, with ratios of around 70% to 80%, which means that borrowers will need to put down a higher percentage of the home value as a down payment.
- Higher interest rates: As noted earlier, interest rates on investment property mortgage loans are typically higher than those for traditional home mortgages, with rates averaging around 4% to 6% or more.
- Longer processing times: Investment property mortgage loans can take longer to process compared to traditional home mortgages, with an average processing time of around 60 to 90 days.
There are several types of loans that can be used to finance investment properties, each with its own set of pros and cons. Here are some of the most common types of loans:
- Conventional mortgages: Conventional mortgages are home loans that are not offered or guaranteed by the government. They are typically preferred by borrowers with good credit scores and a strong financial profile. Pros of conventional mortgages include competitive interest rates, flexible terms, and the ability to customize the loan structure. Cons include stricter qualification requirements, higher down payments, and limits on the number of investment properties a borrower can own.
- FHA loans: FHA loans are government-backed mortgages that are popular among first-time homebuyers and those with lower credit scores. They require a lower down payment than conventional mortgages and have more lenient credit score requirements. Pros of FHA loans include more accessible credit requirements, lower down payments, and competitive interest rates. Cons include mortgage insurance premiums which significantly increase the cost of the loan over time.
- VA loans: VA loans are for U.S. veterans, active-duty service members, and eligible surviving spouses. They offer competitive interest rates, no down payment, and no mortgage insurance requirement. Pros of VA loans include no down payment requirement, lower credit score thresholds, and low closing costs. Cons include eligibility requirements, limited availability, and some restrictions around the location of the property.
- Portfolio loans: Portfolio loans are a type of loan that is held by the lender rather than sold on the secondary market. This can give lenders more flexibility in the loan’s terms and qualifications, including property types that are not eligible for conventional financing. Pros of portfolio loans include flexibility in the loan terms and qualifications, the ability to finance multiple properties, and no mortgage insurance requirement. Cons include higher interest rates, larger down payments, and stricter qualification requirements.
- Hard money loans: Hard money loans are a type of loan that is based on collateral rather than the borrower’s creditworthiness. They are generally offered by private lenders and are meant to be short-term loans that are repaid within a few months to a few years. Pros of hard money loans include faster funding, more relaxed qualifications, and the ability to finance properties that are not eligible for conventional financing. Cons include higher interest rates, larger down payments, and the risk of losing the collateral if the borrower defaults on the loan.
When deciding between a fixed-rate and adjustable-rate mortgage for an investment property, there are several pros and cons to consider:
- Stability: Fixed-rate mortgages offer stability as the interest rate does not change over the life of the loan. This makes budgeting and planning for mortgage payments easier, as borrowers know exactly what their payment will be.
- Predictability: Borrowers know exactly what they will pay for the life of the loan.
- Protection: Because the interest rate does not change over the life of the loan, fixed-rate mortgages offer protection against rising interest rates.
- Higher Rates: Fixed-rate mortgages generally have higher interest rates than adjustable-rate mortgages, making them more expensive over the life of the loan.
- Limited Flexibility: Fixed-rate mortgages don’t provide flexibility to adjust with market changes.
- Refinancing: If interest rates drop after purchasing, it’s more difficult for borrowers to take advantage of them without refinancing.
- Lower Rates: Adjustable-rate mortgages generally have lower interest rates than fixed-rate mortgages, making them more cost-effective in the short term.
- Flexibility: Adjustable-rate mortgages offer flexibility as monthly payments can increase or decrease over the life of the loan.
- Potential Cost Savings: If interest rates drop, borrowers will have the opportunity to save money on their monthly payment.
- Risk: If interest rates rise, monthly mortgage payments can rise as well, making the loan more expensive.
- Uncertainty: Borrowers are unable to predict what their monthly payment will be over the life of the loan.
- Higher Risk: The adjustable nature of this mortgage may make their monthly payments unaffordable and precarious.
Ultimately, the decision between a fixed-rate and adjustable-rate mortgage for an investment property depends on the borrower’s goals, risk tolerance, and financial situation.
Lenders set investment property mortgage rates based on several factors, including:
- Credit score: A borrower’s credit score is an important factor in determining their interest rate. Lenders use credit scores to evaluate the borrower’s creditworthiness and assess their risk, so borrowers with higher credit scores are more likely to receive lower interest rates.
- Loan-to-value (LTV) ratio: LTV ratio is the ratio of the loan amount to the value of the property. Generally, lenders require a lower LTV ratio for investment property mortgages than for primary residence mortgages. The lower the LTV ratio, the lower the interest rate a borrower is likely to receive.
- The property’s location: The property’s location can impact the interest rate a borrower receives. If the property is in a highly desirable location with a strong rental market and low vacancy rates, the borrower may receive a lower interest rate.
- Down payment size: Investment property mortgages typically require a larger down payment than primary residence mortgages. Borrowers who make a larger down payment may be able to qualify for a lower interest rate.
- Borrower’s debt-to-income (DTI) ratio: A borrower’s DTI ratio is the percentage of their monthly income that goes toward paying off debt. Lenders use DTI ratio to determine a borrower’s ability to repay the loan. Borrowers with a low DTI ratio are likely to receive a lower interest rate.
- Market conditions: Interest rates can fluctuate based on market conditions, such as the state of the economy, inflation, and changes in the Federal Reserve’s monetary policy.
Overall, lenders use a combination of these factors to determine a borrower’s interest rate for an investment property mortgage. Hence, borrowers should focus on improving their credit score, making a larger down payment, and shopping around for lenders to obtain lower interest rates on their investment properties.
If you’re new to real estate investing, consider meeting with an expert who can give you the most relevant tips and information regarding your particular situation.
About Brian T. Boyd, Esq.
Attorney Brian Boyd helps clients with real estate, construction, and other business matters, while at the same time growing his real estate portfolio to a six-figure income. He earned a JD from Samford University’s Cumberland School of Law, and an LLM in Taxation from Georgetown University Law Center. His newest book is Replace Your Income: A Lawyer’s Guide to Finding, Funding, and Managing Real Estate Investments.