Are you looking to invest in a rental property in San Diego or the surrounding area? When applying for a mortgage for a rental property, there are some similarities to the process of applying for a loan for a primary residence. But on the whole, there are stricter qualification requirements to obtain financing for a non-owner-occupied property. Let’s discuss what you need to qualify for a rental property loan in more detail.
Financing Rental Properties Carries a Higher Degree of Risk for Lenders
As we will discuss below, lenders consider similar metrics when deciding whether to approve you for rental property financing to those they would if you were purchasing a primary residence. But each requirement is more rigorous.
The reason for this is because lenders consider it riskier to finance this type of purchase. Why? Maureen Martin explains some factors at play:
- You will not be living on the premises. That means you will not be available to monitor the property.
- No matter how high your approval standards for tenants, each tenant is an unknown. It is possible that anyone of them could damage the property.
- You may be counting on income from renting out the property to help you pay off the mortgage. Even in an area where housing is in high demand, unforeseen events could result in fluctuations in rental income.
- Your income from the rental property will also be contingent on your management skills and experience. For those just getting into rental properties, both may be minimal.
Lenders are looking to offset each of these risks. That is why they set higher standards for approval for these types of mortgages than regular home loans.
What Factors Do Lenders Consider?
Lenders assess the same basic factors for rental property mortgages as they do for primary residence mortgages:
- Down payment ability
- Debt-to-income (DTI) ratio
- Credit score
- Cash reserves
Let’s talk about each of these in a little more detail.
1. Down payment ability and loan-to-value (LTV) ratio
Typically, for a rental property, you are looking at a significantly higher down payment and a lower loan-to-value (LTV) ratio than you would be for a primary residence. Down payments often range between 30-40% if you want to qualify for a competitive interest rate. So, if you want to keep your interest rate as low as possible, consider a hefty down payment.
This qualification requirement is about the same for a rental property loan as it would be for a primary residence loan. You will need to provide W-2s or other proof of your income. Lenders want to see at least two consecutive years of steady employment.
If you do not have a W-2, or it does not provide a lender with all the information about your income, consider a bank statement loan. One thing to note is that you will have an easier time qualifying for this type of mortgage if your past two years of work experience include rental property ownership income.
3. Debt-to-income (DTI) ratio
Just as when you apply for a primary residence loan, your debt-to-income (DTI) ratio is important when applying for a rental property mortgage. Usually, it will need to be in the range of 45-50%, but each lender may have different rules.
If you have at least two years of experience as a rental property owner, the expected income from the property you are purchasing can count toward both your income and DTI ratio. Otherwise, you calculate both without it.
4. Credit score
To qualify for a rental property loan with a competitive interest rate and low fees, you will need a credit score of at least 740 or so. Requirements may vary from lender to lender.
5. Cash reserves
At a minimum, you need about six months of cash reserves. Bear in mind that if you are not an ideal candidate in terms of experience or other factors on this list, higher cash reserves may help offset some of those deficits.
Qualifying for a Rental Property Loan Requires a Competitive Borrower Profile
Now you are familiar with the basic requirements to qualify for a rental property loan in San Diego. In many respects, applying for a rental property mortgage is not so different from applying for a primary residential mortgage. The same factors are important. But you will need to have a more competitive borrower profile to qualify.
So, try and raise your credit score, save money for cash reserves and higher down payment, and gather the necessary documentation to verify your income and experience. The better prepared you are going into the application process the more likely you will get approved for a loan.