To purchase a rental property the consensus for a down payment needed is 20 percent. However, the requirement to purchase a rental property is much lower than you think. Here’s what you need to know if you’re buying a rental property….
To purchase a property for rental income purposes 15 percent down is required. If you’re purchasing a rental property and the property is more than one unit such as a two or three-unit property you must put down a minimum of 25 percent.
An additional benefit for purchasing a rental property with 15 percent down is that Fannie Mae and Freddie Mac will allow you to use proposed fair market rents to qualify to offset the mortgage payment. Meaning, if your tax returns, pay stubs and or W-2s do not represent enough income to offset your other monthly liabilities including cars, credit cards, student loans etc. The rents generated by the property that you’re looking to purchase can be covered up to 75 percent of those gross rents.
For example, let’s say the mortgage payment on this new property you’re looking to purchase is $3,500 per month with taxes and insurance and PMI using 15 percent down. Let’s say the rent generated on this property is $4,500 per month. The lender would take a 25 percent vacancy factor and give you 75 percent of the fair market rents in additional income to qualify. Using this example that’s $3,375 per month. That means on paper the monthly liability for this purchase is $125 a month which is far easier to overcome and support then $3,500 per month reflective of the proposed total payment.
Purchasing a rental property means that you intend to rent the property out for income purposes. The property does not need to be tenant-occupied when you purchase the property and you can still use the projected fair market rents to qualify.
When you purchase a rental property with 15 percent down or 20 percent down, the rates on rental properties are always going to be higher than if it was your intent to use the property as your primary residence. Typically, the spread between primary homes and rental homes in terms of rate is about 3/8 in rate difference.
When purchasing a rental property consider the long-term goals; is it for a longer-term investment to break even, cash flowing immediately, or appreciation or maybe all of the above? It could make sense to purchase a rental property even if it only breaks even per month. Multi-family properties are a fantastic example of this as one side can offset the other side. Put another way if you have a 2-unit property and you have a vacancy in one of the units the rental revenue from the other unit offsets the vacancy.
Looking to buy or finance a rental? Begin now.
Scott Sheldon is a local mortgage lender, with a decade of experience helping consumers purchase and refinance primary homes second homes and investment properties. Learn more at www.sonomacountymortgages.com.