How To Finance An Investment Property

When thinking about adding real estate to your investment portfolio one of the key considerations is financing the purchase. Though investment property loan applications are scrutinized a bit more heavily than they were prior to the recent downturn in the housing market, there are still mortgage programs available for financing the purchase of or for refinancing real estate used for investments.

There are several scenarios where the lender will require an investment property loan, as opposed to a primary residence or second home mortgage, for a piece of real estate. Here are a few examples:

• A long term rental. A home that you rent full time to an individual, roommates, or family.
• A short term or vacation rental. A home that you rent out for short periods of time such as nightly, weekly, or monthly. Even if you plan to use the home yourself some of the year if you rent it out you will most likely be required to take out an investment property mortgage.
• A two - four unit property where you rent out all units. For larger buildings (more than four units), subdivisions, developments, and other large projects commercial financing will most likely be required.
• A home you plan on renovating and reselling. Some investors buy distressed properties and fix them up hoping to resell for a profit once the renovations are complete. The purchase of the home is generally financed with an investment property loan, but the money needed to do the work on the property must usually come from another source as rehabilitation loans (where the cost of improvements can be financed into the loan) are rarely available for investors.
• A home you don't plan on living in. Maybe you are in a quickly appreciating market or have just found an amazing deal. You hope to purchase a house and then resell it at a profit. If you will not be living in the home as your primary residence and it does not qualify as a second home (generally if it is located near the home you live in - sometimes exceptions are made in resort or vacation communities) you will need investment property financing. Be sure to discuss capital gains implications with your tax adviser.

Because of the increased risk it can be harder to qualify for an investment property mortgage than it is for a loan to finance the home you live in. (You should also expect to pay a somewhat higher rate.) As with a primary residence mortgage application the lender will collect information on your income, assets, other debts, credit history and score, the value of the property, and whether there are any outstanding liens on the property. The requirements are likely to be a little tougher because you are applying as an investor, meaning you may be asked to show additional money in reserves (generally enough to make the payments for six months or longer even without bringing in any income from the home) and a higher credit score than is traditionally needed to be approved for a primary residence loan. Even a second home loan is somewhat easier to qualify for.

In some cases it is possible to have some portion of any rental income you will be collecting on the investment property counted as income on your mortgage application which will help you qualify. Exactly what amount will depend on such factors as your equity in the property, the expenses that must be deducted, and the length of the rental history. You will generally need to provide a fully executed lease as part of the documentation with your mortgage application.

If you are unable to qualify for an investment property mortgage but still feel confident that you want to purchase the home you do have some other options. These include:

1. Take out a home equity loan on your primary residence. If you have enough equity in your primary residence you may be able to borrow money against it with a home equity loan or home equity line of credit to buy an investment property. It may be easier to qualify for this loan, and home equity loans are available with both fixed and adjustable rates. When considering this option it is important to understand that you are using your home as collateral, meaning if you fail to make the payments on the loan your house could go into foreclosure. While losing a home is never pleasant, it is much more devastating to lose your primary residence than an investment property. This is partly why investment property mortgage rates are higher in general than those for a primary residence.
2. Recruit fellow investors. If you believe in the investment opportunity, perhaps others will too. If you cannot qualify to borrow the full amount on your own you might have better luck when pooling your assets with one or more partners. Of course by sharing the initial outlay and the risk you will also have to share in the return. Be sure to have thorough agreements outlining how the investment will be handled, what each individual will be responsible for, and what happens if someone wants to leave the partnership. Consult an attorney and tax professional for assistance.