Though you may be disappointed and feel misled, we’re not actually going to focus on landlord horror stories here. Instead, we are going to talk about the nuances of getting home financing on the purchase of an investment property which, if done improperly, can certainly take on the stuff of nightmares. If you’re thinking of making the leap into rental property ownership and becoming a landlord yourself, there are some things you need to know about how the mortgage industry will treat your loan application. And this treatment could be quite different from your previous experience with financing your primary residence.
Let’s review the basics. A residential investment property is a dwelling that contains between one and four units. Any greater number of units than that and you’re in the commercial financing realm. You plan to put in place a lease agreement(s) and obtain rental income on this property and you don’t plan to occupy any of the units yourself as your primary residence. If you meet all of the above, we have a residential non-owner occupied (N/O/O, as we say in the biz) home. Since you’ll be applying for a mortgage, let’s break things up first into “conforming” and “jumbo” because the guidelines can vary for both. You won’t need to worry about FHA or VA processes with respect to investment properties because you cannot get these types of loans on a N/O/O property.
If the loan amount that the buyer seeks falls into the conforming loan limits (currently $484,350 nationwide and with specific “jumbo conforming” limits in higher cost areas throughout the country) and the property being purchased is currently not rented, then we, as the lender, will order a rent schedule along with the appraisal. The appraiser will comment on market rents for such a property and we will use 75% of that gross amount as qualifying income. For example, let’s say a buyer purchases a single-family investment property and the market rents are $4000 per month. A conforming loan underwriter will apply $3000 in rental income towards the qualifying total income. If there is an existing lease agreement on the property being purchased and the tenant will stay in the property after its acquisition, then the lender will use the lesser of the lease agreement or the market rental survey, again at 75% of the total. An important aside for conforming. If the purchaser is a first-time buyer (that is, in this case, the buyer does not own a primary residence), most lenders will NOT allow use of the rental income at all in the qualification.
You may concur that conforming’s guidelines are relatively straightforward. If so, you’re ready to advance to jumbo. A key concept to understand as we proceed is the “Qualified Mortgage” or “QM.” Investment property transactions on the jumbo side are going to adhere much more strictly to the characteristics that classify a mortgage as a QM and two concepts that get intertwined with investment properties are:
- Property management history. Does the buyer/borrower have a history of at least two years, documentable with tax returns, to demonstrate ownership and financial management of rental property?
- One-year lease agreement. When talking about rental properties and qualifying income from them, all roads lead back to the lease agreement in place (or that will be in place) and whether or not it had/has at least a one-year agreement to start.
So while there are some investors who will vary from these parameters, on the jumbo side, in order to use rental income from the subject property, you can expect your lender to require that you have a property management history and have obtained a one-year lease on the subject property. If you cannot meet these high standards then you are typically “hit” for the full housing payment of investment home without any offset from rents.
Because conforming’s guidelines are relatively sensible and manageable, we tend to see more difficulty on the jumbo side. Nevertheless, we have solutions that permit buyers to purchase without management history and/or without a lease agreement in place. These options can save the day and create and investment opportunity that otherwise would be exceptionally difficult to approve. If you’re looking down your financial road and are ready to take the leap into passive income through real estate rental property, let me know if I can help and if I can answer any of your questions.
I will gladly pay you Tuesday,
Robert J. Spinosa
Vice President of Mortgage Lending
Marin Office: 324 Sir Francis Drake Blvd., San Anselmo, CA 94960
Berkeley Office: 1400 Shattuck Ave., Suite 1, Berkeley, CA 94709
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