Financing an investment property is significantly different than financing the home you intend to live in.  Before you look at properties, you must understand what is required to qualify for an investment loan.

Investment loans are higher risk for lenders, since they know that should an owner experience financial difficulty, they will be inclined to pay against their primary residence first (take care of family) before they pay on their investment properties.  The lender’s higher risk assessment consequently requires greater care when giving loans to investors.

Not All Income is Income
Let’s say that you currently own a rental property and that your current mortgage on that property is $2,000 per month.  The property has been rented for the past two years without interruption, and you have a new lease already signed for 2 more years at $2,000 per month.  Your debt to income ratio would be a break even, correct?

Unfortunately, no.  To begin with, most lenders do not recognize rental income as equal to the monthly amount.  Typically, a lender will only count 75% of the total rental income.  So for that $2,000 mortgage versus $2,000 rental income, the lender would only count $1,500 of the rental income, leaving you with $500 of additional debt. 

Also, many lenders will not allow unusually high rental incomes for qualifying for your next loan.  For example, if the average rental in your area is $2,000 per month for a comparable home and you rent yours for $3,000, many lenders will not count 75% of the $3,000 unless you can adequately justify the high price.  If you cannot prove that your property is and will continue to be worth $3,000 per month, the lender will only count up to $2,000 based on comparables, meaning that again only 75%, or $1,500, will be credited to your debt to income ratio.

Finally, in many cases the lenders will count none of the income unless you have a certain equity stake in the property.  So if you owe $250,000 on your investment property that is currently only worth $250,000, the lender may require you to either pay down up to 30% of the amount you owe or not count that income from that property towards your qualifying debt to income ratio.

Picking a Good Lender
When determining which lender is the right one for your investment, you have to remember that not all lenders are equal.  In most cases, many residential lenders typically deal with primary residences only and, while they can offer investment loans, do not fully understand the needs of the investor.

An early indicator that a lender may not be the best fit for your investment loan is if the lender starts offering you loan products before finding out what your short and long term goals are.  Like houses, loans come in many different types and a good lender should understand what you are trying to achieve before trying to push you into a loan that may not be the best for your investment strategy.

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