Finance

What You Need to Know About the Downpayment for Rental Property

To get approval for a rental property loan, borrowers must be able to make a downpayment on their proposed rental property. The downpayment is money you pay out-of-pocket toward the rental purchase. Lenders require downpayments to ensure you have some “skin in the game.” This helps to reduce their risk exposure.

If you own your own home (place of primary residence), you already know a lot about mortgage downpayments. But Lyon Property Management explains that downpayment requirements for rental property mortgages differ from when you borrow to buy your home. This is because lenders view investment property mortgages as riskier.

Lenders impose stricter terms on people borrowing to buy a rental property. The reason is that the default rates for rental property loans are higher than those for residential mortgages. A borrower is more likely to default on their rental property loan than their home mortgage because defaulting on the rental will not make them homeless.

As a result, when you apply for a rental property mortgage, lenders want to know that you can sustain the payments. One of the ways they do this is by requiring higher downpayments for investment property loans. What do you need to know about downpayments when applying for a rental property mortgage?

Everything you need to know about downpayments for rental property mortgage

How much should you pay as a downpayment for an investment property? Is there a minimum or maximum downpayment? What factors determine how much downpayment you are required to pay? How do you get money for the downpayment on your investment property? Find the answers to these questions below.

How much should you pay as a downpayment?

How much should you pay as a downpayment

Most experts will tell you that most lenders expect you to pay 20% of the property’s value as a downpayment. But the truth is you can get away with a downpayment as low as 15%. Sometimes, lenders may impose a downpayment above the 20% threshold.

Some of the factors that determine how much lenders require as a downpayment include the following:

  • Your credit score: This is by far the most important factor when negotiating a downpayment with a lender. To qualify for a downpayment of 15%, most lenders expect you to have a credit score of 700 and over.
  • Debt-to-income (DTI) ratio: This is the measure of your indebtedness. DTI looks at how much of your monthly income is left after settling all your obligations to lenders. A DTI ratio of 36% or lower will result in lower downpayments.
  • Type of loan program: With conventional lenders expect a minimum downpayment of 15%-20%. With Federal Housing Administration (FHA) or U.S. Department of Veterans Affairs (VA) loan programs, the downpayment is even lower.
  • Property type: The number of living units in a rental property also influences the downpayment amount. The downpayment is higher if more than four units are in the building and is lower if the owner occupies one of the units in the building.
  • The location: The city where your rental is located also influences how much money you pay down. A sample downpayment rates for major cities: Denver (16%), Los Angeles (17%), Portland, Oregon (15%), San Francisco (17%), Las Vegas (14%), and Boston (16%).

When negotiating the downpayment on a rental property, remember that loans with lower downpayments often cost more in the long term. They attract higher interest rates and loan fees. You may also be required to buy private mortgage insurance (PMI)

How to get the downpayment for your rental property

How to get the downpayment for your rental propert

Conventional lenders have strict rules for how you can source the downpayment on your rental property loan. They expect the money to come from your savings instead of being borrowed. They also require the savings to be seasoned; and be in your account for at least two months prior.

Portfolio lenders, an alternative to conventional lenders, do not have those requirements. Their underwriting is more collateral-oriented; they are more interested in the quality of the rental. They don’t require the money to be seasoned, and you can borrow to make the downpayment.

Some ways you can come up with the money to make the downpayment on your rental property include a home equity line of credit (HELOC), borrowing the money from friends or relatives, taking the money out of your 401(k), and owner financing.

Conclusion

Finally, working with a mortgage broker experienced in investment property loans is the best way to find the most favorable deals, such as those loan options not advertised to the public. Hiring a broker may cost you nothing, but it can help you make or save money.

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