Want to improve your investment portfolio? Learn about investment property mortgage rates in the United States. Here is everything you need to know
Updated: September 5, 2024
Due to the increased risk to lenders, investment property mortgage rates are generally higher than mortgage rates for primary residences. As a rule, if the lender is faced with greater risk, not only is the mortgage rate higher, but the borrowing requirements become stricter. Still, the grass is greener for property investors in the United States.
If you are financially prepared to invest in properties, you will likely reap the rewards in the long run. This includes securing a stable investment and potential tax benefits, not to mention increased cash flow. On the other hand, if you are financially unprepared, there might be risks and pitfalls. This is why it is imperative that you learn about investment property before making a decision.
In this article, Mortgage Professional America will shed light on investment property mortgage rates as well as the type of loan options available to property investors. We will also explore the advantages and disadvantages of investment properties and other vital information. For our usual pool of readers, this is another one of our client education series. If you have clients and leads that are into investment properties, feel free to share this with them!
What are investment property mortgage rates?
Buying an investment property to generate rental income is different from buying a primary residence. Mortgage rates of investment properties tend to be more expensive than rates on houses. This also means that there are stricter requirements to secure an investment property mortgage.
Investment property mortgage rates can be 50 to 87.5 basis points higher than mortgage rates on primary properties. For instance, the average rate for your 30-year fixed-rate mortgage on an owner-occupied property is approximately 3.25%. For a 30-year investment property mortgage, you would likely have a 3.75% to 4.125% interest rate.
More risk for investment properties
The reason for this jump in investment property mortgage rates is that lenders are taking on more risk when lending to real estate investors. More risk means a higher interest rate and stricter borrowing requirements.
After all, if you invest and rent out your investment property to generate rental income, it is possible that you might experience periods of vacancy. In turn, this increases the likelihood of defaulting on the mortgage. If you are financially unprepared, you may be forced to pay your primary mortgage first and walk out on your investment property mortgage.
Learn more about investment property mortgage rates and how much higher they are than the usual home loan rates by watching this video:
Reasons why investing in property is worth it
There are many reasons why investing in property is worth the money and effort. Here are some of them:
- purchase and hold the land for future development
- buy a home for an elderly parent to live in and enjoy the appreciation when you sell it
- generate passive income by securing renter
- flip the property for profit
Whichever your reason, buying an investment property can be a great option to help diversify your portfolio. As for flipping investment property for profit, you might want to read this article on how to get a mortgage loan to flip a house.
What kind of loan do I need for an investment property?
After you have made the decision to buy an investment property, you must figure out which loan you need. Here are four ways to finance an investment property:
- conventional bank loans
- hard money loans
- private money loans
- tapping home equity
Let’s take a closer look at each to better understand which type of loan will work best for your investment property.
1. Conventional bank loans
A conventional bank loan for an investment property is like what you would have gotten for your primary residence. Conventional bank loans conform to guidelines set by Freddie Mac and Fannie Mae. These loans are not backed by the federal government as opposed to FHA, VA, and USDA loans.
The standard expectation for a down payment on a conventional bank loan is 20% of the purchase price of the property. For investment properties, lenders typically require a 30% down payment.
Conventional loans also require these from you:
- credit history
- credit score
- income
- assets
These factors will help lenders determine your eligibility as well as your interest rate. They will prove if you can afford your current mortgage and the monthly loan payments for your investment property.
Keep in mind that your future rental income will not be factored into the debt-to-income (DTI) ratio. In fact, most lenders expect you to have six months of cash set aside to pay for your investment property mortgage obligations.
2. Hard money loans
Hard money loans are short-term loans that are good if you want to flip an investment property rather than purchase it to rent out or develop. Hard money loans are easier to qualify for than conventional loans. The focus of hard money loans is the home’s profitability, even though your lender will still consider factors like your income and your credit.
To determine if you will be able to pay off the loan, the property’s estimated after-repair value (ARV) is calculated. One upside of hard money loans is that you can get loan funding in days instead of weeks or months.
While these loans can be easier to secure and are best for house flipping, the downside is that interest rates can be as high as 18%. You will also have less time to pay it back. It is common for hard money loans to have terms that last under one year. Compared to conventional loans, hard money loans also have higher origination fees and closing costs.
3. Private money loans
A private money loan is a loan from one person to another, usually between friends or family. If neither of these is an option for a private money loan, you may benefit from attending local real estate investment networking events.
The loan terms on private money loans can vary since they are dependent on the relationship between the lender and the borrower. These loans are secured by a legal contract which allows the lender to foreclose on the home if the borrower defaults on payments.
It is important to consider the relationship you have with the lender before you sign an agreement— especially if you are new to real estate investing.
Learn the best real estate investing courses if you are new to real estate investing.
4. Tapping home equity
Another way to secure an investment property is by tapping your home equity. You can borrow up to 80% of the home’s equity value to help pay for an investment property. Tap home equity options through the following:
However, using equity to finance your investment property can have its downsides. For example, if you use a HELOC, you borrow against the equity like you would with a credit card. This means that your monthly payments will cover only the interest. However, the rate is often variable, meaning it can rise if the prime rate fluctuates.
Know more about home equity loans in this video:
Are investment properties worth it?
At first glance, it would certainly seem like investment properties are worth it. But as with any major decision in real estate, it is beneficial to weigh the pros and cons. Seek the advice of the best in the mortgage industry before deciding.
Advantages of investment properties
Let’s take a quick look at the pros of investment properties:
- security and stability
- cash flow
- tax benefits
- long-term investment
Here is a closer look at each of the benefits of investment properties:
1. Security and stability
Properties are in demand, since everyone needs a place to live. While the housing market is notorious for its fluctuations, it is less affected by market changes and is likely to provide fixed returns. Compared to other types of investments, real estate is more secure and stable.
2. Cash flow
There is a high demand for housing, which means that an investment property will provide you with a steady stream of passive income. This is guaranteed if your rental income is higher than your monthly repayments and maintenance costs. You can even use this income to repay the mortgage rates for your investment property.
3. Tax benefits
You may also enjoy tax deductions that allow you to maximize your tax return on investments. Any expense that you incur in the day-to-day operation of your rental property should be claimed against your income. This will then reduce your tax over time.
4. Long-term investment
In the long run, the value of your real estate investment should increase. The same is true for your rental income if your property is in a high-yield area. Your cash flow should also increase. In turn, you can use these additional funds to expand your investment portfolio.
Disadvantages of investment properties
While there are obvious benefits to investment properties, there are also some disadvantages. Here is a quick look at the cons of investment properties:
- liquidity issues
- entry costs
- ongoing costs
- difficult tenants
Here is a closer look at each of the disadvantages of investment properties:
1. Liquidity issues
You will likely have a difficult time accessing cash if you invest in property versus when you invest in stocks. After all, it takes more time to sell a home. If you have an immediate need for cash, like an emergency, you will have a tougher time cashing in on your investment.
Want to know how cash-in refinance works? Find out in this article.
2. Entry costs
The heavy financing required is one of the biggest challenges for anyone who wants to get into the investment property game. The deposit alone can cost a lot of money. After paying the entry costs, you will also need to prepare for the expensive investment property mortgage rates.
3. Ongoing costs
Because of the high costs involved, investing in real estate requires a lot of planning. Aside from the investment property mortgage rates, owning a property will cost you these charges over time:
- council rates
- maintenance fees
- renovation costs
- private mortgage insurance
In turn, your investment strategy should be to generate more income from your property than all your ongoing costs combined.
4. Difficult tenants
If you have difficult tenants, it can be a nightmare. They can cause emotional stress, and their actions may even lead to financial losses. This is particularly true if your tenant does not pay rent or causes damage to the property.
What is the typical down payment on an investment property?
The typical down payment on an investment property is between 20% to 25%. However, it can also be common for lenders to require a 30% down payment. On a positive note, there are some loan programs that offer investment property financing with a down payment as low as 15%.
The typical down payment on an investment property depends on these factors:
- lender’s requirements
- borrower’s experience
- general risk profile
- credit history
The potential level of risk for the lender increases if the borrower makes a smaller down payment, which increases the loan-to-value (LTV) ratio. A smaller down payment lessens the risk on behalf of the borrower and increases the lender’s risk. In other words, the borrower may be more willing to walk away from the investment if it underperforms.
To compensate the lender for taking more risk, investment property loans with a higher LTV ratio usually come with higher interest rates and larger loan fees. Know more about how much of a down payment you need to buy an investment property by watching this clip:
Navigating investment property mortgage rates
As we have seen, investment property mortgage rates are usually higher than mortgage rates for primary residences. However, if you are financially prepared, you will reap the rewards. It is critical that you weigh the risks and implement effective strategies. If you do, you will be able to get the most out of your investment.
What do you think about this article on investment property mortgage rates? Is it helpful? Let us know in the comments section below
