Many individuals are considering purchasing a second home in addition to their primary residence. The increase in remote work makes buying a second home or an investment property possible for many homebuyers.
Whether you want another property to spend time working by the mountains, to use as an investment property, or to enjoy as a vacation home, read this blog to learn more about how to buy a second home or an investment property using a mortgage to finance your purchase.
What Is An Investment Property
An investment property is purchased to generate income – and is not your primary residence. Qualifying for a mortgage to buy an investment property can be more difficult due to the more stringent lending guidelines.
Why Should You Invest In Real Estate?
Investing in real estate is a great way to increase your monthly income by renting the property to tenants. Purchasing an investment property also allows you to diversify your investment portfolio, which can protect you during economic downturns.
Things to Consider Before Buying an Investment Property
As with any large purchase, there are key factors to consider before investing in real estate:
Property Location
The location of the investment property can play a significant role in attracting tenants. Depending on the type of property and the market for tenants, homebuyers may want to purchase a property in a neighborhood close to restaurants, parks, and stores and has a highly-ranked school district.
Property Management
Consider whether you’d like to manage the property yourself or hire a property management company. Being a landlord is a big commitment that requires you to be available 24 hours per day. If you can’t picture yourself dealing with the property upkeep or a tenant who violates the lease terms, a property management company might be the best choice for you (for a monthly fee, of course).
Risks
Owning an investment property can carry many benefits, but there are risks to keep in mind as well. You may experience vacancies, get a bad tenant, or the property could face serious damages – it’s important to weigh these options against the potential income and equity an investment property can bring.
How To Buy A Second Home With A Low Down Payment
A few options are available for homebuyers to purchase a second home. Many homebuyers choose to use either Conventional or Jumbo financing.
Conventional Mortgage For Investment Properties
Conventional mortgages are institutional mortgages that are not insured by the FHA (Federal Housing Administration) or guaranteed by the VA (Veterans Administration). FHA and VA mortgages are sometimes informally referred to as “government loans.” In other words, conventional mortgages make up most loans other than government loans. Conventional mortgages include conforming loans, but they also include jumbo and portfolio loans.
Most commonly, when someone refers to a conventional loan, they are referring to a mortgage that follows the guidelines of Fannie Mae and Freddie Mac.
Conventional loans are often the most sought-after by homebuyers and home sellers alike because of their down payment flexibility, fast closes, and low rates.
To use a conventional loan to purchase an investment property, homebuyers need to meet the following eligibility requirements:
- Minimum down payment of 15% for single-unit properties
- Minimum down payment of 25% for 2-4 unit properties
- 620 minimum credit score
- Cannot use gift funds, regardless of the amount of the gift
If a homebuyer meets those eligibility requirements, lenders will review their loan application to ensure they meet their qualification requirements and their purchase is within the conforming loan limit before approving their loan.
Typically, lenders want to ensure that homebuyers have the following:
- A debt-to-income ratio of 49%
- Ample reserve funds
- The ability to use the rental property and the cash flow to offset their mortgage payment
Jumbo Mortgage Loan For An Investment Property
A jumbo loan is used to purchase higher-priced homes or larger properties with loan amounts that exceed the values set by the Federal Housing Finance Agency (FHFA) for conforming loans. Because these loans do not conform to the loan limits set out by the FHFA, they are not eligible for purchase by government-backed entities such as Fannie Mae and Freddie Mac. These loans are underwritten to individual investor guidelines, as these larger corporations can write stricter rules to fund these loans above the county’s loan limit.
Not all jumbo investors will lend against these properties, and guidelines will vary widely from investor to investor, so discussing potential options with a lender for these higher loan amounts is wise.
To qualify for a jumbo loan to purchase an investment property, homebuyers need to meet the following eligibility requirements:
- Less Stringent Investor – Minimum 20% down with 740+ credit or 20% down with 700+ credit
- Best Priced Investor – Requires a minimum 40% down payment with a 740+ credit score
Why Lenders View Investment Properties As ‘Risky’
Lenders usually view second homes and investment properties differently compared to primary residences and tend to associate more risk with the loans used to purchase them. This is because there is typically a higher risk of default associated with loans for investment properties.
To combat the higher rates that are associated with investment properties, a larger down payment will reduce the risk you present to lenders and can lower your interest rate.
Mortgage rates for second homes and investment properties can range from 0.5 – 0.75% higher than interest rates for primary homes.
One of the drawbacks to purchasing a home as a second home or an investment property is that homebuyers are unable to use VA loans or an FHA loan for the purchase.
Lenders Have Stricter Requirements
Lenders considering a second mortgage application generally have stricter requirements for credit scores and debt-to-income (DTI) requirements, and homebuyers must prove that they have ample reserve funds available.
Frequently Asked Questions
What is the difference between a second home and an investment property?
A second home is a property used for personal enjoyment, such as a vacation home or a remote work location, while an investment property is purchased specifically to generate income through rentals and is not used as a primary residence. Lenders treat these two property types differently, and investment properties generally come with stricter qualification requirements and higher interest rates.
What are the down payment requirements for buying an investment property?
For a conventional loan on a single-unit investment property, the minimum down payment is 15%. For a 2 to 4 unit investment property, the minimum is 25%. Jumbo loans have varying requirements depending on the investor, with some requiring as little as 20% down for borrowers with strong credit and others requiring 40% down for the best pricing. Gift funds cannot be used for investment property down payments under conventional guidelines.
Why do lenders charge higher interest rates for investment properties?
Lenders view investment properties as higher risk because borrowers are statistically more likely to default on a loan for a property that is not their primary residence. To offset this risk, mortgage rates for second homes and investment properties are typically 0.5% to 0.75% higher than rates for primary residences. Making a larger down payment can help reduce the risk you present to lenders and may lower your interest rate.
Can I use an FHA or VA loan to buy an investment property?
No. FHA and VA loans are only available for primary residences and cannot be used to purchase second homes or investment properties. Buyers looking to finance an investment property will need to use a conventional loan or a jumbo loan, depending on the purchase price and loan amount.
What other qualifications do lenders look for when financing an investment property?
In addition to the down payment, lenders typically require a minimum credit score of 620 for conventional loans, a debt-to-income ratio of no more than 49%, and ample cash reserves to demonstrate financial stability. Lenders will also consider whether the rental income from the property can help offset the mortgage payment, which can strengthen your overall qualification.
What are the key risks and considerations before buying an investment property?
The most common risks include property vacancies, difficult tenants, unexpected repair costs, and the ongoing responsibility of property management. Deciding whether to self-manage or hire a property management company is an important consideration, as being a landlord requires significant time and availability. It is also worth researching the property’s location carefully, as proximity to amenities, school districts, and employment centers can significantly impact your ability to attract and retain tenants.
Is an Investment Property Loan right for you?
There is no one-size-fits-all for mortgage financing. The best way to determine whether you should buy a house as an investment property is to talk to one of our mortgage experts at JVM Lending. Our experts can walk you through monthly payment scenarios, property taxes, and closing costs, give you current interest rates, and discuss any other questions or concerns you might have.
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