Experience Counts When it Comes to Acquiring Rentals
First-time real estate investors find the approval process is very much the same as financing an owner-occupied property. There's a credit report checked, bank statements and assets are reviewed, and income and employment. Yet, there are some additional guidelines rental property financing requires. The first and most obvious is the amount of down payment needed. Most conventional programs ask for a down payment of at least 20% while providing slightly better terms with a 25% down payment.
This is much different from a primary residence, where the minimum down payment for a primary residence can be as low as 5%. The other is the interest rate on a loan. Rates for rental properties will typically be anywhere from 0.25 to 0.50% higher. But buying a subsequent rental property is much easier. Why?
Why Buying Rental Properties Gets Easier
One reason might be that the buyers are familiar with financing a rental with the first purchase experience. Yet, the real reason is the way lenders treat rental income. With the initial purchase, income that is produced by the rental cannot be counted. Instead, the buyers must be able to qualify with their current income without the benefit of rent. Even though the unit is rented out and the tenants pay the rent each month, lenders won't use it when qualifying. With the second rental purchase, the income can be used.
That said, investors want to see if the income generated is enough to cover not only the financing costs, such as the principal and interest payment, property taxes, insurance, and an amount reserved for maintenance. If the rent is not enough to cover the costs of ownership, it's very likely the investor will move on to evaluate another property. If there's not enough rent to positive cash flow the investment, it's an expense, not income.
The difference in the way lenders treat rental income between the first and second relies primarily on the notion that lenders want to see the owners properly manage and maintain the unit. If after two years of timely mortgage payments and proper management, the rental income can be used to help qualify. There are still down payments and interest rate adjustments; it's just that it's easier to qualify because the income can be used. There is income coming in both instances, but the way lenders treat the two transactions is different.
After the first, the second is so much easier to qualify for. This is also why real estate investors soon discover how much easier it is to qualify as they ultimately own multiple rental properties. Sometimes to the point of quitting their current jobs and becoming full-time landlords. When this happens, it's not uncommon to hand over the job of managing the properties, collecting the rents, and fixing things when they're broken to a property manager. For a fee, a property manager will handle these day-to-day activities. All the buyers typically need to do is find another property and turn over the landlord duties to someone else.
Contact Us to schedule a free consultation. Whether buying or selling a home, we are always happy to meet with you to discuss your wants and needs, with no obligation.
Eric Slifkin, a Broker Associate, is the founder of the Slifkin Team at Keller Williams Realty. Eric and his experienced agents serve South Florida and the Treasure Coast, including Stuart, Port Saint Lucie, and the Palm Beaches.