Help aspiring and current property investors learn about investment property mortgage rates. Learn how these rates work and how homebuyers can navigate them
Due to the increased risk to lenders, investment property mortgage rates are generally higher than mortgage rates for primary residences. When lenders face higher risk, mortgage rates go up, and borrowing requirements become stricter. If your clients are financially prepared to invest in properties, they can likely enjoy long-term rewards such as stable investment and increased cash flow.
However, if their finances aren't in good shape, they might face risks and pitfalls. That’s why it’s important for them to understand investment property before making a move. In this article, Mortgage Professional America will explore what you need to know about investment property mortgage rates to help you deal with clients who are also property investors.
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 are the interest rates applied to loans used for purchasing or refinancing properties that are not primary residences. These properties include:
- rental homes
- vacation homes
- multi-unit buildings
Because banks and mortgage lenders view investment properties as higher-risk loans, the rates are usually higher compared to loans for owner-occupied homes. Investment property mortgage rates can be 50 to 87.5 basis points above mortgage rates on primary properties.
Mortgage providers will also require larger down payments and stronger borrower qualifications. If you’re a mortgage broker or an aspiring one, understanding investment property mortgage rates is important if you want to guide your clients properly. You must lead them toward the right property loan products while managing their expectations for their investments.
More risk for investment properties
The reason for this jump in investment property mortgage rates is that mortgage lenders are taking on more risk when lending to real estate investors. More risk means a higher interest rate and stricter borrowing requirements. Higher rates help mortgage lenders offset the risk of potential default.
After all, if your clients invest and rent out their investment property to generate rental income, it's possible that they might experience periods of vacancy. In turn, this increases the likelihood of defaulting on the mortgage. If your clients are financially unprepared, they might prioritize paying their primary mortgage first and walk out on their 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:
Do you wish to see your name along with the top mortgage brokers in the country? Being knowledgeable about investment property mortgage rates can prove to be an advantage—especially if you have clients who are into real estate investing.
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:
- buy a home for an elderly parent to live in and enjoy the appreciation when it’s sold
- purchase and hold the land for future development
- generate passive income by securing renters
- flip the property for profit
Whichever the reason, buying an investment property can be a good way to help your clients diversify their portfolio.
Factors that affect investment property mortgage rates
Here are some of the factors that can influence investment property mortgage rates:
- credit score
- down payment
- DTI ratio
- property type
- market conditions
Below is a closer look at these six factors:
1. Credit score
Your clients’ credit score can have a huge impact on the rate they get on an investment property mortgage. Banks and mortgage lenders look at credit scores to measure how likely a borrower is to repay the loan.
Higher credit scores can signal that your clients have a good history of paying debts on time. This makes them a lower risk to the mortgage lender. Lower risk often means lower rates. On the other hand, if your clients have low credit scores, mortgage lenders may offer a higher rate to cover the extra risk.
2. Down payment
The size of the down payment can also affect the mortgage rate your clients receive. Mortgage lenders see bigger down payments as a sign of lower risk. A larger down payment means your clients are borrowing less and have more of their own money invested in the property.
This lowers the mortgage providers’ risk of loss if your clients stop making payments. Others would offer lower rates if your clients can put at least 20 percent down. The larger the down payment, the better the chance of getting a lower mortgage rate.
3. DTI ratio
The debt-to-income ratio (DTI) is another factor that mortgage lenders review. DTI compares your clients’ monthly debt payments to their monthly income. A lower DTI shows banks and mortgage lenders that your clients have room in their budget to take on another loan. It also means they’re more likely to afford both their current debts and the investment property mortgage.
A high DTI suggests a higher risk of missed payments. Most mortgage lenders prefer a DTI below 35 percent. Helping your clients lower their DTI before applying can improve their chances of getting better rates.
Learn more about DTI ratios when you watch this:
4. Property type
The type of property your clients want to buy will also impact their mortgage rate. Single-family homes usually have lower rates compared to multi-unit or mixed-use properties. Mortgage lenders see multi-unit properties as riskier because these depend on multiple tenants to generate income.
If the property is vacant or if tenants aren’t paying rent, your clients might struggle to make payments. Mixed-use properties add more risk because they combine residential and commercial space. Be sure to explain these differences to your clients when they compare investment property options.
5. Market conditions
Market conditions also affect mortgage rates. Banks and mortgage lenders adjust rates based on the economy. For example, when inflation is high, investment property mortgage rates often rise to keep up with the cost of borrowing.
When inflation is low, rates may go down. Movements by the Federal Reserve, such as their monetary policy decisions can also influence mortgage rates. While these market changes are out of your clients’ control, it’s best to keep track of them to monitor the rates’ fluctuations.
What is the 2% rule for investment property?
The 2 percent rule is a simple way to check if an investment property might bring good cash flow. According to this rule, the monthly rent should be at least 2 percent of the property’s purchase price.
For example, if your clients buy a property for $200,000, the rent should be at least $4,000 per month. This helps cover expenses such as mortgage payments, taxes, and maintenance. While the rule sounds good in theory, it might be difficult to achieve in most markets since property prices and rental rates vary by location.
Advise your clients to use this rule as a quick check only. A full review of all costs and income is always the safer way to decide.
Aside from the 2 percent rule, there are other real estate investing rules such as the 50 percent and 70 percent. Learn more about them when you watch this clip:
The 2 percent rule is thoroughly discussed in this article about the risks and rewards of buying rental property. Check out the equation and get extra info about rental property as real estate investments for your clients!
Benefits and downsides of investment properties
At first glance, it would certainly seem like investment properties are worth it. But as with any major decision in real estate, it's beneficial to weigh the pros and cons.
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 these benefits:
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's 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 your clients with a steady stream of passive income. This is guaranteed if their rental income is higher than their monthly repayments and maintenance costs. They can even use this income to repay the mortgage rates for their investment property.
3. Tax benefits
They may also enjoy tax deductions that allow them to maximize their tax return on investments. Any expense that they incur in the day-to-day operation of their rental property should be claimed against their income. This will then reduce their tax over time.
4. Long-term investment
In the long run, the value of their real estate investments should increase. The same is true for their rental income if their property is in a high-yield area. Their cash flow should also increase. In turn, you can advise your clients to use these additional funds to expand their investment portfolio.
Disadvantages of investment properties
While there are obvious upsides to investment properties, there are also some disadvantages:
- liquidity issues
- entry costs
- ongoing costs
- difficult tenants
Here is an in-depth look at each:
1. Liquidity issues
Your clients will likely have a difficult time accessing cash if they invest in property versus when they invest in stocks. After all, it takes more time to sell a home. If they have an immediate need for cash, like an emergency, they’ll have a tougher time cashing in on their investment.
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, your clients 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 your clients these charges over time:
- council rates
- maintenance fees
- home renovation costs
- private mortgage insurance (PMI)
In turn, you must help your clients refine their investment strategy to generate more income from their property than all their ongoing costs combined.
4. Difficult tenants
If your clients 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 their tenants don't pay rent or cause 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 percent. However, it can also be common for banks and mortgage lenders to require a higher down payment.
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 bank or mortgage lender increases if the borrower makes a smaller down payment, which increases the loan-to-value (LTV) ratio. In other words, the borrower might be more willing to walk away from the investment if it underperforms.
To compensate the mortgage lender for taking more risk, investment property loans with a higher LTV ratio usually come with higher interest rates and larger loan fees.
Navigating investment property mortgage rates
As you already know, investment property mortgage rates are usually higher than mortgage rates for primary residences. However, if your clients’ finances are in order, they can enjoy the long-term rewards. It’s vital that you help them weigh the risks and guide them on improving their strategies.
Finally, remember that your advice matters even when your clients are big-time property investors. So, make sure that you’ll be able to properly explain the available property loan options and factors that affect investment property mortgage rates. By doing so, your clients can get the most out of their investment.
Looking for more guidance? Visit Mortgage Professional’s Guides section for expert resources on investment property mortgages
