Getting a conventional loan for a rental property

by | Apr 19, 2022

Can you get a conventional loan on a rental property? Most people think of conventional loans as those classic loans you get on your own home but conventional loans can, in fact, be used on rental properties. However, there are specific rules and regulations on how to qualify a rental property for a conventional loan and if you can meet these qualifications the loan terms are usually MUCH better than what you can find from other funding sources. 

RENTAL PROPERTIES

Rental properties – it’s really the American dream. Everyone wants to own a rental property in this country – at least everyone I know. I’m sure there’s some weird hermit out there who doesn’t want to own real estate and just sit home in his underwear and eat pickles and whipped cream and whatever but for the normal people among us, owning a passive, stable investment like a rental property is the epitome of the American dream. 

IT’S POPULAR

It’s so popular that entire industries like Airbnb and VRBO have erupted to tremendous success to let people dip their toe into the rental business by renting out their own home or even just a room in your house. The ultimate, the cream of the crop, the real goal is, of course, to own a property dedicated just to rentals.  The problem is that most people just don’t have the money to buy a rental property in cash and to be honest, even if you did, buying one for cash isn’t the best way to leverage your money.  

LEVERAGE

What do I mean by leverage? Well to put it simply, if you were able to net 6% on your money with a rental property if you bought it for cash that might sound like a decent return. But if you were to find a loan for only or 4% then you’re making 2% on OTHER people’s money and you can take that money you were going to use for buying that property and spread it out over several properties to leverage the actual cash you have…or in the case of our discussion just getting one property without having to have the whole payment in cash.

AVAILABLE LOANS

Now there are tons of lenders out there you can find for buying rental property. There are things called DSCR loans that don’t take your income into account but just what you can make on the property, there are bank statement loans, hard money loans, private loans, heck you can often convince friends and family to loan you money on rental properties if you are good at showing them the numbers and how much they can make on the deal. 

But conventional loans have a great benefit – they have amazing rates, 30 year terms, and fixed interest. Most hard money loans or private loans have higher rates, need to be repaid much faster than 30 years, or have other things like prepayment penalties that lock you into a certain rate so you can’t take advantage of refinancing if the market shifts. 

So, can you qualify for a conventional loan on a rental property? Absolutely – it gets done all the time.  There are a couple more conditions you have to take into consideration though when getting a conventional loan on a rental property before you consider it seriously.

#1 – the interest rate will always be higher.

There are certain things that will always, 100% of the time get a loan to have a higher rate on a conventional loan. This includes things like having a bad credit score, financing a condo instead of a single family or duplex, and getting a loan on a rental property is right up there with something that will guarantee you a higher rate.

Think about it logically for a moment. The biggest fear that a bank has when lending money out is that you default on a loan. If you don’t pay your mortgage then the bank is forced to eventually foreclose on the property – and while they might make a small profit on a foreclosure banks are just not set up for the infrastructure to repossess property. It’s literally the last thing they want. They want to collect the interest on the loan and be done with the transaction. 

I mean if you loaned your best friend money to buy a jacket for example, and instead of paying you back they said, sorry I don’t have the money to pay you back but you can sell it on ebay for a profit cause I got it for half off. Do you really want the trouble of taking pictures, listing it on ebay, packing it, dealing with the seller feedback – paying ebay a commission on the sale, doesn’t sound so fun does it? You know what it sounds like to me? Sounds like you need a new best friend and to get rid of that deadbeat good for nothing selfish – you get my point.

Well when you’re talking about lending someone money for a rental property and they have a loan on their own home – which do you think they’re going to stop paying the bills on first if the doo doo hits the fan and they’re tight on cash. I’ll give you a hint, it’s not the house where they put their kids to sleep at night. With higher risk, comes a higher rate so investment properties will always always have a higher rate – that being said it’s still a conventional loan so generally, the rates are much better even at the higher rate than going into the private market. 

#2 – the debt of the property falls on you

Just like a conventional loan for your own property a conventional loan for a rental property still requires an underwriter to review your debt to income ratio. Now you might be thinking – what debt, my renters are going to be paying my mortgage and I’m going to be charging them enough to cover the property taxes and insurance too – I won’t have additional debt.

Not exactly the case, I’m afraid. On rental properties they take the amount of you get from your tenant and they take 25% off the top. Just a ¼ haircut on the gross rent you received.  VROOOM – cut off of the top like a buzz saw. So if you’re getting $4,000/month for that property they will only give you $3,000 credit against your mortgage, property taxes and insurance.  This 25% deduction on your gross rental income is called a vacancy factor and it’s there to account for months where your renters may stiff you on the rent or if someone moves out and you have months where you can’t rent it out…and as someone who has dealt with a lot of landlords let me tell you there are often issues like this that come up so the banks are actually pretty smart to make this kind of calculation.

#3 – you need to come in with more downpayment

On a regular home loan you can come in with as little as 5% down on a conventional loan – heck if you’re a first time home buyer you can come in with as little as 3%. Don’t get your hopes up on that kind of situation for a rental. Generally speaking you need to come in with 25% down – not 20% but 25% for a rental property.  Again, this just goes to the risk of the property for the bank so make sure you have enough for 25% down as well as closing costs. 

#4 – You need reserves

When you buy a house for yourself generally speaking if you empty your bank account to zero they’ll still give you the loan. I wouldn’t advise it  ****Please don’t do that – don’t empty your bank account**** but technically speaking you can do it. On a rental property you cannot do that. Part of the requirements of buying a rental property is that you have to have six months worth of your mortgage, insurance, and property taxes in reserves to qualify for the loan.

Just to be clear – this is AFTER you pay your 25% and closing costs. After all that you have to have six months in reserves in case you have vacancies on the property to make sure you can make the payments.  

Now the reserves don’t have to be totally liquid. This is one of those cases where it can be in retirement funds, stocks, sometimes even cryptocurrency will work for reserves so there is a bit of a silver lining for you there. If you have hundreds of thousands you’ve put into a retirement account over the years that will most likely get the trick done. 

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