Investment Property Mortgages: Rates and Revenue
Planning for retirement? An investment property could be a smart way to build up that nest egg. Investing in real estate is a sensible way to combat inflation, setting your investment property mortgage rate and then watching your equity grow over time. There are plenty of benefits to buying an investment property, but you might think it’s reserved exclusively for businesses, corporations or the extremely wealthy.
The truth is people can finance investment property purchases with a variety of investment home loan options. Even so, purchasing an investment house is a major financial obligation, and you want to be absolutely certain you’re ready to take it on. We’ll walk you through the major considerations you need to mull over to make an informed decision.
What is considered investment property?
Most residential home purchases involve primary residences — that is, the buyer plans to actually live in the house for most of the year. Then you have second houses and vacation properties, which offer folks a home away from home. Investment properties are another class of real estate altogether — and that distinction will affect interest rates, loan options and much more.
Investment property definition
An investment property is any piece of real estate you buy with the express purpose to make money and turn a profit.
Now, everyone hopes your home will appreciate in value over time so when you finally do sell your house, you’ll make a tidy profit for yourself. But that’s a secondary concern for primary residences. With real estate investments, it’s the only concern.
How you generate that income doesn’t really matter — it could be through collecting rent each month from tenants or through a lump-sum payment when you sell the property months or years down the road. If you buy real estate solely to make money off of the property, then you’re purchasing investment property.
What are the benefits of buying an investment property?
Before we dig into the potential perks of investment properties, it’s worth stressing that they are investments and, as such, carry inherent risk. There’s no guarantee that you will make a profit with these financial vehicles, even if circumstances seem ideal.
With that out of the way, let’s take a look at the major benefits that may catch your eye:
- Generate recurring revenue
- Protect against inflation
- Avoid volatile markets
Investment Property Rates Help Generate Recurring Revenue
If you choose to rent out your investment property, you’ll be able to tap into an extra stream of income. Better yet, it’s passive income. Beyond fulfilling the duties of a landlord — maintaining the property, handling repair jobs, finding tenants, etc. — you don’t necessarily have to put in a lot of time and labor to collect rent.
Bringing in rent each month can help supplement your income or replace it entirely. No wonder so many people have set their sights on buying an investment property to rent.
Keep in mind, though, that the rent you bring in needs to cover your mortgage, property taxes and insurance —- not to mention building up reserves to pay for routine maintenance and unexpected repairs. When exploring your investment property opportunities, it’s important to obtain an accurate rent projection so you know you’ll have enough left over after your monthly expenses to make a profit.
Inflation Rises, Your Investment Property Mortgage Rate Stays the Same
When inflation goes up, the buying power of every dollar you own goes down. Your checking and savings accounts will need pretty competitive interest rates just to keep up with inflation, let alone generate more wealth with each passing year.
Even if you don’t pay for your investment property in full up front, you could still come out ahead of inflation rates with a fixed-rate mortgage. Depending on the type of loan you get, your investment mortgage rate could be locked in for years — decades, even. If you take out a 30-year fixed-rate mortgage in 2021, then you’ll continue to pay 2021 rates no matter how high inflation goes in the future.
Barring rare circumstances, real estate generally appreciates in value with every passing year. That makes it a great investment vehicle to hedge against inflation, consistently providing a strong return on your investment.
Investment Properties Can Avoid Volatile Markets
The stock market can be incredibly volatile, making it a risky investment vehicle for people who are not familiar with its nuances. Even traders with years of experience get burned by the market’s whims. And while real estate comes with its own share of risk, it’s much less volatile than the stock market. As long as the property is properly maintained and the neighborhood keeps its curb appeal, you can expect real estate investments to steadily appreciate in value.
How can you finance an investment property purchase?
Very few people have the cash on hand to pay in full for one house, let alone have enough left over to fund an investment property purchase. That can leave you thinking it’ll be next to impossible to finance an investment property. But just like with residential transactions, buyers have a number of financing options to consider when investing in real estate.
4 investment property loan options
- Conventional home loan
- Home equity loan
- Hard money loan
- Private money loan
1. Conventional home loan
Your mortgage lender may offer financing options to purchase rental properties and other real estate investments that, to a certain degree, mirror conventional home loans. You still make mortgage payments every month, just like you would for any residential purchase.
Qualifying for these kinds of home loans can be tricky, however, because you’re essentially trying to carry two mortgages at once. Lenders will naturally exercise a bit more caution when extending investment property mortgages due to the increased financial strain.
If you plan to rent out your investment property, then the expected income will be a topic of great scrutiny. The appraisal process is a bit more involved than a primary residence home loan because the lender will want to see how much income you’ll likely bring in from your rental property.
With those stricter qualifying requirements, you may need to put up more money as a down payment, carry a lower debt-to-income (DTI) ratio and maintain a high credit score. The down payment requirements, in particular, can be pretty restrictive. In some cases, lenders will only offer down payment options as low as 30% of the purchase price. Remember: These are conventional loans, so there are no government-backed options to explore if you are unable to meet lenders’ eligibility requirements.
2. Home equity loan
Another option to consider is tapping into the equity you’ve already built up in your primary residence. Few — if any — lenders will allow you to fully fund the purchase of a second home or investment property through a home equity loan. Even so, you may be able to finance as much as 85% of the purchase price by using this type of home loan.
You could also explore a cash-out refi or home equity line of credit (HELOC) mortgage as a source of funding. Keep in mind that any of these financing options will impact your mortgage on your primary residence, potentially extending the length of the home loan. And unlike a conventional investment property loan, your primary residence will also serve as collateral.
3. Hard money loan
With a home equity loan or cash-out refi, you’re trading off the value of your existing home to finance the purchase of a new home. But with a hard money loan, you can use the investment property itself as collateral. How does that differ from a conventional home loan?
Conventional mortgages run for several years — often decades — even when buying investment property. Hard money loans often have shorter amortization schedules because the goal isn’t to sit on the property for a long time and let it appreciate in value. With this type of loan, the lender assumes you’ll try to buy and renovate a piece of property and then sell it for a profit as soon as possible.
In fact, hard money loans are frequently referred to as fix-and-flip loans because house flippers often rely on them to cover both the sale price of investment properties and any repairs or renovations they need to make to fetch a good rate on the open market. You should know up front, though, that hard money loans often carry higher interest rates than many other financing options. Not to mention, the pressure to repay the loan in short order could be immense.
4. Private money loan
Lastly, you might also consider looking into a private money loan to finance a real estate investment. Such loans are difficult to come by because you need to know the right people who have enough money on hand to buy real estate. See, you don’t get private money loans through a mortgage lender. Instead, you have to go through a private party — often an acquaintance, family member or friend.
You might find a little more flexibility in lending terms going this route, but you could also run into a lot of extra headaches. It’s easy to bite off more than you can chew when mortgage lenders aren’t involved to vet your finances and ability to repay a loan. And while you might be thinking that you can avoid putting your investment property as collateral with a private money loan, that might not be the case. Depending on the terms of your agreement with a private party, they could retain the right to foreclose on the property if you fall behind on your mortgage payments — just as you would with any type of mortgage.
Residential Property vs. Investment Property Mortgages: Rates, Down Payment and More
If you choose to go the conventional loan route — which many people do when buying investment property — you should know that this type of financing differs from residential loans in some key ways.
- Limited down payment options
- Higher interest rates
- More stringent eligibility requirements (credit score, DTI, existing funds, etc.)
- No government-backed loan options
- Appraisal review may be less forgiving
At the end of the day, your mortgage lender wants to minimize risk as much as possible. Lenders are going to be very judicious about who they choose to extend investment property mortgages to because borrowers will need to carry two mortgages at once.
Investment Property Mortgage Rates Today
Like any other type of home loan, interest rates on investment properties fluctuate constantly. Keep your eye on current mortgage rates and you’ll likely notice that they change from day to day. As such, it’s important to stay on top of current interest rates while also contextualizing them through historic trends. Agonizing over every slight uptick or dip may not be worth the stress if interest rates remain at historically low levels.
Also, remember that investment property mortgage rates will always be higher than primary residence home loans — sometimes by a matter of percentage points. Again, mortgage lenders set higher rates for investment properties because of the additional perceived risk. When in doubt, reach out to a qualified lending expert for insight on current interest rate trends.
Buying an investment property can sound like a pretty enticing proposition. After all, who wouldn’t want to generate passive rental income every month? Coming up with the funds to invest in real estate is a common barrier, but there are plenty of loan options to consider.
Just know that lenders will hold borrowers to a higher standard when it comes to investment property mortgages. That usually includes ponying up more money for a down payment, agreeing to a higher interest rate and meeting more stringent eligibility requirements.
As with any type of investment, purchasing this kind of property carries inherent risk. There’s no guarantee you’ll come out ahead or even break even in the long run, no matter how strong the current housing market is.
Always consult a financial advisor before making any investment decisions, whether you’re buying real estate, stocks or any other type of investment vehicle. Rushing into an investment property can be disastrous, so take the time to conduct your research and speak with a financial expert.
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