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How to Qualify for a Mortgage for an Investment Property
October 24, 2024 | Posted by: Tim Belanger
Qualifying for a mortgage to purchase an investment property can be more challenging than securing a loan for a primary residence. Lenders often view these loans as higher risk, which results in stricter requirements for investors. To enhance your chances of approval, it's crucial to understand the investment property mortgage requirements, such as the down payment for investment property, credit score for mortgage approval, and factors like debt service coverage ratio and rental income mortgage qualification.
Key Requirements Mortgage for an Investment Property
1. Down Payment for Investment Property
One of the most significant differences between financing a primary residence and an investment property is the down payment. Investment property mortgages typically require a larger upfront payment to mitigate the lender’s risk.
- Minimum Down Payment: Lenders typically demand a 20% down payment for investment homes. But, if you are buying multi-unit buildings or your financial status is deemed riskier, certain lenders might request 25% or more, depending on the best mortgage rates Ottawa Ontario.
- Why Investors' Interest Is Higher: Investment properties are not eligible for the same leniency as owner-occupied homes, which can have low or no down payment choices (such as FHA loans with 3.5% down). Investors with 'skin in the game' are viewed by lenders as evidence of their financial commitment.
- The down payment may rise to 30% or more for larger investment properties (five units or more), especially when considering the current mortgage rates Ottawa.
Important Considerations:
2. Credit score for mortgage approval
Obtaining an investment property mortgage is contingent upon the borrower's credit score. You'll probably get more advantageous terms the higher your score is. This element has a significant impact on the interest rate you will be given and may even decide whether to accept your application.
- Minimum Credit Score: For mortgages on investment properties, the majority of lenders need a minimum credit score of 620. However, a score of 680–720 is frequently needed to secure the best mortgage life insurance Canada offers and better rates and terms.
- Effect on Interest Rates: Not only can a higher credit score increase your chances of being approved, but it also has a direct impact on the interest rate on your mortgage. A borrower with a credit score just below 620 might be eligible for a 0.5% lower rate than someone with a score above 720.
3. Income Verification and Debt-to-Income (DTI) Ratio
Additionally, lenders want to make sure you make enough money to pay your mortgage. Verifying your income is therefore an essential step in the application process. Your debt-to-income (DTI) ratio, which indicates the proportion of your monthly income allocated to debt repayment, is evaluated by lenders.
- DTI Ratio: A DTI of 36% or less is ideal for mortgages secured by investment properties. Since most lenders, including the Canada Trust mortgage company, have a 43% cap, the total amount of debt payments you make each month—including the new mortgage—shouldn't be more than 43% of your gross monthly income.
- Sources of Income: Lenders may take into account rental revenue from your current or future properties in addition to your normal income (from employment or company). However, the majority of lenders need proof of a rental income's dependability, such as tax records and leases.
4. Reserves and Liquidity Requirements
Lenders evaluate your ability to pay for unanticipated costs or vacancies in your investment properties. Because of this, the majority of lenders mandate that investors have reserves, or money set aside over and beyond the down payment and closing costs.
- Lenders typically require investors to maintain a minimum of six months' worth of mortgage payments set aside for each property they own. This covers the property you're buying as well as any additional properties you own.
- Generally speaking, cash in checking or savings accounts, money market funds, equities, or retirement accounts (although the latter may be counted at a lower percentage) are acceptable reserve funds.
- If you're purchasing a multi-unit building or have more than four mortgages, some lenders may increase the reserve requirement to 12 months.
Important Considerations:
5. Rental Income and Debt Service Coverage Ratio (DSCR)
For many investors, rental income is an important consideration, and lenders may take this into account when evaluating your loan application. On the other hand, the acceptance of rental income and the percentage that each lender will take into account vary.
- Debt Service Coverage Ratio (DSCR): When determining if the investment property's rental income will be enough to service the mortgage, some lenders utilize the DSCR. Generally speaking, you need a DSCR of 1.25 or greater, which means that your rental revenue must cover at least 125% of your mortgage payments (including insurance and taxes).
- Vacancy Rates: Some lenders may factor in an assumed vacancy rate (usually 25%) when calculating rental income. This means they’ll only count 75% of the expected rental income in their calculations.
Important Considerations:
6. Loan-to-Value (LTV) Ratio
The loan-to-value (LTV) ratio computes the loan amount as a percentage of the property's assessed value. The loan terms are better when the LTV ratio is lower since the lender is taking on less risk.
- The standard loan-to-value ratio (LTV) for mortgages secured by investment properties is 80% or less. This means that your down payment must account for a minimum of 20% of the property's worth.
- A higher loan-to-value ratio (LTV) may be necessary if you're buying a multi-unit property, particularly if it has five units or more. Lenders may set this ratio at 70–75%.
- An LTV of 65-70% can improve your chances of qualifying for better terms, including lower interest rates.
Important Considerations:
7. Multiple Mortgages and Portfolio Loans
For investors with multiple properties, qualifying for additional loans becomes more complicated. Once you have four or more mortgages, many lenders impose stricter requirements.
- Fannie Mae and Freddie Mac Guidelines: These lenders have specific guidelines for investors with more than four mortgages, including a minimum 25% down payment and a credit score of 720 or higher.
- Portfolio Lenders: Investors with extensive portfolios may benefit from working with portfolio lenders who don’t follow Fannie Mae or Freddie Mac guidelines. These lenders may offer more flexible terms for investors with ten or more properties, including cash-out refinances.
Wrapping up:
Obtaining a Mortgage for an Investment Property requires following stricter rules and meeting higher financial standards compared to buying a primary home. You can set yourself up for success by having a high credit score, adequate reserves, knowledge of lender criteria, and utilizing rental income. Whether you're purchasing your initial investment property or growing your portfolio, collaborating with the correct lender is crucial in achieving your investment objectives.
Ready to Take the Next Step? At Belanger Mortgages, we specialize in helping investors like you secure the best mortgage deals for your investment properties. With access to over 50 competing lenders, we can find the right mortgage to suit your financial goals.
If you want to know how much mortgage you can afford for an investment property and explore the best way to finance home renovations in Canada, check out our website where you can find all the answers you want, to make a well-informed decision.
Contact us today for a free, no-obligation consultation, and let’s start building your investment portfolio together!
Frequently Asked Questions (FAQs)
What is the required minimum down payment for a mortgage on an investment property?
A 20% down payment is usually required for an investment property. However, based on a number of circumstances, including your credit score, certain lenders can want more.
What credit score is required to be eligible for a loan for investment real estate?
To qualify for a mortgage on an investment property, most lenders require a credit score of at least 620. You might require a score of 720 or better if you have more than four mortgages.
