The Difference Between a Mortgage for an Investment Property vs. Primary Residence

Mortgage for an Investment Property vs. Primary Residence

An investment property can yield years of rental income and diversify your portfolio. But getting a mortgage to purchase an investment property is slightly different from getting a mortgage for a primary residence.

Different home loan programs can be used to purchase an investment property. A conventional loan is a common choice. But it is possible to use a government loan, too. These options include VA, FHA or USDA. Keep in mind that the requirements for getting a mortgage for an investment property vary considerably, depending on the chosen program. Here’s a look at what you can expect when financing an investment property.

Buying an Investment Property with a Conventional Loan

Conventional mortgages conform to the guidelines set by either Fannie Mae or Freddie Mac. Many people use a conventional loan to purchase their primary residence, but this type of financing can also be used to buy an investment property.

When buying an investment property with conventional financing, you’ll provide the same documents as someone buying a primary residence. Documentation includes W2s, tax returns, paycheck stubs, as well as bank statements to confirm assets. Additionally, you must authorize a credit check.

However, because you’re buying an investment property, the guidelines for approval aren’t as lenient as those for a primary residence.

For example, qualifying for a loan to buy an investment property typically requires a higher minimum credit score. When applying for a primary residence, you can use conventional financing with a credit score as low as 620. With an investment property, the minimum credit score ranges from 640 to 680, based on whether you get a fixed-rate mortgage or an adjustable-rate mortgage, and the number of units in the property.

Another difference when financing an investment property is that you’ll pay a higher interest rate. This is because investment properties pose a greater risk to lenders than a primary residence.

You should also prepare for a higher down payment and maintain a larger cash reserve when purchasing an investment property with conventional financing. The minimum down payment for an investment property is between 15% and 25% of the purchase price. Conventional financing also requires a cash reserve for investment properties — least six to 12 months of mortgage payments in reserves. This requirement can ensure your ability to pay the mortgage in the event that you experience a lapse in rental income.

Buying an Investment Property with an FHA Loan

An FHA home loan is insured by the Federal Housing Administration. These loans are for the purchase of a primary residence but can be used to finance an investment property under certain circumstances.

There are two ways to use an FHA loan for an investment property. One option is to purchase a one-unit property as a primary residence, live in the home for a number of years, and then rent the house to a tenant. However, a single-family home can’t be bought with the sole intent of being used as a rental.

You can also use an FHA loan for a rental property when purchasing a multi-unit home with up to four units, but only if you’ll live in one of the units. You can get tenants for the other units and collect rental income.

Unlike conventional financing, which has stricter requirements for investment properties, the FHA requirements for buying a multi-unit home are the same as buying a single-family home. Therefore, you qualify for financing with only a 3.5% down payment if you have a minimum credit score of 580; or with a down payment of 10% if you have a minimum credit score between 500 and 579.

You’ll pay mortgage insurance if you put down less than 20%. To qualify, your debt-to-income ratio must be less than 43%, and the monthly house payment shouldn’t exceed 31% of your gross monthly income.

Even though a multi-unit home will be used partly as an investment property, you’ll benefit from competitive rates and lower fees that are common with FHA home loans.

Buying an Investment Property with a VA Loan

The requirements for using a VA home loan for an investment property are similar to using an FHA home loan. You can only use a VA loan if you purchase a multi-unit property and reside in one of the units. Or, if you purchase a single-family property as your primary residence, and then rent it out at a later time.

Properties eligible for VA financing include those with 2 to 4-units, and you must meet requirements set by the VA.

You’ll need to present a Certificate of Eligibility, which confirms that you’re eligible for a VA loan. This program is available to veterans, active-duty military, reservists, members of the Coast Guard and the National Guard, and surviving spouses of an eligible service member.

Getting a VA home loan also requires a credit score of 620 or higher and a debt-to-income ratio under 41%. Similar to buying a primary residence, you can purchase a 2 to 4-unit property with 100% financing and no mortgage insurance.

Buying an Investment Property with a USDA Loan

A USDA loan is for the purchase of a primary residence but can also be used to purchase a multi-unit home with at least five units.

The minimum credit score to qualify for a USDA loan is 640. You must meet other program requirements too (income, employment, assets, etc.). Because this program helps individuals purchase in rural areas, the multi-unit property must be located in a USDA-eligible area.

The monthly rent cannot exceed 30% of 115% of the median income for the area. To qualify, your debt-to-income ratio can’t exceed 41%, and your mortgage payment for the property shouldn’t be more than 29% of your gross monthly income. For more information about the program, check out USDA’s Multi Family Housing Direct Loans.

 Ethos Lending is a new type of mortgage lender. We use technology to keep our operational costs as low as possible. From closing costs to interest rates, we have made it our mission to make the process of buying a home more affordable. Get in touch with one of our mortgage specialists to learn more.