Buying an Investment Property With a Conventional Loan: What To Know
The terms of your mortgage can significantly impact your investment property’s performance. Conventional loans come with lower fees and interest rates for most borrowers than non-conforming alternatives. This can mean smaller mortgage payments and greater returns.
In this article, you’ll learn all about the guidelines that lenders follow when approving conventional loans for investment properties. We’ll also cover a few alternatives to conventional loans that you may still want to consider.
What Do Conventional Lenders Consider an Investment Property?
Investment properties are income-generating real estate. This can be residential or commercial, although conventional loans are unavailable for commercial purchases. For this article, we'll use the term investment property to describe residential real estate with up to four units.
The most common types of investment properties are:
Multi-unit buildings (duplexes, triplexes, and fourplexes)
Conventional loan limits for investment properties are the same as for principal residences. As of 2023, you can borrow up to $726,200 for a single-unit house in most parts of the country. In certain high-cost areas, you can get a $1 million conventional loan for a single-family home.
Investors purchasing multi-unit real estate can take advantage of even higher loan limits, topping $2 million for four-unit properties in some locations.
What Is Not Considered an Investment Property?
For lending purposes, multi-family buildings are not considered investment properties if the borrower plans to make one of the units their primary residence.
Second homes and vacation properties are also not considered investments. While receiving some rental income from these real estate types is possible, you still must occupy them for part of the year. Lenders will have different guidelines for these transactions.
Down Payment Requirements with Conventional Loans
Purchasing an investment property almost always comes with a higher down payment requirement than a principal residence. Investment homes are riskier for lenders, as borrowers are more likely to walk away if they run into economic hardship. A higher down payment provides a more substantial safety net in the event of default.
Fannie Mae and Freddie Mac, the two government-sponsored enterprises that dictate conventional loan guidelines, both require investors to put 15% down on condos and single-family homes and 25% down on properties with 2-4 units.
Investors purchasing a multi-family property and planning to live in one of the units may have lower down payment requirements. If you’re interested in buying a multi-unit property as your primary residence, check out our article on buying a duplex, triplex, or fourplex.
Borrower Eligibility Guidelines for Investment Properties
Many of the borrower eligibility requirements will be the same for investment properties as they are for primary residences. Conventional lenders will want you to have a credit score of at least 620. This minimum increases to 720 for seasoned investors with seven or more financed properties.
Lenders also focus on your debt-to-income ratio (DTI), which is your total monthly debts (including the mortgage you're applying for) divided by your income. Guidelines allow for as high as 45%, although most lenders cap the limit at 43%. Below 36% is considered ideal.
However, you can use some of the anticipated rental income to lower your DTI calculation with investment properties. We'll cover the specifics below.
One big difference when getting a conventional loan for an investment property instead of a primary residence is the required reserve. Your required reserve must be funds you can access, separate from what you’re using for your down payment and closing costs.
For investment properties, conventional lenders require you to have enough to cover six months of housing expenses (PITIA). This includes:
Principal and interest payments
Homeowners association fees and other mortgage-related expenses
If you own other financed properties apart from your primary residence, you'll also need additional reserves for them. Here's another article that details the reserve requirements for multiple properties.
Using Rental Income to Qualify for a Conventional Mortgage
While most transactions require you to qualify based on your regular income, investment properties allow you to use future rent to reduce your DTI. Using either the actual rental income or estimated market rent, you can apply up to 75% of the amount toward your qualifying income. This is your net rental income.
If you have at least a one-year history of receiving rental income or managing other investment properties, you can use all of the net rental income towards qualifying.
If this is your first real estate investment and you don’t otherwise have a year of property management experience, you can apply rental income up to the amount of the property’s monthly housing expense (principal, interest, taxes, insurance, association dues, or PITIA).
Say you’re purchasing an investment home with a PITIA of $1,700 and an estimated monthly rent of $2,500. In this situation, your net rental income would be $1,875 (75% of $2,500).
If you're an existing investor or property manager with at least a year of experience, you can apply the entire $1,875 towards your income for DTI calculations. If you don't meet those requirements, you can still apply $1,700 to offset the PITIA.
Note: Although it’s an uncommon situation, you may not be able to use rental income when qualifying if you don’t own a primary residence or have an existing housing expense. One reason lenders implemented this rule is to prevent reverse occupancy mortgage fraud, which has seen a notable uptick in recent years.
Investment Property Interest Rates
Buyers are attracted to conventional loans for investment properties because they offer more favorable interest rates than alternative mortgage options. But you'll still pay a higher rate than on a primary residence purchase. This premium is due to the inherent risk associated with investments and an uncertain income stream.
Interest rates are constantly in flux. They can be impacted by any number of contributing factors, including your down payment, credit score, and the overall mortgage market.
But by and large, you can expect interest rates for investment properties to be anywhere from 0.5% to 1% higher than principal home rates. In some cases, that difference can be higher than 1%.
Conventional Loan Alternatives for Investment Properties
Conventional loans typically offer the lowest closing costs and interest rates for rental homes. Fortunately, borrowers who can’t get approved through conventional lenders (or need funding faster) still have options. There are several conventional loan alternatives for purchasing investment properties.
Home Equity Line of Credit (HELOC) or Cash-Out Refinance
Most investors are stable financially and have built up equity in their primary residence. Many even have other investment properties with equity as well. Doing a cash-out refinance or taking out a home equity line of credit (HELOC) can let you access the funds to make your next purchase.
Apart from getting a conventional mortgage, these will likely be your two most affordable alternative lending options.
Hard Money and Non-QM Lenders
Non-qualifying (non-QM) lenders offer loans outside conventional or government-backed mortgage guidelines. You can find non-QM funding for just about any investment property purchase. But plan to pay loftier closing costs, plus a larger down payment and higher interest rates.
Hard money lenders offer non-QM loans tailored explicitly for investment properties. This is a short-term type of financing, with terms maxing out at around 18 months. Hard money loans are primarily used by investors planning to "flip" a property or secure long-term funding soon after closing.
You can expect less preferable terms with non-QM loans (especially hard money). But if you need to fund a purchase quickly, these lenders can be your best bet.
Local Financial Institutions
Local financial institutions, particularly ones you have current business with, can be another alternative source for investment loans. These community banks and credit unions are often willing to take a case-by-case approach to applications that don't meet conventional lending guidelines. If you have an existing relationship and a solid basis for your investment, you may still get approved.
Finding the Right Conventional Lender
Choosing a suitable property is only half the battle; your funding source can seriously impact your investment's return. Conventional loans usually offer investors the most favorable fees and rates. However, the best way to find the right mortgage is to work with a lending professional experienced in conventional loans for investment properties.
Tim Lucas spent 11 years in the mortgage industry and now leverages that real-world knowledge to give consumers reliable, actionable advice. Tim has been featured in national publications such as Time, U.S. News, MSN, The Mortgage Reports, My Mortgage Insider, and more.