Single-family rental homes have been one of the best performing asset classes over the last couple of years. Rents continue to soar with double-digit growth in some markets, while property prices are reaching all time highs.
Getting a loan on a rental property may be a good way to boost overall returns even more, provided that risk is balanced with potential reward. In this article, we’ll take an in-depth look at the different sources for finding a single-family rental loan, and explain how loans on investment property are different from owner-occupied home loans.
- Sources for obtaining a single-family rental loan include traditional lenders like banks and credit unions, mortgage brokers, and private and portfolio lenders.
- Some of the differences between a SFR loan and mortgage for a primary residence are a bigger down payment, slightly higher interest rate, higher required credit score, and a reserve account requirement with funds to pay several months of mortgage payments and property operating expenses.
- To improve the odds of qualifying for a single-family rental loan, a borrower should work to maintain a good credit score and debt-to-income ratio, prepare loan documents for a lender ahead of time, and shop around for a lender used to working with real estate investors.
How SFR loans are different from primary home loans
A borrower can go to the same place to apply for a single-family rental loan and a loan on a primary residence, such as a bank, credit union, or mortgage broker. However, while the place might be the same, there are several differences between a SFR loan and a owner-occupied home:
- A down payment of 25% of the purchase price is generally required on investment properties, in addition to other closing costs such as title and escrow fees, property inspection and appraisal, and loan fees. Depending on the borrower’s qualifications and the lender, a larger down payment may help a borrower qualify for a lower interest rate and loan fees.
- The interest rate on a single-family rental loan is generally 0.50% to 0.75% higher than the loan rate for a primary residence. The current mortgage rate for a 30-year fixed loan for an owner-occupied home is 3.25%, according to Bankrate (as of December 10, 2021). That means an investor could expect to pay an interest rate of between 3.75%-4.0% on a SFR loan, based on today’s interest rates.
- Borrower qualifications may also be stricter when applying for a single-family rental loan, particularly if a borrower already has one or more properties and is taking on additional debt. As a rule of thumb, a borrower should have a credit score of 700 or more to qualify for the best financing terms and interest rate. While it still may be possible to get a SFR loan with a lower credit score, a borrower may have to jump through more hoops to prove to the lender that the mortgage will be paid.
- A reserve account containing funds to pay for 6 months of mortgage payments and operating expenses is also usually required. That’s because a lender does not want to see a borrower depending solely on rental income each month to pay the mortgage and other ownership costs. If a tenant pays late, or repair costs are higher than expected, or it takes longer than usual to find a qualified tenant, a lender wants to know that the funds are still there to pay all of the bills.
Options for single-family rental loans
One of the many advantages of investing in single-family rental property is that there are a wide variety of loan options available compared to a large apartment building or commercial property. Two good resources for getting a free rate quote on a single-family rental loan are the Stessa Mortgages and the Roofstock Financing Calculator.
Here are several loan options an investor may wish to consider when applying for a new rental property loan or financing an existing mortgage.
Traditional loan options
The first place to look for a SFR loan is from a local bank, credit union, or mortgage broker. A borrower will find a variety of conventional loan options, along with loans backed by the FHA and VA:
Conventional or conforming loans are originated by banks or credit unions, then packaged together and resold to institutional investors. Because these loans are resold, they must meet guidelines established by Fannie Mae or Freddie Mac.
Provided a borrower has good credit, interest rates may be lower and down payments may be less than 25%. While Fannie and Freddie technically allow a borrower to have up to 10 loans, oftentimes a bank will set a lower maximum limit.
A mortgage broker is another good source for finding a single-family rental loan. Instead of working with only one bank, mortgage brokers usually have access to a wide variety of loan programs to help an investor find the best mortgage.
Loans backed by the Federal Housing Administration (FHA) are originated by traditional lenders and mortgage brokers. Minimum credit score and required down payment may be lower than with a conventional loan. However, an investor will have to plan ahead to use an FHA loan for a single-family rental property. The FHA requires a borrower to use a home as a primary residence for at least 1 year, and to take possession of the home within 60 days of the loan closing.
The U.S. Department of Veterans Affairs (VA) backs single-family home loans for active-duty service members, veterans, and eligible spouses. A borrower may apply directly with the VA, or work with a traditional lender that offers VA financing. As with an FHA loan, a borrower with a VA loan must occupy the home as a primary residence for at least 12 months. After that, it may be possible to use the home as a rental property, although a borrower may wish to speak with the lender before making a move.
Alternative lenders may be a good source for a borrower looking for “creative financing” because most alternative lenders hold the loans they originate in their own portfolio instead of reselling them. This allows an alternative lender to be more flexible, and create a SFR loan with terms and conditions that meet the needs of both a borrower and the lender.
Private loans for single-family rental property are made by experienced real estate investors who offer debt financing. Instead of purchasing a rental property directly and hoping to make a profit from net income and appreciation, a private lender makes money from monthly interest paid on the loan.
Because private lenders know the real estate business, they may be a good source for a borrower looking for a lender who can think outside of the box. In some cases, if an investment looks attractive, a private lender may accept a small equity position in the deal in exchange for a lower interest rate or loan fees.
A portfolio lender is an individual or company that provides financing for single-family rental loans. Oftentimes a mortgage broker will have access to private lenders who offer portfolio loans.
While loans are made on individual properties, a portfolio lender may offer a discount for multiple loans. Loan terms such as down payment, interest rate, credit score, and loan length can be customized to fit a borrower’s needs. However, in exchange for customizing a loan, a borrower may pay higher fees or a prepayment penalty if a loan is refinanced before the end of the term.
A blanket loan may be a good choice for a borrower looking to financing or refinance multiple single-family rental properties under one loan. Two sources for finding a blanket SFR mortgage loan are mortgage brokers and private portfolio lenders.
As with a portfolio loan, a blanket loan may be customized to meet the specific needs of a borrower and lender. Oftentimes, properties financed with a blanket loan are cross-collateralized, which means that properties serve as collateral for one another. Blanket loan terms normally include a release clause, which allows one property to be sold without having to refinance the remaining homes.
Sellers who own a property free and clear (or with very little mortgage debt) may be willing to provide financing by carrying a mortgage note instead of cashing out.
A seller who offers financing acts like a private lender, and will expect a down payment, a competitive interest rate, and a borrower to be qualified. Instead of receiving cash for the sale up front, a seller receives monthly mortgage payments of principal and interest from a borrower.
There are two potential advantages to offering seller financing. First, a seller receives a steady stream of interest income with each mortgage payment, Second, instead of paying any capital gains tax in one lump sum, seller financing allows a seller to spread out capital gains tax payments over the term of the loan as an alternative to conducting a 1031 tax deferred exchange.
Here are 3 more ways to raise the funds for a single-family rental loan to raise a down payment, or even bypass a bank completely.
With savings rates at all-time lows, an investor may find it easy to raise funds from friends, family, or partners looking for a decent return from their money. An investor could form an LLC, pool together capital from partners, pay all cash for a property, then make regular principal and interest payments to each shareholder in the LLC until the self-funded loan is paid off.
Retirement plans such as a 401(k), IRA, or SEP-IRA may be another good option for finding money to purchase a rental property. A saver may be able to convert a retirement plan into a self-directed IRA for real estate, with any profits from a rental property staying inside the IRA tax free until withdrawals begin.
A home equity line of credit (HELOC) is like having a credit card that draws funds from the equity in an existing home. For example, if an investor has a home with $150,000 in equity, a HELOC can be used to turn 80% of that equity into cash, when and if an investor needs it. Funds accessed with a HELOC are paid back over a period of time with interest, similar to the way a credit card works.
Tips for qualifying for an SFR loan
There’s a tremendous amount of demand for single-family rental property today, and there’s no reason an investor should be left sitting on the sidelines. Here are a few tips to help qualify for a SFR loan:
- Shop around for the right SFR loan by speaking with lenders and mortgage brokers who are familiar with the local real estate market.
- Making a large down payment of 25% or more may increase the odds of getting a lower interest rate and better loan terms and conditions.
- Work hard to maintain a good credit score of at least 700, and a maximum debt-to-income (DTI) ratio of 36%.
- Prepare mortgage application documentation before applying for an SFR loan, including W-2s and bank statements, tax returns, and a report listing all assets and outstanding debts.
Use Stessa to generate income statements, net cash flow, capital expense, and balance sheet reports showing owners equity for any existing rental properties.