Last Updated: Dcember 2023
A conventional mortgage is the most common way to finance a rental property. Conventional rental property loans typically have fixed interest rates that are usually slightly higher than primary residence loans. They are available in a variety of terms, with the most common being 30-year and 15-year fixed-rate mortgages and also a variety of adjustable-rate mortgage (ARM) products available. Given their lower rates and longer loan terms, conventional loans for rental properties are usually more conservatively underwritten.
What is a Conventional Loan?
A conventional loan (also called a conforming loan) for a rental property is a mortgage that is not insured or guaranteed by a government agency, such as the FHA or VA. These loans are typically offered by banks or private lenders and follow standard guidelines set by Fannie Mae and Freddie Mac, making them popular for financing buy and hold rental properties due to their relatively lower interest rates locked in over long periods of time.
Important Conventional Loan Terms
Interest Rate – In the context of real estate loans, the “interest rate” refers to the amount a lender charges a borrower for the use of money, expressed as a percentage of the principal loan amount.
Debt-to-Income ratio (DTI) – Debt-to-income ratio (DTI) is a measure that lenders use to assess a borrower’s financial stability. It is calculated by dividing a borrower’s total monthly debt payments by their gross monthly income.
Conventional Loan Requirements for Rental Properties
When applying for a conventional real estate loan for a rental property, borrowers typically need to meet the following requirements in addition to having a sufficient understanding of rental property finance terms such as DTI and PMI:
1. Sufficient Down Payment
Conventional loans for rental properties often require a larger down payment compared to loans for primary residences. While the exact amount may vary by lender and borrower qualifications, a down payment of at least 20-25% is common for investment properties to avoid private mortgage insurance (PMI) and secure more favorable terms.
2. Good Credit Score
Lenders generally require a higher credit score for rental property loans compared to primary residence loans. A credit score of at least 620 is typically required for a conventional loan, but a score of 680 or higher is often preferred to secure better interest rates and terms.
3. Acceptable Debt-to-Income Ratio (DTI)
Lenders assess a borrower’s ability to manage the additional debt of a rental property loan by evaluating their debt-to-income ratio. While requirements may vary, a DTI of 43% or lower is generally preferred, although some lenders may accept higher ratios for borrowers with strong credit profiles or substantial cash reserves.
4. Stable Income and Employment
To qualify for a conventional loan for a rental property, borrowers must demonstrate a stable and reliable source of income. Lenders typically require at least two years of consistent employment and may request pay stubs, tax returns, and W-2s or 1099s to verify income stability. Additionally, lenders may consider the rental income potential of the property as part of the borrower’s overall income.
Pros & Cons of a Conventional Mortgage for a Rental Property
Conventional Loan Pros
- Lower interest rates: Conventional loans often have lower interest rates compared to government-backed loans, such as FHA (Federal Housing Administration) loans or VA loans. This can result in significant savings over the life of the loan, making the property investment more profitable.
- Flexible terms: Conventional loans offer a variety of loan terms, such as 15, 20, or 30-year fixed-rate mortgages, as well as adjustable-rate mortgages. This flexibility allows investors to choose the loan term that best suits their financial goals and risk tolerance.
- No mortgage insurance: Conventional loans for rental properties typically do not require mortgage insurance if the borrower puts down at least 20% of the property’s value. This can lead to lower monthly payments and overall cost savings compared to government-backed loans that require mortgage insurance premiums.
Conventional Loan Cons
- Stricter qualification requirements: Conventional loans often have more stringent credit score and debt-to-income ratio requirements compared to government-backed loans. This may make it more difficult for some borrowers to qualify, particularly those with lower credit scores or higher debt levels.
- Larger down payment: While government-backed loans may offer lower down payment options, conventional loans typically require a down payment of at least 20% for rental properties. This can be a significant barrier for investors with limited available capital.
- Limited property types: Conventional loans for rental properties are typically limited to financing multifamily properties such as single-family homes, duplexes, triplexes, and fourplexes. For investors interested in purchasing larger multi-unit properties or commercial real estate, alternative financing options may be necessary.
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Rental Property Conventional Loan FAQ
How Much Down Payment do I Need for a Rental Property Conventional Loan?
While down payment requirements can vary, most lenders typically require a minimum of 20% down for rental or investment properties. This is because mortgage insurance, which usually protects the lender from potential loan defaults, is generally not available for rental properties. Some lenders might even require 25% or more, depending on the number of units in the property and the borrower’s creditworthiness.
Are There Property Condition Standards for Rental Property Conventional Loans?
Yes, properties financed through conventional loans typically need to meet certain condition standards set by Fannie Mae, Freddie Mac, or the specific lender. This ensures the property is a sound investment and does not pose excessive risks. An appraisal of the rental property will be conducted to ensure the property’s present value and condition align with these standards.
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