Don’t have the full amount to buy your piece of the Outer Banks? Investment property mortgages will enable you to complete the transaction. Financing investment property is not all that dissimilar from financing your home. The investment property lenders will still want to make sure you are credit worthy, so they will be checking your credit score, ensuring that your income will cover the 28/36 ratios, and so forth. The 28/36 ratio refers to your mortgage payment not being more than 28% of your total monthly income and the mortgage payment plus other monthly expenses not exceeding 36% of your monthly income. The one big exception is that they will only add in rental expenses that exceed your rental income into this calculation.
Investment property loans are also more expensive than home residential mortgages. In a normal home buying market, they generally run about 75 to 150 basis points higher than the residential home mortgage loan. What’s a basis point? A basis point is a subdivision of one percentage point. So, 100 basis points equals one percent. If you hear someone say that Mortgage A is 150 basis points higher than Mortgage B, and let’s assume Mortgage B is 5%, that means that Mortgage A is 1.5% higher than B or 6.5%. Investment property mortgages are consider riskier than standard home mortgages because mortgage lenders believe that, if forced to make a choice, you will continue paying the mortgage on the house that you live in and default on the investment property mortgage forcing foreclosure. If this is your first investment property, the mortgage lender may define the mortgage as a secondary home loan. The spread on these loans versus the standard home loan is generally 50 to 75 basis points, and therefore cheaper than an investment property mortgage. Make sure you ask your mortgage broker about this option.
Just like the residential home mortgage, investment property loans are also divided by size. Prior to January 1, 2009, a conforming mortgage permitted you to borrow up to $417,000, with any loan amount greater being classified as a “Jumbo” loan. As of January 1, 2009, by order of Congress, conforming mortgage limits were expanded to include loans up to $625,000. The difference between a conforming and jumbo loan is whether Fannie Mae is permitted to underwrite these loans. As a result, due to the larger size of the loan, and the inability to have these loans backed by Fannie Mae, jumbo loans are considered more risky. The net to us is that conforming loans during normal markets (the mortgage market form 2000-2007) are generally 50 basis points lower than jumbo loans. In a restrictive mortgage market, like 2008 and 2009, the spread between a conforming and jumbo loan is even higher, usually running anywhere from 100 to 300 basis points. In this scenario, investment mortgage lenders have made it difficult to buy investment property, causing the squeeze on the investment property market. As a result, property owners who want to sell or need to sell cannot because there are no buyers. This has led to the foreclosure issue in investment property.
As with residential home mortgages, investment property loans come in all shapes and sizes, from the 30 year fixed to the adjustable rate mortgages (1, 3 and 5 year ARM’s) to the interest only mortgages. The choice here is based on what form of financing are you comfortable with.
I’ve spoken about investment property mortgages in general, now let’s talk about some additional considerations if you are looking to build. If you decide to build, you will need not only an investment property mortgage, but also a loan for the build phase. The build phase loan is usually the current prime rate plus or minus 50 basis points. This is much more expense than the rate you will have on your investment property mortgage, because the risk during this phase is considered much higher by the lenders. This is for two reasons; first there is no rental income to offset cost at this phase and, secondly, the risk of the house not being completed. This will generally result in two closings on the property, one at the beginning of the build phase to secure the land and build financing, and the other when the house is ready for occupancy to secure the investment property mortgage. When we were building our Salvo property, we found an investment mortgage lender that actually combined both of these loans into one, although you still had to pay the higher loan amount during the construction phase, that allowed for only one close at the beginning of the process and a minor step called a conversion at the end to start the investment property mortgage.
Your investment property lender could be a great help during this phase to make sure the builder is delivering as promised. A representative from the lender will also come out to the property to inspect it to assure the milestone has been met. The investment property lender will only release funding as the builder achieves certain milestones. As a result, you are only paying interest as the lender releases funds and the lender is validating that items within that milestone have been achieved.