While most homeowners shop around for the best interest rate for their primary residence, those who want to finance an investment property may not fare as well when it comes to interest rates.
There is no simple answer to the reason behind the high cost of interest rates on investment properties, however, the bottom line is that banks and other lienholders know that a person will not be as concerned about losing a home if they don’t reside there. For this reason, obtaining non-owner occupied financing, also called NOO, can prove to be a challenge.
To help reduce interest rates, buyers should follow several tips when purchasing investment properties.
A high down payment will show a bank that the buyer has made a significant financial investment into the property. Because federal laws don’t allow mortgage insurance to cover investment properties, the buyer needs at least 20 percent down to obtain a loan. As the buyer increases his down payment, even by five percent, he can possibly decrease his interest rate.
A smaller bank or credit union may be willing to work with investors who don’t have the full down payment. Local institutions are typically more concerned about area economics, so they can be a great choice. An experienced mortgage broker can provide a variety of loan options in challenging circumstances.
Investors should know their credit score prior to negotiating for a loan. The saying that “knowledge is power” holds true in personal finances. A high credit score can be one of the best negotiating tools a buyer has. As a person’s credit score drops, the interest rate will generally increase. At the very least, a lower credit score will mean an upfront fee added onto the loan.
[Check out our top 7 reasons why your credit score isn't higher.]
Lenders also want to see funds on reserve to cover at least six months of personal and investment-related expenses. These multiply for those who hold more than one property. The bank wants to insure their loan in an unstable economic market so that if a property is vacant for a while, the investor can still make payments.
One way around this might be to buy a property with a tenant already living in the residence. Banks view this favorably since someone is already making payments. In addition, the owner will need to transfer the security deposit to the new owner along with pro-rated rent payments. If they seem to be good tenants, the investor can keep them. Otherwise, they can begin the search for new renters immediately.
Owner financing bypasses the need for mortgage insurance and permits an investor to work directly with the owner. This option has increased in popularity as it has become more difficult to obtain bank financing. However, the investor will need to know the market and have a solid offer in mind when going this route. He will need to convince the owner that he is a good candidate for this option. Other creative financing options, such as using a line of credit, borrowing from a family member, cashing in an IRA or looking at private loans, can also work in tightened economic conditions.