Residential and Investment Property Mortgage Loans: 3 Differences
There are several differences between investment property mortgage loans and residential mortgage loans. A borrower who is looking to purchase a home for their personal use face different lender requirements than one who is purchasing rental or other investment property. A lender looks at the property’s use as a criterion for down payment, collateral and income verification requirements.
The main differences between residential and investment property mortgage loans include income verification requirements, collateral and down payment requirements and terms and rates. These differences are discussed in detail below.
Difference #1: Income Verification Requirements
A residential mortgage loan applicant is going to be required to verify their source of income in order to secure the loan. This requirement helps the lender determine whether the borrower’s income is sufficient to service the mortgage debt on an ongoing basis. It also helps to ensure that the borrower’s debt to income ratio is appropriate in order for them to afford the home.
The income verification process for an investment property mortgage loan is different. Income for an investment property can includes receipts from rents paid by tenants, whether it is a rental house, vacation home or commercial retail property. In this instance, the lender will look at the net income statement and other financial documents as reported on the borrower’s income tax schedules to determine the relationship between income and the amount borrowed.
Difference #2: Collateral and Down Payment Requirements
The down payment is used by the lender to determine the amount of risk the lender will be facing. Most lenders require a minimum down payment for a residential mortgage loan of 20 percent. This creates a loan-to-value (LTV) ratio of 80 percent, which means the residential homeowner is not subject to any additional requirements such as private mortgage insurance (PMI). An LTV that is higher than 80 percent requires the purchase of PMI.
The investment property is used as collateral to secure the investment property mortgage loan. This eliminates the need for a down payment by the borrower. Rents and other income generated by the investment property are used to service the mortgage debt and are typically built in the income statement for the owner as an expense item.
Difference #3: Loan Terms and Rates
Depending on where the investment property is located and type of income that is generated, the investment mortgage loan borrower is in a better position to negotiate a more favorable loan rate and terms than a residential mortgage borrower. A successful shopping mall can produce a good consistent income cash flow that can be used to lower the interest rate on the loan. The lender may see other opportunities in their relationship with this type of investment property owner and be more willing to lower rates or offer better terms than they could with your average residential mortgage property owner.