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I am researching purchasing a three unit brownstone in Washington DC to serve as a rental. I am comfortable with my understanding of a personal mortgage, but don't fully understand how an investment mortgage works. What are the differences between the two?

  • It would be helpful to know if you intend to occupy one of the units for a couple of years. – SpecKK Oct 22 '10 at 16:59
  • I was thinking about living in one of the units and renting out the other two. – Ryan Michela Oct 22 '10 at 18:38
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Banks consider investment mortgages (and any mortgage where you don't live in the property), as a riskier investment than an owner occupied, home collateral mortgage. The sources of increased risk range from concerns that you will screw up as a landlord, your tenants will destroy the place, you won't have tenants and can't afford to pay the bank, and/or you'll take out several other investment mortgages and over extend yourself. All of these risks are compounded by the fact that it is harder for the bank to convince you to pay when they can't put you out on the street if you default. Banks lend and invest in money, not real estate, so they would much rather have a paying loan than a foreclosed house, especially with the modern foreclosure glut.

The increased risk means the bank will charge higher interest for the loan, may require a higher downpayment, and will require higher lending standards before issuing the loan. A new housing investor can get around these higher prices by living in the home for a few years before renting it out (though your lender could possibly require you to renegotiate the loan if you move out too soon).

  • It's also good to know if you live in the area. The bank probably won't consider that a risk factor, but you can take better care of an investment than a disinterested management company will. – SpecKK Oct 22 '10 at 17:06
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According to my wife who used to work in the industry, since an investment mortgage is more likely to fail (they are just riskier) there are higher loan to value requirements and higher interest rates.

They are just different products for different situations.

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I used to own a few investment properties, so I'm pretty familiar with this. As MrChrister mentions, lenders see investment mortgages as higher risk. People who fall into financial trouble are much more likely to let their investment properties go than their personal residence. Consequently, the interest rates and downpayment requirements are generally higher.

Typically a mortgage for an investment property will require 20% down, vs. as low as 3-5% down for a personal residence. With excellent credit and some shopping around, you could probably do 10% down. Interest rates are typically about a half-percent higher as well.

You'll also find that the more investment properties you have, the harder it becomes to finance new ones. Banks look at debt-to-income ratios to determine if you are over extended. Typically banks like to see that your housing payments are less than 20% or so of your income. However, with rental properties, housing payments generally account for far more than 20% of your rental income. Other income you have can offset that, but after buying 2-3 houses or so, your DTI generally creeps into the range where lenders are uncomfortable lending to you anymore. This is why you'll find that many rental properties are bought on land contracts with owner financing rather than with mortgages.

  • The part about the ratio of housing payments to income surprises me. If your mortgage payment for a given rental unit is $800 and you collect $1,000 rent - that's 20% profit and a very nice margin. But it also means that your housing payment for that unit is 80% of the rental income and spells trouble according to what you describe. – Doug Harris May 20 '11 at 19:29
  • @Doug - that's correct, but lenders tend to look at as your total income vs. your total debt, and don't consider the investment properties separately. In the scenario you describe, your income would go up $1,000/mo but your debt payments would go up by $800/mo. Depending on your income and other debt, it doesn't take many properties to push your overall DTI over the 20% threshold. – Eric Petroelje May 21 '11 at 1:53
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It's just a guess, as I'm from the UK and am unfamiliar with the term "investment" mortgage but is it one where you are buying the property in order to rent it out, and make money from it, rather than to live in?

In the UK we call those "buy to let" mortgages and one of the main differences is that you have to have a higher deposit to get that type.

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If you are going to live in the house for awhile, you can probably use a regular mortgage. Shop around and look for a mortgage program that works. Look at local banks/credit unions, particularly those with community development programs.

Usually an investment mortgage is higher rate, higher payment and has higher underwriting standards.

  • I'm looking to purchase a small multi-tennant building. Here in DC those run between $1M and $1.5M. I know for a fact I don't qualify for a one million dollar mortgage on my personal income, but with the help of tenants it's possible. – Ryan Michela Oct 23 '10 at 5:38
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    @Ryan - Typically banks will allow you to count 75% of expected rental income when qualifying. So if your personal income + 75% of the expected rents gives you enough income to qualify, you'll probably be OK. If you would consider living in one of the units though, then duffbeer's answer might apply. – Eric Petroelje Oct 25 '10 at 14:42

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