For current and upcoming rental property investors, 2022 has been a challenging year to add units to their portfolios as house prices skyrocketed. According to CEIC Data, as of June 2022, house prices experienced a 17.0% year-over-year (YoY) increase and a 17.8% YoY spike in the preceding quarter. In these trying times for real estate, single-family rental (SFR) loans may be an investor’s lifeline.
SFR loans are a great option for investors that want to start their rental portfolios but cannot or don’t want to pay in full cash. This option helps investors purchase or refinance rental properties and boost overall returns. In this article, we’ll take an in-depth look at the difference between SFR loans and primary home loans and how to qualify for an SFR loan and keep your rental loan costs low.
SFR loans vs. primary home loans
These types of loans can both originate from banks, credit unions, or mortgage brokers. Yet, there are several differences investors should note.
Higher down payments
In general, SFR loans require a 25% down payment. Aside from helping the borrower qualify for a lower interest rate and loan fees, larger down payments give enough equity in the property to weather a sudden decline in real estate prices. Note also that in addition to the down payment, there are other costs like loan fees, title and escrow fees, and the property inspection and appraisal.
Higher interest rate
Compared to owner-occupied home loans, interest rates on SFR loans are typically higher by 0.50% to 0.75%. Now, as per Spark Rental’s report, the current 30-year fixed interest rate for primary home loans is 5.9% at minimum. Based on this, the smallest interest rate for SFR loans is 6.4% to 6.65%.
Backup account
This may not always be the case, but some lenders will require a reserve fund that can cover at least 6 months of mortgage payments. This is to ensure that borrowers still have enough budget to pay even if they spend more than what is expected on repairs or if rent payments come in late. Also, this guarantees lenders that borrowers are not entirely reliant on rental income in making payments, especially in cases of longer vacancies or delinquent tenants.
How to be eligible for SFR loans
There’s not too much of a difference between applying for SFR and owner-occupied home mortgages. But, lenders see SFR loans as riskier because investors tend to return the property whenever the rental demand declines. This is the main reason why they require the following criteria before approving applications:
- A credit score of at least 620 (some lenders might require a minimum of 680 FICO score)
- A large down payment of around 25% of the total property price
- A debt-to-income ratio that does not exceed 36% (for example, a borrower who has a gross monthly income of $20,000 should have a total monthly mortgage payment of no more than $7,200)
- Prepared loan application documents like W-2s and bank statements, a report of all assets and existing debts, and tax returns
In addition to the above lists, be prepared for higher interest rates and a reserve fund. Without all these items, you can still apply for an SFR loan, but it may not be approved. Note also that condominiums, single-family homes, small multifamily homes with a maximum of four units, and townhomes are the only property types that qualify for SFR loans.
Single-family rental loan options
Several options for single-family rental loans are actually available for investors to choose from. To help you find the one that meets your needs, we compiled a list of the most common SFR loan alternatives.
Conforming loans
These are offered by traditional lenders like banks and credit unions. Based on the borrower’s credit score, the required down payment may be less than 25% and the interest rate may be lower than typical. However, since conventional loans are guaranteed by Fannie Mae and Freddie Mac, they should meet the established guidelines. Although Fannie and Freddie allow up to 10 rental loans, banks usually set a lower cap per investor (typically 4).
VA financing
Backed by the U.S. Department of Veterans Affairs (VA), this SFR loan is available for active-duty service members, qualified spouses, and veterans. A minimum down payment or credit score is not required. Two options for applying are (1) going directly to the VA or (2) through traditional lenders that have VA financing. A notable requirement is that the borrower must use the home as their primary residence for at least a year. Only after a year can it be used as a rental.
FHA financing
Offered by traditional lenders and mortgage brokers, these loans are guaranteed by the Federal Housing Administration. Again, depending on the borrower’s credit score, the down payment and interest rate may be lower than with a conventional loan. Similar to VA loans, the investor must use the property as their primary home for at least a year. Approved mortgages can be used for property updating, new construction, or purchasing.
Private
Basically, private loans come from seasoned real estate investors who offer debt financing. Since they have experience in the industry, borrowing from private lenders might bring advantages as they can offer outside-the-box arrangements. For example, they may even accept a small equity in an appealing investment in exchange for lower fees and interest rates. After all, private lenders are making money from the monthly interest on the loan instead of buying a rental property of their own.
Blanket loans
A blanket loan is a type of SFR loan that can be used to finance multiple rental properties under one loan. All rentals are also cross-collateralized. This means every unit serves as collateral for the others. The deal can be customized to the borrower’s needs and terms normally have a release clause, allowing one property to be sold without refinancing the others.
Portfolio loans
Similar to blanket loans, portfolio mortgages can be used in financing multiple homes. However, unlike the former, the latter have separate loans made per property under one lender. A flexible deal can also be offered but may cause higher interest rates and fees, prepayment penalties, and shorter loan terms.
Home equity line of credit
Also known as HELOC, this is a credit line that draws funds from the equity of an existing home. Up to 80% of the equity can be converted into cash and utilized to finance an SFR property. So, if the borrower has a residence with $100,000 in equity, up to $80,000 can be used. The downside, however, is a higher interest rate and fees compared to long-term financing. Lastly, similar to credit cards, HELOCs have a fixed interest rate and should be repaid every month.
Seller financing
From the term itself, this loan comes solely from the seller who owns a home free and clear. The seller acts as a private lender, requiring a down payment and implementing a competitive interest rate. Frankly, the advantages of this loan are mostly with the seller as they receive a steady interest income through every mortgage payment. So, for newer investors, this SFR loan might not be the best option on the list.
Up next: How to Evaluate a Rental Property Investment
Tips to have lower rental loan costs
From the above information, investors can learn a few things to keep their loan costs low. First is to work hard to maintain a good credit score of at least 740. As repeatedly mentioned, a good credit score can lower interest rates and fees. It’s also important to record the financial performance of your existing rentals. Showing off your successful track record shows lenders that you are trustworthy and capable of paying monthly mortgages. Lastly, do not forget to compare terms from different lenders to gather enough information about which options have lower rates and fees.
Final thoughts
From comparing terms to preparing the necessary documents, finding the best single-family rental loan will definitely require a lot of time and effort. But knowing your options is already a great start. Aside from conventional loans from traditional lenders, it pays to be familiar with alternatives such as portfolio loans, private loans, HELOCs, and seller financing. This gives you a wider perspective on better rates and fees. So, put in the work and you’ll be on your way to building your own stellar rental portfolio.
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