Mortgage rate for rental property vs primary residence

Buying rental properties is a smart move. Interest rates are still relatively low, which means the value of rental income has gone way up. Therefore, there’s good value in owning rental property, especially with inflation so elevated.

However, getting a rental property mortgage is more expensive than getting a primary residence mortgage. In this article, I will explain why rental property mortgages are more expensive than primary home mortgages.

To understand why rental property mortgages are more expensive than primary home mortgages, put yourself in the lender’s shoes.

Let’s first take a look at review a primary mortgage and then a rental property mortgage.

Primary Mortgage 

The primary mortgage is underwritten based on the assumption that your day job income + other alternative incomes will be around so that you can comfortably pay every month.

Your W2 income viability is the ANCHOR that propels a bank to move forward and give you a new mortgage. After assessing your W2 income will the bank then account for your alternative income streams if needed.

The most important ratio your bank will look at is your debt to income ratio. They ratio they are generally looking for is roughly 33% or lower. That said, my recent loan modification required just a D/E ratio of 43% or less. Each bank is different, but the percentage is roughly around there. The number one goal for the bank is to earn a consistent spread over the life of the loan.

Rental Property Mortgage

Your rental property mortgage is underwritten based on the assumption of the feasibility in collecting rental income. The bank then looks at your W2 income to arrive at your total income.

W2 income is preferred, however underwriters try to match income sources with the types of mortgages they are lending. The main issue is the viability of your income streams.

If you are refinancing an existing rental property, you’ve got to come up with a lease and rental history. No lease and a sketchy rental history full of missed payments will probably end your rental property mortgage refinance. 

Rental property mortgages often require a 30% or more downpayment compared with your typical 20% downpayment for a primary residence.

Risk Reward Between Rental And Primary Mortgage

It’s all about risk assessment for a bank. From the bank’s point of view, they are making a default assumption that you as the landlord require rental income to pay the mortgage.

Even if you have a huge salary and lots of money saved in the bank with the existing institution, the mortgage underwriter does not put as much weight as the rental history of the property.

For rental mortgages, they are essentially making a derivative bet.

Last Property Standing

In a housing downturn, the first properties to go are vacation homes followed by rental properties. A primary residence is the last mortgage a multi-property owner will default on since s/he has to live somewhere.

The primary home mortgage is presumably more affordable once the multi-property homeowner gets rid of other debt. Banks know this and are more stringent in their rental mortgage lending practices.

The last thing a bank wants is to repossess a property. Banks are not in the business of buying and selling properties!

Think Like A Banker When You Borrow Money

Now that you understand why a bank places a higher risk on rental properties, you now know why rental property mortgage rates are often 0.5%-1.5% higher than the SAME primary property mortgage rate. Due to higher risk, banks demand a higher return on their investment in you. Banks have tighter lending standards post crisis.

Take my current San Francisco rental for example. My 5/1 ARM rate for a conforming rental loan (<$417,000) is 3.375%. Meanwhile, my 5/1 ARM jumbo primary resident mortgage is only at 2.625%.

My primary home mortgage is more than double my rental property mortgage and my rental property income is more than quadruple my rental mortgage interest payments, yet the rental property mortgage is still 0.75% higher.

If my rental property mortgage was a jumbo loan, making the comparison apples to apples, then the rate would probably be closer to 3.875% (from 3.375%) vs. 2.625% for my primary mortgage.

I’ve checked multiple banks, including my favorite online mortgage lending marketplace, and the rate spread is consistently at least 0.5% higher for rental property mortgages. Always check online for the latest mortgage rates. You’ll get multiple real offers for free.

Refinance Before Your Property Becomes A Rental

When I bought my first San Francisco property in 2003, I knew it was only a stepping stone for something nicer as my income grew. I was 26 at the time and the place was a cozy two bedroom, two bathroom apartment overlooking a park in a great part of town. As it was my first and largest purchase ever at the time, I wanted to be conservative and purchased at the bottom of my range.

A couple years later, I found a house that I currently reside in and made my first property a rental. I refinanced my first residence as a primary residence, locked in the lowest rate at the time and subsequently moved out three months later and converted it into a rental.

I didn’t anticipate to move out so soon after my refinance, however, when I found my new house, I just knew it was the one. I was able to make the transition work because I gave a three month rent back to the old owners of my new home. Consider the same strategy to lock in a lower rate. It’s all about flexibility and planning.

Due to refinancing my first property mortgage before moving out, I estimate to have saved over $50,000 in interest expense in the past 10 years all things being equal. That is real money that went towards savings, investments, and ultimately allowing me to no longer have to work today. When you are trying to retire early, every dollar savings counts.

Repeat The Refinance Cycle And Build Wealth

There might be a point over the next five years where I will also want to rent out my current primary residence and move to a new property. I’m not sure if I’ll get a better rate than 2.625% for a five year fixed jumbo. If I plan to rent out my house, I will certainly try to at least re-lock a 2.625% rate for five years or get the best rate possible at the time.

The biggest issue will be my lack of W2 income. As such, I will be working hard to build my passive income streams. Thanks to Bernanke’s quantitative easing efforts, I’m bullish that mortgage rates will stay low and rents will continue to rise.

Not only is refinancing a primary home mortgage easier than refinancing a rental property mortgage due to less documents needed (e.g. rental history, rental contract, HOA info), the rates are also much lower. The median homeownership duration of 5.6 years is too short to build real wealth. Buy, hold, refinance, and hold some more. You will be glad you did!

Bottom line. You should refinance your property now if you: 1) feel your job is at risk, 2) feel there is a chance you will be relocated, 3) plan to upgrade or downgrade and still keep your existing property, 4) want to save money and haven’t refinanced in the past twelve months.

Wealth-Building Recommendations

Shop around for the latest mortgage rate. Check the latest mortgage rates online. You’ll get real quotes from pre-vetted, qualified lenders in under three minutes. The more free mortgage rate quotes you can get, the better. This way, you feel confident knowing you’re getting the lowest rate for your situation. Further, you can make lenders compete for your business. 

Explore real estate crowdsourcing opportunities: If you don’t have the downpayment to buy a property, don’t want to deal with the hassle of managing real estate, or don’t want to tie up your liquidity in physical real estate, take a look at Fundrise, one of the largest real estate crowdsourcing companies today.

Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible.

For example, cap rates are around 3% in San Francisco and New York City. But cap rates are over 8% in the Midwest.

I’ve personally invested $810,000 in private real estate funds since 2016 to diversify and earn more passive income. It’s free to sign up and explore Fundrise.

Why Are Rental Property Mortgages More Expensive Than Primary Home Mortgages is a Financial Samurai original post. FS has been around since 2009 and is the leading personal finance site in the world.