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Home Loan or Investment Loan?

The road to successful investing is often paved with other people’s money. And that usually means a mortgage.

Taking out a mortgage to finance rental property is the smartest move an investor can make. Just ask Jason Hartman, whose “refi till you die” strategy for building wealth in real estate recommends starting with a fixed rate mortgage and refinancing as the property appreciates over time.

But loans for buying residential property come in many forms. And when you’re looking for that first mortgage, knowing the difference between a residential home loan and an investment loan can be crucial.

Residential Mortgages

The residential mortgage – that typical home loan that gets you a house to live in for yourself and your family – is intended for just that purpose: to finance a primary residence. It’s the kind of mortgage that carries the lowest of those historically low interest rates you’ve probably been hearing about.

Residential mortgages also fall under the new Qualitative Mortgage Rule, a lending standard put into place by the Consumer Financial Protection Bureau in January 2014 in an attempt to reform the lending industry and head off bad loans that borrowers can’t pay off.

The QRM puts tighter standards around all aspects of qualifying for a mortgage. Those include the borrower’s debt to income ratio, credit scores and amount of down payment required. Lenders aren’t mandated to apply QRM standards to the loans they write, though – and they can make any loan they choose. But applying QRM standards to their loans means that if those loans do fail, the lender won’t face legal action for knowingly making the loan.

It’s possible to turn a residence into a rental – but certain rules apply. If you’re planning to buy a second residential property, it’s important to be clear about your plans for it.

Residential home lending also includes an option for a “second home” loan. But that’s for homes intended as vacation homes, or partial residences. To qualify for that kind of home loan, the applicant has to be the home’s only resident for a portion of the year – it can’t be used as a rental for the part of the year the homeowner isn’t in residence.

Turning a family home into a true rental property can be tricky. Empty nesters who downsize but rent out their old house, or owners who rent out a portion of the house such as a garage or basement apartment, may face modifications on their mortgages if they opt to refinance – and tax issues because of the property’s change in status.

Residential Investment Mortgages

Investment mortgages are made with the entrepreneur in mind. They’re structured to account for the use of a property for income generating purposes only. There are two types of investment mortgages: residential and commercial.

Like simple home mortgages, residential investment loans involve properties used as dwellings – but for the specific purpose of generating income. Investments still qualify as residential, not commercial, if they contain four or fewer units.

These kinds of loans may have higher interest rates by a point or two compared to simple residential loans. Residential investment loans are available in a variety of forms, including the typical 30-year fixed rate type recommended by Jason Hartman.

Residential property investment loans behave much like typical home loans. Lenders consider an applicant’s debt to income ratio and credit score. But lenders may also consider the property’s loan to value ratio: the total amount of the loan compared to the total fair market value of the property. That ratio can indicate a lender’s likely risk .

In some cases, lenders may consider an applicant’s previous landlord experience as part of an application for a residential investment loan. If an investor is trying to finance more than one property with multiple loans, the debt to income ratio can go up fast, even if tenants are paying off the debt. So lenders may add a borrower’s rental income to their regular mortgage income.

But you may get the kind of help only if you’ve been a property investor for more than two years. That requirement varies greatly among lenders, though – as does the choice to apply the Qualified Mortgage Rule.

Commercial Property Investment Loans

Once you opt to buy a property with five units or more, you’ve stepped into the realm of commercial real estate, which can cover not only residential priorities but also real estate used for other purposes, such as business, industry and shopping.

Though these kinds of loans behave much like residential property investment loans, lenders typically give more consideration to the loan to value ratio. A new benchmark also applies to commercial lending – the Debt Service Coverage Ratio, which establishes the property’s ability to generate income.

There are other kinds of loans for income properties, too, offered by private and hard moneylenders who operate outside the standards set by conventional mortgage services. Clarifying your goals and doing the research are the first steps in finding the right financing – and refinancing – to build wealth from your investment properties for years to come.  (Featured image:Flickr/lgargerich)

Read more from Heroic Investing:

The Creating Wealth Show: Top Tier Advice for Investors

Reduce Tenant Turnover to Keep Cash Flowing

The Heroic Investing Team

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