Whether the economy is bullish or bearish, real estate remains one of the most prudent investments available, particularly in residential real estate. While the office real estate market has been thorny lately, rents on homes and apartments continue to rise; mortgage rates and home values are still incredibly high, making renting an attractive option for millions of Americans.
About a third of the overall US population rents their homes, though this can vary by demographic; for example, only 44% of Black Americans own homes, and the other 56% are renters. It’s clear that this trend of renting will remain over the long term, making buying and renting property a solid investment.
However, there’s a great deal of confusion and mystery regarding one of the key components of buying investment properties: the interest rate and mortgage programs. Today, we’ll answer some of your most burning questions about this topic so that you can become a true real estate leader with a healthy, highly competitive portfolio.
Why Are Investment Property Rates Higher?
In your initial investigations into investment property mortgage rates, you’re hit with an unsettling and disappointing truth: interest rates are higher than those for residential property. As of September 2023, the average rate for a 30-year fixed-rate investment mortgage is about 7.24%, while residential mortgages average 6.98%; the numbers may change significantly throughout the course of a month or even a week, but the discrepancy between investment and residential rates remains about the same.
The reason is that, for lenders, investment borrowers are inherently riskier than residential borrowers. Many investors may choose to pay off their loan early should their properties make more than expected, or they may quickly refinance to a better rate as soon as mortgages drop. They might also simply walk away from the investment entirely, which is something that rarely occurs with those who live in their homes.
Understanding this makes it easier for you to assess a property for its return on investment, as you’ll be aware that you’ll need to pay higher rates and thus charge more, even if the property you’re purchasing is similar in price to owner-occupied property.
Are Investment Interest Rates Tied to the Residential Housing Market?
This is a simple answer: yes. They do not track perfectly, but the entire mortgage industry is deeply intertwined, both with itself and the overall state of the economy. This is especially true due to the fact that the Fed is closely involved with the housing market thanks to Fannie Mae and Freddie Mac, and they raise and lower interest rates in response to market demands. When consumer spending is high, they will raise interest rates to lower demand, and interest rates drop when the market is slow.
When you’re considering investing in property, you must carefully watch the residential housing market and its interest rates to predict when things may heat up: purchase properties when rates are low, hold them throughout market fluctuations, sell when rates are high, and refinance when they drop below your initiate rate.
Who Lends Money to Investors?
There are three types of loan for real estate investors: agency loans, bank loans, and non-qualifying (non-QM) loans. Agency loans can be guaranteed by Fannie Mae and Freddie Mac, while bank and non-QM loans cannot. An agency loan has a very similar process to getting a residential mortgage for your home.
Bank and non-QM loans require less paperwork and are primarily based on the property’s ability to satisfy its debts. As bank regulators prefer banks not to hold these types of mortgages, they tend to require financing later in the life of the loan.
For investors, non-QM loans, also known as Debt Service Coverage Ratio (DSCR) loans, are the best bet, as they focus almost solely on the property rather than the borrower. They make a great choice for self-employed investors and those with unusual financial circumstances, especially when seeking a self employed mortgage, because, unlike agency loans and bank loans, they don’t require personal income verification.
How Does One Know If a Real Estate Investment Mortgage Rate Is a Good Deal?
This is a highly subjective question because you must look at the whole picture rather than just the number: you must determine how well the property will perform in the market compared to your mortgage rate.
A high interest rate in a well-performing area with great economic promise will be less painful than the same rate in an area with a slumping job market; this is why economic analysis and predictions of tenancy rates are also a crucial component of identifying whether a particular interest rate is worth the investment. The employment of your tenants and their own economic prospects are quite relevant to you whether you’re buying storefronts or single-family homes: if they can’t pay their own bills, they can’t pay for your mortgage either.
When determining whether you will make a good return on investment, turn to local experts, such as realtors, who can help you identify promising properties based on the particular market, then compare this with the potential rates you can get from the three different mortgage types. It takes good research and a keen eye to track mortgage rates, then identify when a promising rate appears, so blend advice from multiple sources – including the information provided here – before making a major decision on an investment.
