Financing options for my first property

[Jason R.]

I currently own my current home (mortgaged) and am preparing to buy my first rental property. My question relates to the financing of the rental property.

Since the rental property I would buy is a 2nd home, all the banks and brokers I have talked to said I would need 25% down to avoid PMI. I have a friend who referred me to a local bank that he said he has used for investment properties and he only puts 20% down, but finances through his LLC. I contacted the same loan officer and they told me they have to have 25% down whether I finance it or my LLC does.

Are there lender's that will allow you to do 20% down on an investment property without PMI? Am I just asking the loan officers the wrong questions? I don't think the 25% down is related to my credit or DTI, I hadn't gotten that far with anyone yet.

[Andrew Postell]

@Jason R. this is a pretty common problem.  I'm tagging @Derek Diamond here too so he can read this as well.

The short answer here is "yes", it is entirely possible to find lenders that only require 20% down...or even 15% down when purchasing a property. For most lenders, 20% down would NOT require PMI. There might be some differences here though. This might take a few minutes for me to explain but I hope this lengthy of a response will help you in finding the right lender for you.

Investment property lending has 2 main types of loans:  "Conventional" and "Portfolio"

Conventional - I want you to think of this loan type of Fannie Mae and Freddie Mac (if you recognize those names).  They are 30 year fixed rate loans.  Usually the best rates but it's not the bank's money....it's Fannie/Freddie's money.  So we have to obey their rules of lending.  Their money - their rules.  You would usually need a stable job, reasonable credit, and decent assets to qualify.  HOWEVER - and this is a big one....Lenders are allowed to put extra rules OVER the Fannie/Freddie rules.  So if you hear a lender say "our credit score minimum is 680"....well, that's an overlay since Fannie/Freddie loans require 620.  A lender can have more restrictive rules (to limit their exposure) but they can't have less restrictive rules.  AND some lenders won't even offer both Fannie Mae and Freddie Mac (more on this in a minute).  Obviously, this will cause confusion when shopping around.

Portfolio - I will define this as money that comes from the lender's OWN portfolio of money.  These are commonly 20 year adjustable rate loans (very different when comparing against a 30 year fixed Fannie/Freddie loan).  Sometimes these are refered to as "commercial" loans.  Bank money = Bank rules.  Sometimes your income won't matter.  And sometimes they will just qualify you based on the property itself.  And since each bank will lend it's own money a little differently.....well, each bank may have entirely different rules when it comes to lending!  And that certainly will create confusion from time to time.

You can see how lending can be confusing in a hurry, right?  Here's what you need to know based on your scenario:

Fannie Mae and Freddie Mac will not require PMI at 20% down. With a Single Family home, you can put 15% down when purchasing with both Fannie and Freddie...BUT WITH REFINANCING....only Freddie Mac allows 85% "Loan to Value".  Fannie will only lend 75% MAXIMIUM when refinancing.

Portfolio lending....?  Anything is possible.

So if you can only qualify for the portfolio route.  Then keep calling around, maybe lean on the state forum here on Bigger Pockets you are investing in to ask who is the best lenders in your state for this type of lending. 

Now with Fannie Mae and Freddie Mac we can almost ask the same set of questions....since the only thing we really need to know is how to avoid overlays...so I made a list of questions for you to ask your potential lenders when interviewing them.  These questions don't cover everything....but if they answer these correctly it will give you a good idea is you are working with an investor friendly place.  Here's the list:

Questions for Lenders

1. When do you start using rental income to help me qualify? (the answer needs to be immediately)
2. When do you start using “After Repair Value” on my property?
3. How long do you need me to be on title to refinance? (this is important if you do need a short term loan to purchase then refinance out - and the answer should be 1 day...very important that it is 1 day on title is all that is needed to refinance)
4. What is my minimum down payment required? (if they only require 15% down on a single family home that is usually a good sign that you are working with a flexible lender)
5. Can I change title to my LLC?
6. Do you sell your mortgages?
7. What is your loan minimum?
8. Can you explain to me what your reserve requirements are?

*WHEW*  I know this was a lot but I hope some of this helps.  Thanks!