Real estate is a reliable investment option, evidenced by the high number of millionaires (90%) with properties in their investment portfolios. However, the entry barrier is high, and not everyone has the capital to purchase a property outright. Fortunately, there are different types of mortgages in Maryland; loans from banks and mortgage lenders are available to those who want to buy a property but lack the funds.
Two of the most popular mortgages are investment property mortgages and traditional mortgages. This article will discuss their differences to help property buyers determine the most suitable mortgage for their goals and financial situation.
What Are Traditional Mortgages?
Traditional mortgages are financing options for individuals or families purchasing a primary residence. These loans are typically paid back over 15 to 30 years with fixed interest rates. Traditional mortgages are backed by the property being purchased. If the borrower defaults, the lender can seize the property through foreclosure.
What Are Investment Mortgages?
Investment mortgages are loans for purchasing properties solely for investment purposes. This could be for income generation, such as rental properties and vacation homes, or capital appreciation, such as fix-and-flip projects. These loan terms can vary. In some cases, a fixed rate loan up to 30 years is still available.
Key Differences Between Investment Mortgages and Traditional Mortgages
The key differences between investment mortgages and traditional mortgages besides their intended use include the following:
Down Payment
Down payment requirements for traditional mortgages are often more lenient than investment mortgages. This is because lenders view investment properties as riskier investments, owing to market volatility, but primary residences are not significantly affected by market fluctuations.
The exact down payment amount varies based on factors such as credit score. Typically, traditional mortgages require down payments ranging from 3% to 20%, while investment mortgages may range from 15% to 25%.
Interest Rates
Interest rates in mortgages are partly premised on risk. And as already established, investment mortgages are considered riskier than conventional mortgages. As a result, interest rates on these loans tend to be on the higher end. The investor's credit score and financial status may also influence the rate charged for either mortgage.
Eligibility Requirements
The eligibility requirements for investment mortgages are stringent compared to traditional mortgages. For traditional mortgages, lenders typically use credit score, debt-to-income ratio, and employment history to determine a borrower's creditworthiness. Borrowers taking out an investment mortgage need to prove their ability to cover mortgage payments through rental income and their experience in real estate investing, in addition to the requirements mentioned above.
Risk Factors Associated With Each Type of Mortgage
Traditional mortgages carry a significant risk when taken out to finance a purchase in a highly volatile market. The borrower may end up with negative equity, where they owe more than the value of their property. This would make it hard to sell the home and clear the mortgage debt with the proceeds or to refinance, should the need arise.
Investment mortgages are also high-risk as their returns, or lack thereof, are tied to the performance of the real estate market. A downturn in the market would impede income generation, which would affect repayment. Lengthy vacancies can also reduce the investor's ability to repay the loan.
Factors to Consider When Choosing Between Investment Mortgages and Traditional Mortgages
Deciding between the two mortgage types comes down to the intended use. A traditional mortgage may have better loan terms and lower interest rates but can only be used for owner-occupied properties. Investor mortgages are tailored for income-generating properties.
However, there are cases where both options can be viable, such as house hacking, the purchase of vacation homes, and mixed-use real estate properties. In such scenarios, the borrower should assess the financial standing. A traditional mortgage is better if the borrower’s credit score, employment history, and debt-to-income ratio are strong.
Note that for some use cases, the borrower can take out an investor mortgage and later convert it to a traditional mortgage. These include:
House flipping: An investor can initially obtain an investment mortgage to purchase a property to renovate and quickly resell it for a profit but later decide to hold onto it. That property would qualify for a traditional mortgage.
Vacation rental property: Similarly, an investor may borrow an investor's loan to purchase a property with vacation rentals in mind. Should they decide to adopt the property for personal use later, they can convert the loan to a traditional mortgage.
Owner-occupied duplex or multi-family property: An individual can purchase a multi-unit property as an investment but later decide to occupy one of the units. In such a case, the current investor mortgage can be converted into a traditional mortgage.
Explore Maryland Mortgage Options With Woodsboro Bank
Woodsboro Bank offers various mortgage options for home buyers and investors in Frederick County, Maryland, and surrounding areas. These mortgages are for first-time home buyers or experienced real estate investors looking to construct, purchase, or refinance a property. Woodsboro Bank also offers HELOC, FHA, and adjustable-rate mortgages. Contact Woodsboro Bank today to explore Maryland mortgage options.
Sources for Internal Use Only
https://sparkrental.com/home-loan-vs-investor-loan/
https://www.woodsborobank.com/mortgages-loans/
https://themortgagereports.com/101719/heloc-for-investment-property#:~:text=Investment%20property%20mortgages%20are%20seen,applies%20to%20mortgages%20and%20HELOCs
https://www.linkedin.com/pulse/what-real-estate-creates-90-millionaires-ben-lovro/