The amount you pay for your mortgage depends on the risk the lender takes to provide you with the financing you will need to acquire your dream. If you are investing in real estate to generate rental income or a vacation home, you can expect to pay more than if you were buying a principal residence.
Likewise, if your home purchase is in an area considered riskier due to past hangovers, the interest rate you pay could also be higher. Here is an overview of the difference between mortgage rates when buying a property.
Investment properties versus conventional loan rates
If you are considering buying a property as an investment to let, you can expect to face more stringent requirements and a higher mortgage rate than if you buy a house that will be your principal residence. According to LendingTree, you could look a mortgage rate 50 to 87.5 basis points higher than the current rate.
Why is it? Investors will want to keep their roof over their heads, so if the rental unit sits vacant for too long, they might just “cut their losses and flee.” With this in mind, lenders want to cover the increased potential risk by charging a little more for the loan. They will also ask for more information about the potential borrower’s creditworthiness and ability to meet the financial demands of owning an investment property.
Buy a second home or a vacation home
If you’re looking to buy a second home or vacation property, you can also expect to incur additional costs compared to your primary residence. You will be asked to cough up a little more for the down payment and have a slightly higher interest rate on your loan. Additionally, your lender may apply stricter cash reserve and debt-to-income ratio (DTI) requirements.
According to Bankrate, the interest rate on your second home mortgage could be between 0.5% and 1% higher. You may be asked to deposit at least ten percent in advance, compared to only three to five percent for a primary residence.
The bank will probably ask you, depending on your credit and financial profile, that you have two to six months of cash reserves to cover the payments for your two properties. During your principal residence, the lender can be flexible with your DTI, allowing a ratio of up to 50%, it can be as low as 36 percent in the case of a second home.
Redlining and Lending Inequality
Although redlining was removed in 1968 with the Fair Housing Act, that remnant of the past that codified existing racial biases into law to classify geographic investment risk still haunts some owners and buyers to this day. Neighborhoods deemed particularly risky for investors have been denied access to federally insured loans.
These tended to be in the older parts of towns and had mostly non-white residents. Even though the policy was scrapped, decades of underinvestment have left these and other nonwhite neighborhoods with the perception that they are riskier for investors. This makes it harder for residents to leave these areas, entrenching segregation to this day.
It also contributes to the wealth gap between black and white families. The increase in interest rates paid by black homeowners adds about $1,800 more each year in addition to $400 more in property taxes.
Affordable Housing Projects Do Not Decrease Property Values
And if you’re a homeowner or buyer worried that an affordable housing project being built in your area is driving down your property value, research from the Urban Institute can put your mind at ease. A look at house prices in Alexandria, Virginia using Zillow’s appraiser and real estate database between 2000 and 2020 to estimate the relationship between affordable housing developments and sale prices of a range of nearby properties found a small but statistically significant increase in property values. These properties within 1/16 of a mile from an affordable development, a distance comparable to a typical city block, on average, its value increased by 0.09%.