Income Property Mortgage: What It is, How It Works

What Is an Income Property Mortgage?

An income property mortgage is a specific type of mortgage given to an investor to purchase a residential or commercial income property.

An income property refers to a piece of real estate purchased or developed primarily to earn income by renting or leasing it out to others, with a secondary goal of price appreciation. Income properties, which are a subset of investment properties, may be either residential or commercial.

Understanding Income Property Mortgages

An income property mortgage is a type of mortgage available to investors interested in buying rental properties. If an individual wants to purchase a larger rental property, they apply for an income property mortgage, which is typically much harder to qualify for than other mortgages.

When applying for an income property mortgage, individuals must usually include estimates of the projected rental income from the property. In contrast with owner-occupied and single-family residences, the federal government has very few loan programs available to assist in the purchase of income properties. The lack of federal support forces investors to use private mortgage lenders.

Rental property can appeal to experienced real estate financial investors and novices alike. As opposed to stocks, futures, and other financial investments, many people have firsthand experience with both the rental market as tenants and the residential real estate market as homeowners. This familiarity with the process and the investment make residential rental properties less intimidating than other investments.

For real estate investors, the biggest hurdle in acquiring rental properties is securing an income property mortgage due to the larger down payment this type of mortgage requires.

Investing in Income Property

Income property refers to any property bought to earn income. Though that income commonly comes through renting or leasing, the term also refers to property purchased to benefit from price appreciation. Generally, the 2% rule of real estate investing states that the property should generate 2% of the home's property value in monthly cash flow.

Income property includes both residential and commercial property. Residential income properties are commonly referred to as non-owner occupied. Banks generally only offer an income property mortgage to non-owner occupied buildings. Income property investors need to be high-credit quality borrowers with steady incomes to make monthly installment payments.

But, owning an income property requires a lot of time, effort, money, and patience. For instance, dealing with tenants can be difficult at times. This can lead to additional repairs, trips to the home, and court costs if the owner needs to pursue an eviction. Furthermore, if the owner isn't able to manage the property themselves, they may have to spend additional money to hire a property management company to do the work for them.

Special Considerations

Investors find income property attractive for a variety of reasons. Income property offers an alternative to standard market investments in stock equity and company bonds, as well as the security of real property with many investment diversification benefits.

When investing in real estate for income, an individual needs to consider interest rates and the housing market environment. An investor also needs to look closely into the location, rent levels, and the potential for return.

Sometimes, an investor takes out income property mortgages to fund the flipping of a house. Rather than holding a real estate property and collecting rental income over a long period of time, a flipper purchases a home, fixes it up, and sells the property quickly at a higher price.

The Bottom Line

An income property mortgage is a mortgage loan used to buy a residential or commercial rental property. An income property mortgage can be harder to qualify for than mortgages geared toward owner-occupied and single-family residences and may require a large down payment. However, investors can generate rental income or sell the property—called flipping—for a price gain if the home's value increases. Those wanting to buy income properties usually use private lenders since few federal loan programs are available for income property mortgages.