Buying an investment property works like buying a home you’d live in, with tighter money rules and a second layer of legal duties that start the day you close. To buy an investment property, you’ll need at least 15% down, a credit score in the mid-to-upper 700s for the best pricing, six months of cash reserves, and a plan for the taxes, insurance, and federal landlord obligations that follow ownership.1Fannie Mae. Eligibility Matrix The steps below walk through what changes compared with a primary-home purchase and where the money and legal risk actually sit.
Financing an Investment Property
Lenders treat non-owner-occupied loans as higher risk because no mortgage insurance is available on them, so the lender carries more exposure if you default. That risk shows up in every part of the application. Before you apply, gather two years of federal tax returns and recent bank statements documenting your liquid assets and income.
The application itself is the Uniform Residential Loan Application (Fannie Mae Form 1003). In Section 4a, select “Investment Property” as the occupancy type so the loan is underwritten under the right guidelines.2Fannie Mae. Instructions for Completing the Uniform Residential Loan Application Misstating occupancy can delay closing and create legal problems later.
Key financial benchmarks:
- Credit score in the mid-to-upper 700s to secure the most competitive pricing.3Fortune. Buying an Investment Property – What You Should Know to Get Started
- Down payment of at least 15% on a single-unit property, and often 20% to 25% on multi-unit properties or to avoid steeper pricing adjustments.1Fannie Mae. Eligibility Matrix
- Debt-to-income ratio capped at 36% under Fannie Mae’s baseline, with automated underwriting allowing up to 45% when compensating factors are strong.4Fannie Mae. Debt-to-Income Ratios
- Six months of mortgage payments on the investment property held in verifiable accounts as reserves.5Fannie Mae. Minimum Reserve Requirements
- No gift funds. Unlike a primary-home purchase, gifted money cannot be used for any portion of the down payment.6Fannie Mae. Personal Gifts
Interest rates run higher through loan-level price adjustments that range from 1.125% to over 4% of the loan amount depending on your loan-to-value ratio.7Fannie Mae. LLPA Matrix Larger down payments reduce the surcharge.
If you already own several rentals, know that Fannie Mae caps total financed properties at 10 when you’re buying a second home or investment property, and each additional financed property increases reserve and documentation requirements.8Fannie Mae. Multiple Financed Properties for the Same Borrower
DSCR Loans as an Alternative
If you’re self-employed, have irregular income, or don’t fit conventional underwriting, a Debt Service Coverage Ratio (DSCR) loan qualifies you on the property’s rental income rather than your personal income. The lender divides expected monthly rent by the monthly mortgage payment; a ratio of 1.25 or higher generally clears the bar, and some lenders accept 1.0 with strong reserves. The trade-off is a higher rate, higher fees, and a 20% to 25% down payment. DSCR loans tend to fit experienced investors with solid rent projections.
Choosing a Property You Can Actually Rent
Physical condition matters, but zoning matters first. Confirm the property’s zoning and land-use designations permit the use you have in mind: long-term rentals, short-term stays, or a multi-unit conversion. A property in a zone that prohibits rentals is not an investment at any price.
Working with a buyer’s agent gives you access to the Multiple Listing Service and to comparable sales, vacancy rates, and rent estimates you’ll need to project return. Attractive numbers on a single listing can dissolve once you look at neighborhood vacancy trends or falling rents nearby, so evaluate the market, not just the building.
Making the Offer
The purchase agreement is the binding contract. It sets the price and, more importantly for your protection, the contingencies: financing, inspection, and property condition. Include an accurate legal description of the property from previous deeds or tax records to head off boundary disputes, and specify the loan amount, down payment percentage, and the deadline by which you must secure a mortgage commitment.
Once the seller accepts, you deposit earnest money into a neutral escrow account. Deposits generally run from 1% to 10% of the purchase price depending on market conditions and local practice, with competitive markets often expecting 3% or more.9National Association of REALTORS. Earnest Money in Real Estate – Refunds, Returns and Regulations The funds stay in escrow until closing or until any dispute is resolved under the contract’s termination clauses.
Due Diligence
Due diligence is your window to verify the property’s legal and physical condition before you’re committed to close.
Title Search and Insurance
A professional title search examines public records for liens, judgments, and easements. You then buy title insurance to protect against claims that might surface later from defects the search didn’t catch. Lenders require a lender’s policy, and you can purchase a separate owner’s policy for your own protection.
Appraisal
Your lender orders an independent appraisal to confirm the price is supported by comparable sales. If the appraisal comes in low, you can renegotiate with the seller, pay the difference in cash, or walk away if your contract includes an appraisal contingency.
Inspections
A general home inspection covers the roof, foundation, plumbing, electrical systems, and other structural components. The report also helps you estimate immediate repair costs and confirm the building will meet safety standards for tenants. Depending on the property’s age and location, a sewer scope, lead-based paint testing (for pre-1978 buildings), asbestos testing, or radon testing may be worth adding. These cost extra upfront and can surface expensive problems that would otherwise become yours after closing.
Insurance Built for Rentals
A standard homeowner’s policy will not cover a property you rent out. Lenders require a landlord policy, often called a dwelling fire policy. Two forms are common:
- DP-1: a basic policy covering the structure at actual cash value (today’s depreciated value), with no coverage for lost rental income if the property becomes uninhabitable.
- DP-3: a broader policy covering the structure at replacement cost and including lost rental income during repairs.
Most lenders require at least a DP-1; a DP-3 gives you materially better protection. If you own several properties, an umbrella policy adds liability coverage in $1 million increments above your underlying landlord policy limits. Insurers typically require minimum liability limits on the underlying policies before writing the umbrella.
Closing
Your lender must deliver the Closing Disclosure at least three business days before closing, a window required by federal law under the Truth in Lending Act.10Consumer Financial Protection Bureau. TILA-RESPA Integrated Disclosure FAQs Use those three days to compare the disclosure against your earlier Loan Estimate; if any numbers moved, ask your lender to explain before you sign.
Closing costs on investment properties generally range from 2% to 5% of the loan amount and cover lender fees, title insurance, recording fees, and prepaid taxes and insurance.11Fannie Mae. Closing Costs Calculator You’ll wire the remaining balance, sign the deed, and the settlement agent records it at the county recorder’s office. That public filing establishes you as the legal owner, and you take possession.
Taxes After You Own It
Rental income is taxable, and you can deduct mortgage interest, property taxes, insurance premiums, repairs, and property management fees against it. Three tax rules deserve attention before you buy.
Depreciation
The IRS lets you deduct a portion of the building’s cost each year over a 27.5-year recovery period, even if the property is appreciating.12Internal Revenue Service. Publication 527 – Residential Rental Property Only the building is depreciable, not the land, and you must use the straight-line method. Depreciation lowers your taxable income now and lowers your cost basis, which raises your taxable gain when you sell.
Passive Activity Loss Rules
Rental real estate is generally passive, so losses ordinarily offset only other passive income, not wages. A special allowance permits up to $25,000 in rental losses against non-passive income if your modified adjusted gross income is $100,000 or less and you actively participate in managing the property.13Internal Revenue Service. Instructions for Form 8582 The allowance phases out between $100,000 and $150,000 of MAGI and disappears above $150,000. Losses you can’t use carry forward.
1031 Like-Kind Exchanges
When you sell an investment property, you can defer capital gains taxes by reinvesting into another investment property through a 1031 exchange. Two deadlines are strict: identify the replacement within 45 days of the sale, and close on it within 180 days or by the due date of that year’s tax return, whichever comes first.14Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment Fix-and-flip properties held primarily for resale don’t qualify. A qualified intermediary must hold the sale proceeds; you cannot take possession of the funds yourself.
Federal Landlord Obligations
Two federal rules apply regardless of where the property is.
The Fair Housing Act prohibits discrimination in advertising, tenant screening, lease terms, and evictions based on race, color, religion, sex, national origin, familial status, or disability.15Office of the Law Revision Counsel. 42 USC 3604 – Discrimination in the Sale or Rental of Housing Many state and local laws add protected categories on top. Violations can bring federal complaints, lawsuits, and significant financial penalties.
If the property was built before 1978, federal law requires you to disclose any known lead-based paint hazards to tenants before they sign a lease, provide the EPA pamphlet “Protect Your Family from Lead in Your Home,” and make existing lead inspection reports available.16Office of the Law Revision Counsel. 42 USC 4852d – Disclosure of Information Concerning Lead Upon Transfer of Residential Property The same disclosures apply when you eventually sell, and a buyer must receive a 10-day window to conduct a lead inspection.
Holding the Property in an LLC
Owning a rental in your personal name means a tenant lawsuit, for an injury on the property for example, can reach your personal savings, other real estate, and other assets. Many investors form a limited liability company to hold each rental, separating the property’s liabilities from personal finances. If someone sues over an incident, the claim targets the LLC’s assets.
An LLC also keeps rental income and expenses separate from your personal books, and ownership can be transferred by assigning membership interests rather than re-deeding the property. One caution: moving a property into an LLC after closing can trigger a due-on-sale clause in your mortgage, so coordinate with the lender first. Some lenders write commercial loans directly to LLCs, which avoids the issue.
The liability shield only holds if you treat the LLC as a real entity. Keep separate bank accounts, file the required state reports, and don’t mix personal and business funds. Courts can pierce the corporate veil when the entity is run as an extension of the owner’s personal finances.
Managing the Property
Self-managing saves money but means handling tenant screening, rent collection, maintenance, and legal compliance yourself. A property management company handles advertising, screening, rent collection, maintenance coordination, and financial reporting; fees for single-family rentals typically run 5% to 12% of monthly rent, and many managers also charge a leasing fee — often one month’s rent — for each new tenant placed. Before signing, get clarity on which services are included, how maintenance is authorized and billed, and how you can terminate the agreement.