In some markets, one property can have up to four dwellings. and still be financed with traditional residential loans. Financing a multi-unit property is similar to taking out a mortgage for a single-family home – either as a primary residence or a rental.
What Is a Multifamily Property?
People often refer to duplexes, triplexes and fourplexes as multifamily properties, but that’s not how the term is typically used in the mortgage industry. Generally, apartment buildings and condo complexes with five or more units are considered multifamily properties. And the commercial loans used to purchase those properties are called multifamily mortgages.
Duplexes, triplexes and fourplexes are known as multiunit properties.
Why Buy a Duplex, Triplex or Fourplex?
Some buyers might look for a multiunit property to share with family or friends. But often, people purchase a multiunit property to start building an investment property portfolio.
“Buyers that are purchasing these types of properties are typically new to real estate investing. And they’re using this as not only a vehicle for investment, but a vehicle for them to live in the property,” says Frank Gallo, senior commercial lending officer at Tropical Financial Credit Union.
If you plan to live in one of the units, you can buy a rental property and finance the purchase as a primary residence, which typically comes with a more favorable rate than an investment property loan. The rental income from the other units can help you qualify for the mortgage.
At the same time, managing a property with tenants entails more responsibilities than looking after a single-family home, so it’s important to do your research before becoming a landlord. In particular, consider the financial risks of tenants failing to pay rent on time or moving out and leaving you with vacancies. You should also be prepared for future increases in taxes and insurance costs on the property.
What to Look for When Buying a Duplex, Triplex or Fourplex
When evaluating a potential rental property, take into account its location, which can affect how easy it is to rent out the units or replace tenants who leave.
“If they lose a tenant, could they easily fill that vacancy with an individual to lease it? And based on the location, the answer to that question could vary. It could take them a week or it could take them six months, and meanwhile they’re stuck with the expenses related to it,” Gallo says.
The risk of theft or damage can also vary by location.
Consider the property’s condition and whether renovations or extensive maintenance will be required. If you have to displace a tenant to complete renovations, the rental could be less profitable. Also look into how much insurance will cost and what kind of maintenance the insurance company stipulates as a condition of coverage.
Check whether current tenants have a history of paying on time and if any of them are charged below-market rent. And find out when current tenants’ leases end. If you plan to get a multiunit mortgage as an owner-occupier, you’ll have to move into your unit within 60 days of closing.
Finally, make sure that the property complies with zoning regulations.
“The rule of thumb is that the number of kitchens on a property match what the city has in terms of it being a two- to three- or four-unit,” says Kevin Leibowitz, president of Grayton Mortgage. “So if you have six kitchens on a property and what looks to be six subdivisions on a four-unit, you’re going to have trouble getting financing because it’s now nonconforming use of space.”
Multiunit Mortgage Programs
You can buy a multiunit property as an investment or to live in as your primary residence. If you plan to live in the property, you can finance the purchase as a primary residence, which offers some advantages. You have access to conventional or government-backed loans with low down payment requirements, you may be eligible for down payment assistance and interest rates are often lower.
However, if you aren’t going to live in one of the units, you’ll need to get an investment property mortgage.
[SEE: Current Jumbo Mortgage Rates]
Financing a Multiunit Property as Your Primary Residence
If you’re going to live in the property, you can qualify for the mortgage based on your income and the projected rental income of the other units. If there are no restrictions, lenders count 75% of the projected rental income from leases in your qualifying income.
“If you are an experienced landlord, then you could use typically the full potential rent of a unit, if you have the ability to show management of rental properties on your tax returns,” Leibowitz says.
If you don’t have landlord or property management experience, however, the lender may not count all of the rental income. Here’s what Fannie Mae’s guidelines allow:
— If you own a primary residence and have at least one year of landlord experience, your qualifying rental income is not restricted.
— If you own a primary residence or have housing expense, but don’t have at least a year of landlord experience, your qualifying income from the property is limited to its principal, interest, taxes, insurance and association dues, or PITIA.
— If you don’t own a primary residence or have housing expense, rental income from the property cannot be used to qualify.
You can prove your landlord experience by submitting a tax return that shows rental income.
Loan limits are higher for multiunit properties than for single-family homes and depend on the number of units.
The following loan programs allow for purchases of multiunit dwellings.
Fannie Mae
Fannie Mae’s eligibility requirements for a 2- to 4-unit primary residence include a down payment of 5% and six months of reserves. Reserves can be met through bank account balances or investments, including vested retirement savings.
Fannie Mae allows a debt-to-income ratio, or DTI, of up to 45%. Minimum credit scores vary depending on the DTI, down payment and number of units. For instance, a credit score as low as 640 is acceptable on a 2-unit purchase with a DTI of 36% or lower and a 25% down payment.
Freddie Mac
Freddie Mac’s multiunit mortgages are designed for borrowers who have low to moderate income or who are purchasing properties in urban or underserved areas.
Income must be no higher than 80% of the median for the property’s location to qualify for a Home Possible mortgage. Like Fannie Mae, Freddie Mac Home Possible loans allow down payments as low as 5% on an owner-occupied 2- to 4-unit property. Two months of reserves are required.
The maximum DTI allowed is 45%, and the minimum credit score is 700.
FHA
FHA loans allow down payments as low as 3.5% if your credit score is at least 580. Credit scores of 500 through 579 are acceptable with a 10% down payment. DTIs of up to 50% are allowed with compensating factors like conservative credit use, substantial reserves and minimal payment shock.
Three months of reserves are required for 3- to 4-unit rental properties. The FHA also requires that 3- to 4-unit properties have self-sustaining cash flow.
“If those current rents are not the same or higher than what your mortgage payment will be, then you can’t go with an FHA loan. So an FHA loan is going to be more restrictive on a three- or four-unit than a conventional loan,” says Becky Conner-McDuffy, senior loan advisor at Penny Lane Financial.
VA
VA loans typically don’t require a down payment. And the VA doesn’t mandate minimum credit scores or DTIs, instead allowing lenders to set their own requirements.
“VA loans are probably the most flexible type of loan, in my opinion. In my career, I’ve just seen the most flexibility and room for underwriter discretion,” Conner-McDuffy says.
Six months of reserves are required, and you may also need landlord experience to use rental income to qualify.
Financing a Multiunit Property With an Investment Property Mortgage
If you’re not going to live in the property, you’ll need to finance it with an investment property mortgage. Expect to put more money down with this mortgage product.
“The big agencies, and I think rightfully so, don’t have a great interest in providing low-down-payment options on investments,” Leibowitz says.
You might consider borrowing through one of the following mortgage programs.
Fannie Mae
A 25% down payment is required, and you need at least six months of reserves. You will need to show a greater amount of reserves if you own other investment properties.
Freddie Mac
You need a 25% down payment, and your DTI cannot exceed 45%. If you own six or fewer properties, you need two months of reserves for each investment property or second home. If you own seven to 10 properties, you need eight months of reserves for each investment property or second home.
Portfolio Loans
Most borrowers choose conforming mortgage programs from Fannie Mae or Freddie Mac, or government-backed loans if they plan to live in the property. But if you want to borrow more than government-backed or conforming loan limits, you’ll need to get a portfolio loan. The requirements for these loans depend on the lender and can vary widely, but they are often more expensive than conforming loans.
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Multifamily Mortgage: How to Buy a Duplex, Triplex or Fourplex originally appeared on usnews.com
