If you ask an experienced real estate investor who owns multiple properties how they got started in real estate, don’t be surprised if the response is they first bought a duplex or a fourplex. The reasoning is that the rental income can offset part or all of the financing costs and associated maintenance. It makes a lot of sense.
When you hear the phrase, “let your tenants pay your mortgage for you” what’s happening is the rent payment is more than sufficient to pay for the costs plus some extra money in your pocket.
But the initial hurdle comes with the first unit. When qualifying to buy and finance a duplex or a 3-4 unit property and it’s your first, the lender won’t use the rental income from the other units to help you qualify. Instead, the lender wants you to have at least two years of ownership, evidenced by your own federal income tax returns. If on your Schedule E of your tax returns for the past two years shows rental activity that’s enough evidence to satisfy the lender. On the next purchase of a duplex or 3-4 unit, the lender can use the rental income. This essentially means the owner is not only living in his property “mortgage free” but also pulling in extra cash as income each and every month.
When lenders calculate the income from the property, they will use the amount that appears on the appraisal report. The appraiser will compare market rents for the area and apply those to the subject property. Or, the lender may use the actual rental income from the property if the rental income can be documented with lease agreements signed by the owner and tenants. The total amount is then reduced by 25% to take into consideration any future vacancies.
Duplex vs. Fourplex Financing
There are some basic differences as they relate to a duplex compared to a 3-4 unit property, but not by much. For example, if the borrower occupies one of the units in a duplex many conventional lenders ask for a down payment of at least 15%. Financing a triplex or fourplex and the minimum down payment is 20-25% of the sales price, depending upon the loan program. Down payments for adjustable rate mortgages may also require more down payment. Note that with a conventional loan with less than a 20% down payment there will still be mortgage insurance required. These loans are those underwritten to guidelines established by Fannie Mae and Freddie Mac.
Further, if you live in one of the attached units the property is also eligible for VA and FHA financing. If VA eligible, there is no down payment required and with an FHA loan the down payment is still 3.5% of the sales price and subject to loan limits for the area. If you don’t intend to live in the property government-backed financing such as VA and FHA cannot be used as they are both reserved for owner occupied homes.
If you don’t intend to live in the property and use conventional financing the down payment requirements for a duplex to a fourplex is 25% of the sales price. These are for conforming conventional loan amounts. The maximum high balance loan limit for a duplex in 2017 is $784,700, $948,500 for a triplex and $1,178,750 for a fourplex.
In general, when financing an owner-occupied multi-unit property lending guidelines will be a bit less stringent compared to a non-owner occupied property. Typically minimum credit scores are higher, there is more down payment required and more cash reserves verified. Cash reserves are defined by the total number of mortgage payments left in a liquid account after closing. The mortgage payment includes the principal and interest portion and a monthly allotment for property taxes, insurance and mortgage insurance where necessary. An investor cash out requirement of 12 months cash reserves is common for most investor loans. If the total house payment, including taxes and insurance is $2,500 per month and the cash reserve requirement is 12 months, the lender would need to verify an additional $30,000 for reserves. This is in addition to the funds needed for a down payment and closing costs.
To verify these funds, lenders will need copies of your most recent bank and investment statements where the funds used to close on the transaction are kept. The deposits appearing on the bank statements should coincide with regular monthly income. Self-employed borrowers will provide both personal as well as business bank statements.
Lenders will also verify your employment and will ask for your most recent pay check stubs covering a 30 day period along with your past two years of W2 forms. For the self-employed borrower, lenders will ask for the most recent two years of federal income tax returns as well as a year-to-date profit and loss statement. Income from year to year should be relatively consistent. Any drop-off from one year to the next that exceeds 20% of the previous year’s business income can indicate potential problems with the business and the lender could turn down the loan application.
Financing a multi-unit property does take a few more steps but in general the loan application is approved in much the same fashion as with any other type of property. The lender reviews income, credit, employment and sufficient funds to close as with most all other loan programs. The primary differences relate to how many attached units there are as well as whether or not the applicant intends to occupy the property as a primary residence or purchases it purely as an investment property, renting out all the units simultaneously.
“Hi Juliann and Chad, I wanted to take a moment and thank you guys for what would have been impossible for us to do without you. We wouldn’t have our keys in hand if it had not been for your help in navigating the financing, and Juliann’s perseverance in getting the rest of the players in the transaction to deliver. Out of everything, our interaction with your office has been a highlight – and your customer service has been beyond everything we’ve experienced in the real estate industry. Is there a way we can provide any reviews, ratings, testimonials, or other statements that can express to your potential future customers how much you guys do to make the customer’s life easy? Please let us know how we can share our great experience with you to the rest of the public. Whether we refinance this under a VA, or get in a bigger/better house in a few years, we’re not going to go anywhere else for financing. We are customers of yours as long as you are in business. Thanks again for getting us in a house!”
I HIGHLY recommend Chad and his team.
Chad and The Chad Baker team really helped me from start to finish with my loan process. They were extremely responsive and provided me updates on a daily basis. I had a few personal issues that they helped me work through so I could get the best loan program and best rate. Very knowledgeable about the industry, rates and trends.I HIGHLY recommend Chad and his team. I’m happy to offer a reference upon request. Please ask Chad for my contact information.”
When looking for a house, we had couple recommendations for a lender. After talking with all the lenders, many were difficult to work with and couldn’t get it done as quickly as we needed. I was referred to Chad Baker’s team and I am glad we did. Not only did they get the things done quickly for us, they were very easily to get ahold of. It wasn’t rare to get a response within 15 minutes whenever an email was sent. I could not express how friendly and outgoing this team is. And on top of that, they came back with the best offer for us amongst all the other brokers. I am glad I worked with these guys. If you are looking for a lender…MAKE SURE TO CALL CHAD BAKER AND TEAM!!! Thanks Chad for all your hard work. Next time we buy another house I am calling you first!