Financing Your First Multi Unit Property?

Are you interested in buying a 2-4 unit property either as an investment property or primary residence? The process to purchase the home is similar to buying a single family home but there are some differences in the mortgage loan requirements. If you are considering purchasing a property, speak to a lender early.  This conversation will let you know where you stand as far as qualifying for a loan and the amount of financing that you can receive. If you are purchasing a building with 5+ units or a mixed use property, you will need to speak to a commercial lender.


Who’s Going to Live in the Home?

Financing a multifamily home has different considerations depending upon who will occupy the home. If this will be a family building, financing with an FHA loan is similar to the purchase of a single family home. The down payment, credit score and debt to income requirements are the same. The FHA down payment is a minimum 3.5% of purchase price and the credit score starts at 580 (620 for some lenders). The debt to income requirement for FHA is 45% up to 50% possibly depending upon individual situation.

If you are purchasing as an investment property, financing is different depending upon if you plan to occupy one of the units or use the building strictly as a rental property. If you buy and plan to occupy one or more of the units and rent the remaining, an FHA loan remains the same as a family building. This is also true for a VA loan. A conventional loan will require a 15% down payment for an owner-occupied 2 unit. The down payment for 3-4 units is 25%.

Some good news is that if you are purchasing as an owner occupant, you may be able to take advantage of down payment assistance. Ask your lender about using the IHDA down payment assistance program. This can provide up to $7,500 towards down payment and closing costs.

If you are not occupying the building, you cannot use FHA or VA financing. Many investors will use a conventional loan when purchasing a rental property. If you are looking to purchase as a rental property, the down payment for a 2-4 unit is 25%.  You may also consider a portfolio loan for your purchase.  These are loans are held by the lender and may have different qualifying requirements than a traditional conventional loan.


Cash Flow of Building

 As a potential landlord, your consideration for a rental property should include some analysis of projected cash flow. Cash flow is calculated as Net Rental Income – Expenses – Debt Service (Mortgage Payment). This is important information for you to know as you assess whether any property is right for you.

Your lender will also do an analysis of expected cash flow for the units you plan to rent. The lender will analyze expected rental income based on market rental rates for the neighborhood and number of bedrooms.  This rental income will be part of the lender’s projected cash flow for the property and will be a qualifying factor for approval of your loan.  The good news is that this rental income will also be used in your debt to income calculation. For FHA loans, they will use 75% of rental income as part of debt to income.  For conventional, 70% of rental income will be used.


Determining Rental Income

In determining your rental income, there are a couple of sources for this information. Your realtor can help by pulling rental income from similar properties in the neighborhood. You want to make sure that you factor in square footage for the unit, number of bedrooms and total room count. Not all units available for renting are listed in the MLS so you may want to use other sources for this information also. Online, you can use sources such as, Craigslist and Zillow Rentals to see rental rates for other units in the immediate area. There is also a tool, which is good for information.

You may purchase the properties with existing tenants. While this is excellent for instant cash flow, some long term tenants may be paying below market level rents. You’ll need to determine how to handle this.  The current owner should be able to let you know the tenant’s past rental history. As you move new tenants in or make improvements to the property, you may be able to increase the amount of rent collected. Keep in mind, you will have to honor any existing leases.

Some investors will plan for Section 8 renters. Make sure you find out what Section 8 rent will be for the unit. Keep in mind that Section 8 has a process and requirements for inspecting the property and approving the tenants.  This may add some time upfront for approval before you can start leases with these potential tenants. Factor that in to your analysis.


Repairs / Improvements Needed

Often, purchasing a 2 to 4 unit will require repairs or improvements to be made. FHA and VA property standards remain for multi-unit properties. There may also be deferred maintenance on the property as well as updates diy remodel.jpe needed. If using an FHA loan, you can add a 203K loan for the renovations or repairs needed. The 203K loan is paired with the purchase loan and will only require 3.5% down payment.  This is a great option for owner occupied buildings. Of course, cash is good too.

If you are purchasing as a straight rental property, you can also use a rehab loan.  The down payment for investor rehab loans is usually 25%.  It is a good idea to investigate the different options available for investor rehab loans.

Realtor note here – Listed sales prices for these properties often reflect property condition. Don’t skip on the home inspection when buying your multi-unit property. You will also want a contractor to give an estimate of expected renovation costs during the home inspection period. Doing during the inspection period will allow you to get back your earnest money and withdraw from the deal if these projected costs are significantly higher than you expected. The costs to repair can potentially kill your future profitability or available funds so know your numbers.  A good contractor should be part of your investment team.


Cash Reserves

The lender may require a certain amount of cash reserves to be in place for approval of the loan. Be sure that you understand upfront if this will be required. This amount would be in addition to the down payment.


Closing costs

Closing costs for buyers include such expenses as attorney and appraisal fees, loan fees, title costs, property tax and insurance escrow. Expect this to be about 2-3% of the purchase price.  If buying as an owner occupant, this can often be included in the negotiation with the seller but that is not guaranteed, of course.


Debt levels

Lenders require that your debt levels be limited to a certain percentage of your income. Lenders determine Total Revolving Debt (credit cards, loans, other mortgages) plus the Principal, Interest, Taxes and Interest (PITI) for the property being purchased. This debt is calculated as a percentage of your monthly gross income. As mentioned above, the lender will also consider a significant portion of rental income in this calculation. Debt to income should be between 45-50% depending upon the loan requirements.  The lender may also consider other compensating factors such as cash reserves, past investor history and other assets.

The above is primarily targeted to small investors who may be purchasing their first investment property. Seasoned investors who may have multiple properties might consider other sources of financing for their purchase.  As mentioned before, it is best to meet with a lender early in the process.  In addition to assessing your qualifications, a lender will give you a dollar amount of how much you can expect to get.

On top of whatever you are told by your lender, you also need to look at your individual obligations.  You also need to factor in tuition payments, child care costs, retirement savings, emergency savings and any other obligation that determines how much you can afford to pay for a mortgage.  Make sure that a short-term vacancy or eviction won’t wreck your finances.

If you are considering this rental property to help meet your goals for retirement savings or income or other needs, pay attention to the cash flow.  Make sure that there is enough margin to help you get to your goal.  Investing in real estate is definitely a viable option for helping you reach your financial goals if managed right and determined to be profitable.


Millie C. Lumpkin, Broker