Mortgages on Single-Family Rentals vs. Multi-Family Rentals
If you're planning to invest in rental property, you have the option of a single-family rental or multi-family units. Obtaining a mortgage will have similarities and differences, depending on which path you choose, and it's important to understand those differences before commencing to make the loan process as straightforward as possible.
The Differences in Multi-Family Rentals
A single-family residence is a property that houses only one family; for example, a detached house is a single-family property. Multi-family properties are more complicated, and for financing purposes, they are broken down into residential and commercial properties. If you have four or fewer units in your property, you should know it's considered a residential property; this includes a duplex or triplex. More than four units in one property is deemed to be a commercial property, and apartments and condominiums are included in this category.
Financing for Residential Multi-Family Properties
Financing a property with four or fewer units is considered a residential loan, and it operates much the same as a single-family property purchased for a rental unit. If you plan to live in one of the units and rent out the others, you can apply for an FHA loan. You'll likely have a large cash reserve requirement and may be limited to how much of the rental income can be included in the income qualification. The benefit of this loan is a lower down payment with only 3.5 percent required.
If you don't plan to live in any of the units, you'll need to seek out a conventional residential loan; regardless of whether you want to purchase a single-family property or multi-family home, you have a limit of 10 for Fannie Mae. Of course, many lenders impose even stricter regulations, often capping out a four. Whether you have four single-family dwellings or four multi-family properties, your restriction would be the same, but the income received would be quite different.
Your credit score is a significant factor when purchasing rental properties, just as if you were buying your own personal residence. However, the requirements become even stricter when you are purchasing more properties; the first four loans require you to have a credit score of 630, while any loans over that amount will only be approved with a credit score of at least 720.
The requirements for down payments go up with a higher number loans, especially if they're multi-family dwellings. For loans above four with Fannie Mae on single-family properties, you'll need 25 percent down, while the first four loans only require 20 percent down. Multi-family property loans require at least 25 percent for all, and many lenders set even higher terms.
Commercial Multi-Family Property Loans
If you plan to purchase a property with five or more units, you'll need to apply for a commercial loan. This type of loan has a different set of requirements, often requiring the borrower to have some experience in property management. They'll also have to provide a copy of the rent roll along with their own personal income information and business tax returns.
Lenders will look at the net operating income and how much cash flow the property has in relation to its debt, and the borrower will be required to have at least 25-30 percent for the down payment. Multiple loan products are available, just as with residential loans, and they may be long-term or short-term with five to 10-year terms. The interest rates may be either fixed or variable, or they may start out fixed for a specific term and then adjust at the end of the period. In general, commercial loans are more expensive than residential loans, but they are also usually allotted for a higher amount with many loans originating for several millions of dollars.
Most property owners who choose a commercial loan will purchase the building as an LLC or limited liability corporation, which limits the liability on the owner or owners, providing them some protection of their own personal assets. They will need to provide a lot more documentation than on residential loans, and they may be requested to include photos of the property, the description, floor plans, listing of current rents and expectations for raising or lowering them, and even information about competing properties within the vicinity. If the owner has plans to upgrade the property, this intent will also need to be included along with the costs for these changes.
Most beginning landlords will apply for a residential loan until they have proven experience in the business. The key for any loan on an income property is to find a lender who is experienced in investment properties, which helps ensure a smoother process. Anyone who plans to enter the rental property industry should consider long-term goals, whether they want to tie up their loans in single-family properties and limit their income or purchase multi-family residences.
No matter what type of rental property you intend to purchase, you should find an experienced lender to guide you through the process and work with a real estate agent who has experience in this area. Rely on their expertise, and do your own research to be prepared, since this will eliminate much of the hassle and ensure the end result is you becoming the owner of your own rental properties.
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