Recently, I was having lunch with my friends Rob Novak (fellow Loan Officer) and Andrew Norman from ING. It was one of those lunches where topics moved left to right without filters or agenda. While sharing ideas and opinions of the current marketplace, the topic of first time home buyers was mentioned. At that moment, I told Andrew, “By the way, if any of your clients have children who are looking to buy their first home and would like to get more for their money, tell them to buy a multi-family.”
From that statement, we started to discuss all the benefits of why a first time home buyer should buy a multi-family. Within a 2 minutes of talking about this, I wondered “Why didn’t I think of this earlier?!” FHA has always allowed buyers to use FHA financing to buy a multi-family as their primary residence.
The basic concept is simple. The buyer buys a duplex, triplex or four-plex with the same 3.5% down payment requirement as a house. They rent out the other units and cover the difference from the mortgage payment as their share. If the homeowner decides many years later that living in a multi-family doesn’t fit their lifestyle, they either sell the property or move out and rent the unit they were living in.
I always ask my buyers, “How long do you see yourself in this home? What do you plan on doing when you move out?” Almost all of my first time home buyers do not see themselves in their first home forever. With home prices and mortgage rates so low, many of them plan on renting the home when they’re ready to buy their next place.
Statistically multi-family properties have a much better CAP Rate (capitalization rate), which is a fancy term for how profitable a rental property is compared to the price you pay for it. If these buyers don’t plan on keeping the property anyways, why not buy a property that will make more money?
Here are some bullet points:
- The down payment required is the same as a Single Family Residence (house), which is 3.5%. On 3-unit and 4-unit purchases, you must calcualte the maximum loan amount by making sure the property rent rates can sustain the mortgage payments if the owner moves out (see more details below)
- FHA loan limits for multi-family are higher than for standard 1-unit homes
- Rates are the same as a FHA loan for a Single Family Residence
Let me paint a perfect picture. Let’s suppose a young college student, Johnny, is considering buying his first home. Johnny’s parents want to co-sign for the purchase. Johnny knows he can’t afford a house by himself, so he looks at condos and townhomes for sale.
However, Johnny can’t commit to buying anything because he doesn’t want to live there forever. His very smart real estate agent (hint, hint) tells him to make sure he buys a FHA warrantable condo and that his association will likely have restrictions if he chooses to rent the condo out in the future (see related blog).
Johnny’s parents suggest looking at a multi-family. Johnny finds a great four-plex by his school. The price is much more, but after doing some research Johnny calculates he’ll be paying less than any of the condos he’s looked at due to the rental income he’ll get from the other 3 units. If and when Johnny graduates from school, he knows he can either put the four-plex up for sale or rent out the last unit he previously occupied, making even more money than he did when he lived there.
When purchasing a three-unit (triplex) or four-unit (fourplex), the maximum loan amount is calculated by both the maximum amount set by HUD AND the max loan amount where the payment doesn’t exceed the estimated rental income for all units combined. The appraiser is required to do a rent-schedule on the appraisal to determine the average market rent rates for each unit and the average vacancy.
Here is an example:
Let’s suppose you have a four-plex where the rent schedule shows each unit should demand $1,000 a month. The average vacancy rate is 10%, which means we should expect the $1,000 a month per unit 90% of the time.
four units * $1,000 a month = $4,000
$4,000 * 90% occupancy rate =$3,600 estimated rental income for all units
In this scenario, the mortgage payment including all housing expenses (Mortgage payment with taxes, insurance, mortgage insurance and HOA dues) must be at $3,600 a month or less. .
Sounds great, right? Of course, you’ll want to prepare properly before diving in. Being a landlord is a job. Here are a few pointers for the novice landlord:
- Find out the market rent for your area and charge that amount. Renters who are willing to pay way above the market price should be a red flag. That’s often a sign of bad rental history. However, you also want to make sure you don’t leave money on the table.
- Do credit and background checks on your tenants. You can easily setup an account with a company like Kroll Factual Data that will collect a renter’s background and credit for a small cost. You can even setup the account so these reports can be charged to a credit card, which the renters can pay.
- Keep a slush fund for rainy days. You’re probably going to save a lot of money for your living costs by buying a multi-family. Try to save most of it to cover the cost of unexpected repairs.
- Learn the laws and steps to evict clients. Hopefully you’ll never need this, but if you do have a renter that has to go, you should know how to do it.
- Be properly insured. Remember, every renter can sue. Having the proper amount of coverage is vital to protecting your assets.
Sounds like too much work? You can always hire a property management company to do most of the chores listed above. They take a share of your profit and handle your service and maintenance duties including collecting rent payments and maintenance calls in case one of your renters toilet breaks or they have a leaky faucet.
Update 12-21-2009
I just read about some obscure facts about the current home buyer tax credit that is set to expire on April 30th, 2010 which includes multi-family purchases.
A home buyer is to use 10% of the purchase price at a maximum of $8,000 for first-time-home buyers and $6,500 for move-up buyers to determine the buyer’s tax credit. For buyers of 2-4 unit multi-family, they are to use 10% of the unit they own.
For example, if a first-time-home-buyer buys a 4-plex, they would need to spend at least $320,000 to get the $8,000 credit. Here is the formula:
$320,000/ 4= $80,000
$80,000 x 10%= $8,000
You can learn more about this and other tax credit facts at the link posted HERE.
Can you provide more information on this?
Rick,
If you want to use FHA for financing a multi-family, you’re limited to 1-4 properties, it must be owner occupied and all other FHA guidelines apply. This means you must fit within FHA’s credit, income and down payment requirements which isn’t too hard.
There is a stipulation though. FHA will NOT give a loan to a multi-family that will not at least cash-flow positive at a 90% occupancy rate if all units were rented. What this means is they want the rent schedule for the property to be enough to service the loan in case the homeowner were to move out and rent all the units. Pretty smart on their part. It forces the buyers who are looking for a multi-family 2-4 unit to only look at cash-flowing properties.
If the property does not cash-flow, you must put more than the 3.5% FHA required down payment so you get to the point it does cash-flow to their standards.
The key to the blog I wrote is a parent can co-sign for their children who want to live in a mulit-family. Instead of a college kid buying a condo, the parents co-sign for a 4-plex. They can rent out the other 3 units and their child can occupy one of the units. FHA allows this.
Hi, gr8 post thanks for posting. Information is useful!
No problem! Let me know if you have any questions.
Does the down payment have to be 10% on a 4 unit multi-family instead of the traditional 3.5% ? It would be owner occupied and the rent roll would cover the mortgage.
You can put 3.5% down if the rent roll will cover all the units.
The key is to make sure that the rent schedule for ALL the units can cover the mortgage payment with a 90% occupancy factor (check your local lender for their guidelines as some have a lower occupancy rate).
For example, if your mortgage payment is $2,700 for a triplex and the rental income of all the units IF you moved out of the unit you lived in was $3,000, you would multiply the rent income by 90%. In this scenario, the figure you would get would be just enough to cover the mortgage, so you can put 3.5% down. If it is not, you need to put enough money down so the mortgage payment does fit the requirements above.
Hello,
I am purchasing a multifamily property in Brooklyn, NY. The purchase price is approx $4,000,000. The cap rate is 8% and the property is 100% occupied.
I am Canadian Citizen and my credit is excellent.
Is it possible for me to qualify for FHA loan? What is the minimum down payment I require. Can I purchase with 3.5% or will I need higher down payment?
Please let me know.
Thanks.
Ameek,
It was good talking to you today. As we talked about, FHA is only for the purpose of a primary residence. I’ll forward you the info you requested later.
Keane
One tip, the occupancy rate to determine how much of the rental income you can use and to cover the mortgage payment can range. Some lenders will only count 75% of the rental income of the other units.
To be clear, FHA considers a multi-family a 2-4 unit residential property. They must be zoned as a duplex, triplex or fourplex.
Hi Keane,
Excellent article at the right time. I have been searching the internet on more information about buying a multiunit with an FHA and you hit the bulls-eye!
Thank you so much!
Jaime
Jaime,
I’m glad it was helpful. I wish more people would do this including when I bought my first home.
Keane
Hello, I was looking to buy a bank owned multifamily home, the asking price is 24,000.00 but the property needs repair, It is 5 units, but we plan to make it into 3 units. Is FHA still available for rehab work or do the standard FHA rules apply. Let me know. Thanks
Thanks for the question. Your scenario is similar to another someone recently asked me. If you get a full-blown 203k rehab loan, you MAY be able to do this as long as you already have the permits in place to show it will be zoned as a triplex once the work is finished. You may have a problem finding a lender to do this but it should be within the capacity of FHA if the lender wants to do it. If you can get it rezoned before you apply for the rehab loan, it would be much easier.
Keane
Keane,
Great blog.
You said that “FHA will NOT give a loan to a multi-family that will not at least cash-flow positive at a 90% occupancy rate if all units were rented.”
Q: What is the basis? PITI? PITI plus expenses & HOA? M&I?
You said “If the homeowner decides many years later that living in a multi-family doesn’t fit their lifestyle, they either sell the property or move out and rent the unit they were living in.”
Q: What is the time frame? If we buy a mutiplex and live in one of the units for 6 mos, if we then decide to move to another home is the loan still ok?
You said, “If you want to use FHA for financing a multi-family, you’re limited to 1-4 properties…”
Q: What we already have four properties (three rentals SFDs)? Can we still qualify for a FHA loan on a fourplex?
We are interested in this foreplex which which at 75% of current rents and assuming 3.5% down and a 30yr FRM@5% would cover 96% of mortgage & interest.
Thanks for your sage advice,
Nik
Nik,
All great questions.
There isn’t a specific timeline to you need to live in the property before you can move out but the intent must be to buy and occupy as an owner without the future intention of moving out. Sure, life has it’s ways of changing, but you shouldn’t have a plan to move out at the time of your purchase. If you learn of a life changing event that requires you to move out 2 months after closing, you can move out. Just remember that FHA loans are Federally backed home loans and the liability for fraud is a huge fine and time in jail. If your transaction is legit and are just worried that life may throw you a curve ball, just keep documentation of the events. If you’re relocated for work and have to move out, documentation of the relocation would easily protect you from any audits.
The rental income must cover the entire mortgage payment including taxes, hazard insurance and mortgage insurance (PITI). If 75% of the rental income is 96% of the full payment, you’ll have to put more down to reach 100% of the payment OR buy-down your rate so 75% of the rental income on all units would cover the entire mortgage payment.
The reference regarding how many properties you can have financed is a Fannie Mae and Freddie Mac guideline for conventional loans. If you own many other properties, the FHA lender may have a hard time believing your intent for buying is solely to use as an owner-occupied home. Especially if your other homes are single-family units. If you have a good reason for owning a 4-plex, such as having a large family and needing at least 2 units for yourself, that may be more believable.
You can buy up to a 4-plex on FHA. Anything larger is considered commercial.
-Keane
Oh…Keane?
State in question is Idaho, where all four props are currently.
Nik
Keane,
Thank you so much. Really interesting to crunch the numbers. My idea for the property in question went to requiring a hefty 34% downpayment to meet the 75% of rent figure. Either that or the purchase has to drop from $320K to $256K to get to a 20% down.
It really sobered me up!
THanks! I’ll keep your blog bookmarked!
Nik
Keane,
Great blog. It has answered many of my questions that I have had for a long time.
I know there are regulations that the 4-plex has to meet as far as the building requirements. What are all of the building regulations for a 4-plex to qualify? For example I was looking at two duplexes that were on the same tax id number which means it is a 4-plex. It would qualify because they were two building on the same tax id.
I’m interested in having my parents cosign with me. I have good credit and enough savings for a down payment plus enough to cover the mortgage for at least a few years. I lack a constant steady income, will the loan be based off of my income more or my parents? My parents have a much more steady income than I do.
Thanks for your help.
Jordan
Jordan,
The legal description of the dual- duplex property will need to be looked at, but you will likely be fine. FHA allows non-occupying co-borrowers to co-sign for both credit and income, so the underwriter will review your income AND your parents income to qualify.
-Keane
Thank you for publishing this blog. It is difficult to find this kind of quality information.
Here is my situation. I am looking at a fourplex, which is 3 1br/1ba and an efficiency. 2 of the 1br/1ba are rented at a rate of $575 a month each. I plan to rent the other at the same rate, and live in the efficiency. With 3.5% down on a 30 year fixed at 5%, im looking at a monthly cost of $1300. Does this meet the requirements of an FHA? the $8,000 credit? My credit is not very good, i started a new job about a month ago, but my parents will cosign. Do they look more heavily at the cash flow of the property than my personal finances? Is this going to work for me, or am i looking at going with hard money and 20% down?
Hi, can I buy 2-4 units residential multifamily properties with FHA with out living in one of the units myself?
Will the down payment change, since I don’t live in it?
How many loans can I have thru FHA?
KH,
FHA is only designed for owner-occupancy, but if you do live in a unit for a couple of years and choose to rent a years later, that is okay. You must be occupying the property and intend for the property to be your home at the time you’re acquiring it. You will not be asked to live in the home for the rest of your life.
However, to be very clear, you must buy and occupy the property at closing. Many buyers, regardless of the type of property, are choosing to buy their first home because they know they’ll build equity. Many buyers know they’ll eventually sell and buy another home, so if you have similar plans with a multi-family, you can do so.
Keane
Would a property with two separate houses on the same lot being sold together count as a multi-family property?
Bethany,
It depends. You can have a separate house and still be zoned as a “Single Family Residence”. This is typical when you have a property with a small house that is basically a “mother-in-law” home or apartment if it’s attached. These are also called “Accessory Dwelling Units” or “ADU” in some areas.
If it is not a legal mother-in-law or “ADU”, you may have to purchase it under a 2-unit/duplex guidelines.
How quickly after closing on a two family with FHA do you have to occupy 1 of the units? Both of the units at the property I am interested in have tenants in them and leases in place until the end of August. Once the lease expires in one of the units I plan on moving in.
Thank you for all the helpful information.
Here’s my situation. My husband and I are applying for a FHA 203K loan on a two family in NYC. Our original plan was to duplex two floors and rent out the third. But we realized we cannot qualify for the loan w/o a bit more income from a co-signer. We then learned that co-signers must also occupy the property. My father, who is local, and currently separated, agreed to co-sign, and live in the second unit for a time to help us out. The thing is, he doesn’t want to do this forever. We don’t want to commit occupancy fraud, but we all really want this house. How long to you think my father in law will need to live there in order not to raise red flags? If we get audited, and he says that he decided to move out, will he get fined or go to jail if the reason was voluntary and not a job move? Will he need to have all of his bills changed to the new address to make sure we leave a good paper trail? Seems these fraud laws are there to protect the homes from investors – we aren’t investors, we plan to rehab this home and raise our kids there. But I don’t want to do anything unethical or illegal. Seems we are in a gray zone.
Mark,
Your situation may seem slightly grey, but there is a very specific white/black question that needs to be answered. Is your father’s intentions to own and occupy the home with you now? That’s it. Many homeowners do not plan on owning and occupying a property forever. In fact, FHA REQUIRES that we prove a 3-4 unit property can sustain itself without the owner living there KNOWING the owner is likely to move out and rent out all the units later on. If his intentions are true, you’re fine.
If he lives there and understands he’s an owner and must occupy the property, then it’s not fraud. If he’s already found his next home and is doing this just to help you qualify, then it is fraud. That simple.
The questions related to proof, they should all reflect the new address but that’s natural. If he has reservations about changing those items, then there’s a good chance his real intentions are not to live there.
Is this home legally a duplex now or is it a single-family with a mother-in-law?
The truth, if it’s a true duplex and your father is NOT planning on living there, you may not have a choice to have him live there. You can count the rental income of a duplex 2nd unit, which may be enough to qualify without using his income. If it is not a legal duplex and just a single-family residence with a mother-in-law apartment, then it’s legally a 1-unit property and your father can co-sign as a non-occupying co-borrower. Either way, it sounds like that may be your solution. Let me break it down simply:
PROPERTY IS A LEGAL DUPLEX:
- You can count the rental income of the 2nd unit not occupied by the buyer
- Must be rented to a non-interested party (cannot rent that unit to your father)
This means that if you rent the 2nd unit, you can count that rental income to qualify. This may be enough to fix your problem. If your father really needs a place to stay, he can live in the unit you occupy only
PROPERTY IS A LEGAL SFR WITH A MOTHER-IN-LAW (OR ACCESSORY DWELLING UNIT)
- This is treated as a single unit
- Rental income of the 2nd unit cannot be used to qualify
- Since it’s a 1-unit property, you CAN have a non-occupying co-borrower, which means your father can co-sign without occupying the home
You can’t be double-dinged. It’s either treated as a duplex and you can use rental income of the 2nd unit or it’s a 1-unit with a mother-in-law apartment and you can have a co-signor that isn’t committed to occupying the home.
My wife and I are looking to move to the other side of town. We recently purchased a home 6 months ago when the market was down. Since then the market has gone back up and we are looking to sell our home with a 20,000 profit. I had heard that if you don’t live in a home for over two years there are some huge taxes that are taken out of your home sale. Does that apply if the money is used to buy a new home?
Question #2
The new home we are looking to buy has a MIL apartment. Can we could 90% of the rent for the apartment when we go to purchase the home?
Scott,
You’ll have to ask your first question to your tax consultant.
As for using rental income to qualify, the property must be zoned as a residential 4-unit or less property to use for FHA. If it is, you can use all the rental income for the rented units x the occupancy rate. For instance, if the vacancy rate is 10%, then you would multiply the rents received by the rented units by 90%. The vacancy rate is determined by the FHA appraiser.
Keane
I will be a first time home owner and am currently pursuing a 4plex building using the FHA loan program and the 90% occupancy rate rental income to qualify. While talking with a local mortgage rep, it was stated that I would not be eligible to use the rental income to qualify for the loan since I do not have a history of being a landlord. Is this correct?
Also the 4plex building is currently owned by one individual and rented out to 3 tenants with one unit owner occupied. The property is being sold as a “whole” but is taxed as 4 condo units. Does this property still qualify as a multifamily in terms of the FHA loan programs? Thank you in advance for your help.
Nate,
The lender you’re working with may want you to have a history of being a landlord, but that’s not a FHA guideline, so if this is a deal killer, you can search for a lender who doesn’t require this. This IS a requirement for VA purchases on multi-family to count rental income.
As for the property type, that’s tougher. FHA has very special guidelines for lending on condos. Your lender will have to contact HUD to see if this is allowable.
I am working on purchasing the triplex I have lived in for seven years from my landlord. As a first-time home buyer,I want to use an FHA loan to do this. I will still occupy the larger unit, but continue to rent the other two which are smaller.
The lender I have been working with told me today that he didn’t realize this was a triplex, but thought it was a duplex, and it is going to be very difficult to purchase a triplex through FHA.
He stated that the FHA appraiser will use the comparable rents for the area to determine the rental amount on the other two units and that if that amount goes over the mortgage amount I can’t use an FHA loan. He could not tell me how the FHA appraiser will determine the comparable rental amounts
This triplex is in a slightly depressed area, but it does share a zip code with some expensive homes. I have looked up HUD FMR information and the rental amounts they provide for a 2 bedroom unit in this county are several hundred dollars more a month than I could ever rent these units for.
Is he correct and could this affect my ability to get an FHA loan?
Mark,
There are more guidelines to follow on buying a triplex/fourplex vs. a fourplex but not impossible.
The appraiser will determine the market rent rates for ALL the units including the one you live in. The rent for all 3 units multiplied by the occupancy rate must be equal or greater to than the mortgage payment, not the other two units, so he’s partially correct but not completely correct.
However, all that still doesn’t state whether or not you can get a FHA loan. Even if the mortgage was greater than the rent for all 3 units, you can counter that by getting the payment smaller by either taking a lower rate loan product like a FHA 5/1 ARM or you can put more money down.
Thanks Keane. That makes me feel some better, but let me clarify a bit.
This is Florida if that has any bearing on my situation.
The lender is under the impression that if the total rental rates determined by the appraiser go over the mortgage amount I could not qualify for an FHA loan because a person is not allowed to generate income from rental property that is greater than the mortgage payment on the FHA loan that financed it.
If I am approved and am only receiving income from the other two units, I will NOT have a positive cash flow from the rentals.
Mark,
This is the guidelines for FHA regardless of the state. You do not need positive cash flow from the other two units. You only need enough rental income multipled by the occupancy rate for ALL units to cover the mortgage payment. This is because FHA wants to make sure that the property can easily be sustained if you chose to move out and rent the unit you’re living in.
Hi Keane,
We’re first time buyers who would like to purchase the house we’re currently renting in (we are one of three tenants). The home is, according to the building card, classified as a “Residential – Four to Six Family Units”, however it currently holds 3 units. How is this house classified as, from a FHA point of view (i.e. as a 3 unit house or as a 4-6 unit house)?
Thanks!
Best regards
Louise
Louise,
Is the property zoned residential or commercial? If it’s residential and the FHA appraiser states it’s a triplex, it would be treated as such. You can always pay a small fee to a local FHA appraiser to ask them to evaluate the property and see how they would classify the property.
Hi,
first of all, thank you for your post. It was very helpful in answering a lot of questions I had. However, I’m having trouble finding more information about this program anywhere else on the internet or the fha website. Is it possible to provide some links to those resources.
I’m a first time buyer and I’m looking to purchase a triple family home, occupy one of the units and rent out the other ones. I have a good credit and no significant debt. The buildings in the area that I’m interested in, are priced in $400k range and the typical rent is between $1200-$1500 My yearly income is $65k Does this seem like a plausible scenario to qualify for this program?
Will FHA use what the renters are accuatly paying today (ie: long tern tennent where the current land lord has not raised rents to keep up with market demand) or what the market rent will demand if I put in new tennents. Also, concerning appraisals. Does FHA have a typical multiplier effect for appraising based on rent? Example: 1000 monthly x 100 = $100,000 and will they use market demand on this or real rent roll as above? Thanks for answering all these questions above-very usefull information.