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Mortgage for multi family properties

Aerial photo of houses

Real estate as an investment is quite popular. You’ll often hear friends, family and colleagues rave about it.

It’s a great way to generate passive income and create wealth over time. You can read the pros and cons of buying investment properties in great depth in our article here 

While the aforementioned article talks more generally about real estate investing, this particular article specifically covers topics related to multi-family properties.

The reason we decided to write a separate article for multi-unit properties is that the characteristics and the mortgage process for those exhibit quite a few differences when compared to single-unit properties. As a result, for buyers who are specifically interested in multi-unit properties, we felt it’ll be quite useful to cover that topic in greater detail.

The goal is to inform prospective buyers about the nuances of buying multi-family properties and what to keep in mind when buying one. While that is one of the motives, a broader focus will be on the financing and the mortgage process related to such properties.

So let’s straight get to it.

What is a multi-family property?

A multi-family property, as the name suggests, is a property that has multiple units. 

It could be as small as a duplex (a two-unit property) to as big as an apartment building (with a dozen or more apartments).

No matter what the size, they all fall under the class of multi-family properties because they can accommodate multiple families at the same time.

Types of loans for multi-family properties 

As far as financing of multi-family properties goes, there are two primary kinds: Residential and Commercial

Residential Mortgage Loans

When a property is 1 to 4 units, it classifies as a residential property. 

The biggest advantage of being classified as a residential property is that the loans for those enjoy the lower rates that are very similar to any other residential property such as single family homes, townhomes and condominiums.

Not only that. They offer an additional advantage. Because conforming loan limits for multi-family properties are higher, one can get a loan for a higher amount than a corresponding one-unit property.

Commercial Mortgage Loans

Multi-family properties with more than 4 units are classified as commercial property. 

Rates for commercial mortgages tend to be higher. Because such loans are not backed by Fannie Mae and Freddie mac, lenders for such loans are far fewer in number. This market is mostly served by private lenders and commercial banks.

Why do people buy multi-family properties?

Buyers of multi-family properties can have very different objectives in mind. For that reason, a multi-family property caters to a variety of people.

Although the objectives can be different from person-to-person, based on those objectives, we can broadly classify the multi-family properties into two categories:

Owner-occupied properties

Owner-occupied properties are those properties where the buyer occupies one of the units as a primary residence. The remaining units in the property are rented out by the owner. 

The advantages of owning such a property are:

Lower effective mortgage payment

By renting out the other units, the rent received from those can be used by the borrower to cover a part of the mortgage payment. That effectively lowers one’s own contribution to the monthly payment. For a one-unit property, on the other hand, the buyer has to cover the full monthly payment.

Eligible for Conventional, FHA and VA Loans

For owner-occupied 1-4 unit properties, the owner is eligible to get for all three types: Conventional, FHA and VA

Higher loan limits

Loan limits for 2-4 unit properties are typically higher than those for one-unit properties. It allows the buyer to make a bigger investment.

Lower rates (compared to investment properties)

Rates for 2-4 unit properties where one unit is occupied by the borrower are typically lower than the ones that are purely investment properties.

Investment properties

The other main purpose of buying a multi-family property is as an investment. The big difference is that the owner does not occupy any of the units. Instead, all the units are rented out

The few major differences (when compared to owner-occupied properties) are:

Ineligible for FHA and VA Loans

For 2-4 unit multi-family properties, the owner is not eligible for an FHA and a VA loan. The only loan they are eligible to get is the conventional loans

Higher down payments

The maximum LTV (Loan-To-Value) ratio for a multi-family property used for investment purposes typically tends to be lower.

What that means is that the borrower has to make a higher percentage down payment for multi-family investment properties (compared to owner-occupied).

This of course depends on whether the loan is a purchase, refinance or a cash-out refinance. But for most cases, the required down payment is higher.

Reserves requirements

For 1-4 unit multi-family homes classified as investment properties, the borrower is required to hold more in reserves.

This is primarily because all units are meant to be rented out. If there is a vacancy in one or more units, the borrower is more susceptible to missing a monthly payment.

For that reason, Fannie Mae and Freddie Mac have stricter requirements on reserves.

Higher rates (compared to owner-occupied properties) Rates are higher for multi-family homes that are classified as investment properties.

Maximum Loan amount for Multi-family properties

Multi-family properties that have 1 to 4 units are eligible for a residential mortgage backed by Fannie Mae (or Freddie Mac). Because these loans typically offer lower rates than commercial mortgages, there is a maximum loan amount that applies for each of these.

Loan limits are higher for high-cost counties, where real estate prices are typically higher. Please review conforming loan limits for your county. See loan limits for Colorado, Connecticut, New Jersey, Pennsylvania and Virginia here.

Notice that the limits for multi-unit properties are higher.

Quite often, buyers can afford higher loan amounts (due to their higher income). Not only are they interested in getting a bigger loan amount, they are also eligible based on Fannie Mae criteria of credit score and Debt-To-Income (DTI) ratio.

But the loan limits impose constraints on how much loan they can get. For borrowers who are fine occupying one unit and renting out one or more units, multi-family units can be very attractive. 

Not only do they allow borrowers to get higher loan amounts (thereby accruing more equity over time), a portion of the monthly mortgage payment can also be covered by the rental income from the other units. This reduces their contribution to the monthly payment.

Loan-To-Value (LTV) ratios

As mentioned earlier, the LTV ratios for multi-family properties tend to be typically lower than single family homes.

While there is no specific reason stated for why that’s the case, we believe that this could be because the demand for multi-family properties is lower than single unit properties.

Due to this lower demand, in the event of a default, there may be fewer people interested in the property and for that reason, might sell for less. The expected loss for the lender, therefore, could be higher. By asking the buyer to make a higher down payment, the lender’s risk in that regard is reduced. 

The table below shows the maximum LTV, or CLTV (Combined LTV, i.e. total of all loans if there is more than one mortgage on the property) for loans underwritten using the Fannie Mae Desktop Underwriter Automated Underwriting System (AUS):

Conforming Conventional Loan to Value Limits

Purchase, Rate Term Refinance Cash-out Refinance
Occupancy: Primary Second Home Investment Primary Second Home Investment
Units: Max LTV/CLTV/HCLTV: Max LTV/CLTV/HCLTV: Max LTV/CLTV/HCLTV: Max LTV/CLTV/HCLTV: Max LTV/CLTV/HCLTV: Max LTV/CLTV/HCLTV:
1-Unit 97% 90% 80% 80% 75% 75%
2-Units 85% N/A 75% 75% N/A 70%
3 to 4-Units 80% N/A 75% 75% N/A 70%

Minimum credit score

The minimum credit score required for all conventional loans for 1 to 4 unit properties is 620. For FHA loans, the credit score limit is more relaxed with the minimum requirement being a score of 580 or more. But remember, for FHA loans, the property has to be owner-occupied.

Final words

Let’s summarize everything we’ve learnt so far:

  • Buying a multi-family property is a great way to generate wealth. 
  • The rental income generated from the property can be used to cover a significant portion of the income.
  • It does require more commitment in the form of the management of those units.
  • Mortgages for 2-4 unit properties allow higher loan limits (compared to single-unit properties). 
  • The allowed loan amounts as a percentage of the value of property are lower though.
  • FHA and VA loans for multi-unit properties are only allowed when one of the units is owner occupied.

We tried to address all the questions that are commonly asked by buyers of multi-family homes. But there are nuances that we felt were beyond the scope of the article. If you are thinking seriously about buying a multi-family property, we are here to guide you and answer any questions you may have.

Start by providing us some information about your property of interest: stemlending.com/apply. You’ll hear from us right away.