Have you considered buying a multifamily property? Multifamily homes can be the ticket for investors looking to build wealth, whether you’re a first-time homebuyer or an experienced investor. In fact, 35% of Americans believe real estate is a superior long-term investment compared to stocks, according to a Gallup poll.
However, multifamily financing can be tricky for people who aren't familiar with the process. This guide focuses on your loan options, borrowing limits, down payment amount and other key elements you need to know about multifamily financing.
What is Multifamily Property?
Multifamily property is a type of commercial real estate. It’s a single structure made up of multiple units where different families can live. Each space will have its own kitchen and bathroom, a separate entrance and individual utility shut-off valves and meters.
Apartments are the most common type of multifamily property. However, condominiums purchased by individual owners and duplex houses are also considered multifamily properties.
Is Multifamily Financing Right for You?
If you’re looking to increase your income to achieve financial independence or other financial goals, a multifamily property can open the door to passive rental income. But you likely don’t have a large deposit of cash sitting around to invest in real estate.
That’s why many buyers use multifamily financing to purchase their property. Financing a multifamily property can jump-start your investment, improve cash flow, open up tax benefits and diversify your portfolio to hedge against other investments.
Financing Terms You Need to Know
Multifamily loans are an excellent tool for first-time real estate investors and seasoned professionals. But there are some commercial terms you should know about this type of financing:
- Investor: The buyer looking to purchase the property.
- Owner occupant: The property owner who also lives and resides on the property.
- Interest rate: The amount a lender charges a borrower, calculated as a percentage of a loan the borrower pays to the lender.
- Term: The amount of time a borrower has to pay back the multifamily loan.
- Loan limits: The maximum amount an applicant can borrow from a lender for a particular purchase.
- Loan to value (LTV) ratio: A comparison of the amount of the mortgage to the value of the property. A higher down payment can result in a lower LTV.
- Pro forma: A report that projects current and estimated income and expenses to show a property’s projected net operating income and cash flow.
- Market rate: The purchase price a buyer is willing to pay for a property. (It can be different from the appraised or assessed value.)
6 Multifamily Financing Options
Financing a multifamily property can be complex. For example, some multifamily loans are great for investors who want to rent out all units. But other options may require the buyer to reside in one of the units as an owner-occupant. Here's a rundown of six options to consider:
1. Conventional Loans
Conventional loans are what most people think of when it comes time to buying real estate. It isn’t insured or guaranteed by the federal government. It’s also a “conforming” loan, which means it meets guidelines set by Fannie Mae and Freddie Mac.
Conventional multifamily mortgages generally require substantial cash reserves and a good credit rating. Although conventional loans are subject to stricter credit standards than government-backed loans, buyers can usually get a lower interest rate compared to other options.
2. Jumbo Loans
Jumbo loans are a type of non-conforming loan because the amount is above conventional mortgage limits set by Fannie Mae and Freddie Mac. Not all lenders offer it as an option for a multifamily property. Depending on your loan purpose and property type, you may face stricter requirements to qualify for a jumbo loan.
3. FHA Loans
If you’re looking for an option with a low down payment, consider an FHA loan. FHA loans offer more flexibility regarding credit history and down payments. However, FHA loans have a few downsides:
- Can only buy a property with up to four units
- Requires mortgage insurance premiums (MIP)
- Must be owner-occupied for at least one year
If you don’t want to be an owner-occupant, the FHA’s commercial loan program might be better. You can apply for an FHA commercial loan for properties with at least five units if the property doesn’t need substantial repairs.
4. VA Loans
Service members, reservists, veterans and surviving spouses can pursue multifamily financing with a VA loan. The program is through the Department of Veterans Affairs, but you must apply at a bank or mortgage company to get the funds.
VA loans require you to prove service time requirements using a Certificate of Eligibility. If approved, you can purchase a property with up to four units without a down payment. VA jumbo loans are also available if you’re looking at a more expensive investment.
5. Commercial Loans
Consider a commercial mortgage if you’re looking at a multifamily home with more than four units. Commercial real estate loans typically allow financing up to $6 million. However, you should be prepared with a 20% down payment.
6. Bridge Loans
A bridge loan is short-term financing. It’s used for buying commercial real estate but isn’t a permanent financing solution for multifamily homes. Still, it can be helpful for:
- Funding renovations and upgrades for a commercial property
- Borrowers who aren't initially qualified for permanent financing
How Much Can You Borrow for a Multifamily Property?
When you're trying to secure financing for a multifamily property, you'll face loan requirements that affect your borrowing ability. Most banks limit the amount of money you can borrow, and it can depend on the loan amount, LTV and down payment.
- Loan amount limits: Conforming loan limits depend on the number of units. In most areas of the US, two-unit properties are capped at $828,700, while the four-unit limit is $1.24 million. Jumbo loan limits can be much higher.
- Loan to value requirements: LTVs depend on the type and amount of the loan and can range from 70% to 95% for conforming loans.
- Down payment options: The loan program you use and the property type determine how much money you need for a down payment. VA loans require no down payment, while commercial loans can require 20%.
However, the most important thing to know when shopping for a multifamily loan is whether or not you can afford the payments. So, can rental income help you qualify for a loan? Usually, yes — rental income can be counted when you apply for multifamily financing.
The Bottom Line
Financing an investment property can seem intimidating, but it doesn't have to be. It's pretty easy to get the financing you need if you know where to look.
The key to making a smart loan decision is to be sure you're comparing apples to apples — in other words, be sure you know exactly what you're getting into when it comes to both the features and the price of each loan. That way, you can find the multifamily loan that will best fit your needs, requirements and budget.
When you're ready to take the next step, whether you're a first-time investor or a seasoned professional looking to expand your portfolio, you’ll need landlord insurance to protect your investment. If you aren’t sure what you need, talk to a licensed insurance agent. They can help you determine the cost of a policy, what it covers and what can happen if you decide not to buy one.