One of the greatest hurdles in purchasing a fourplex is financing the purchase. Since the real estate bubble and the passage of the Dodd-Frank Act, obtaining a residential mortgage has become a much more rigorous process. It is important that potential investors work with a qualified mortgage professional to obtain prequalification early.
Here are some important items that an investor should know when considering the financing a fourplex in California. For help, I reached out to James Frazier & Robert Sinohue from California Mortgage Advisors.
The loan-to-value ratio (LTV) is an important factor in determining a property’s financing. This ratio is calculated by dividing the loan amount by the value of the property. Lenders use this to make sure that there is adequate security in the property should they have to seek repayment through the ownership and sale of the property.
LTV ratios are much more restrictive on investment properties than for owner-occupied properties. The maximum LTV varies by the loan amount. Investment properties that do not exceed the maximum conforming loan limits, require a minimum down payment of 25% or an LTV of 75%. The maximum conforming loan amounts are $800,775 for a 2 unit (duplex), $967,950 for a 3 unit (triplex), and $1,202,925 for a 4 unit (fourplex). Loans exceeding these levels are considered non-conforming. Non-conforming investment properties typically require a minimum down payments of 30% or an LTV of 70%.
The term “investment property” implies the investor should receive some relative return on the investment. Ideally, an investor should strive to have the rental income serve as the primary source of loan repayment. Be advised, the rent collected is not always a true indication of the return. After expenses, depreciation and write-offs, this number could appear more favorable. Please seek the advice of a professional financial advisor before making any investment decision.
When a mortgage application is being evaluated, rental income is generally not fully credited to the borrower by the lender. Lenders will “discount” the rent because of the cost and risk associated with owning investment property. If someone does not have at least two years history as a landlord, they may not be able to use the rental income to help qualify for the full mortgage payment. However, there are several lenders who can provide exceptions to this rule if buyer has excellent credit and lower LTV’s.
The underwriter will use 75% of the gross rental income to qualify a borrower. The maximum debt-to-income (DTI) ratio is 43% for conforming loans and a maximum DTI of 40% for nonconforming loans. From this figure, property taxes, insurance, home owner’s association dues and any mortgage payments are deducted to create the amount of rent (positive or negative) that the lender will use for qualifying purposes.
Additional Items to Consider
Multi-unit properties do require additional management. In the case of a fourplex, the owner is responsible for ensuring all units 4 roofs, 4 furnaces, 4 water heaters, etc…are maintained. Potential buyers should consider the cost and the additional time and resources required to serve the residents.
From an underwriting standpoint many deals are lost because clients do not have the income or reserves to satisfy lender guidelines. Be extremely proactive in regards to these standards and understand each lender may operate under a different guideline.
Financing a 2-4 unit property can be accomplished with the help of a skilled mortgage professional. They will help to guide you through the process and to avoid the pitfalls that can skew a wise investment. The ability of your mortgage professional and your real estate advisor to work together is critical in accomplishing your goal of purchasing your investment real estate.
Thanks again to James Frazier (925) 208-4531 and Robert Sinohue (925) 364-5210 for their contributions on this article.