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How to Buy Your First Fourplex With 3.5% Down

How to Buy Your First Fourplex

You want to become an investor in Nampa, Idaho, and you have your eye on this beautiful fourplex. You will live in one unit and collect rent from the other three. But there’s a problem — you are low on cash. Most conventional financing options require a 15%- 25% down payment, much more than you currently have.

Before you consider yourself relegated to begging and borrowing from friends, or worse, waiting until you have the total amount saved, let me tell you about two options that can get you into that fourplex with as little as 3.5% down.

Normal financing options usually require a hefty down payment in the 20% average range, but these two programs can get you into that fourplex with just 3.5% or 5%.

Option 1: FHA —The Original Low Money Down Loan

If you have been looking to buy, you have most likely heard of the FHA loan. Many assume that FHA stands for First-Time Homebuyer. FHA refers to the Federal Housing Administration. Anyone can apply for this loan.

FHA loans were introduced back in 1934, during a time when the US economy was suffering through the Great Depression and housing was struggling. Estimates show that only 1 in 10 people owned their home then, meaning 90% of the population was renting. Tragic!

To encourage more banks to lend during this risky time, the FHA offered an insurance guarantee covering bank losses if the borrower defaults. The guidelines for these loans were also tailored to make qualifying easier, making them more attainable to many of these risky borrowers.

Thankfully, the same guidelines you must meet to qualify for this FHA loan to buy a single-family home you will live in are the same guidelines you must meet to buy a 2-4 unit building. FHA financing offers some nice perks, so let’s look at those guidelines and why they matter.

Lower Credit Score and Looser DTI Ratios

In today’s world, getting financing depends on several factors, including your credit score. Credit scores range from 300 to 850, with 850 being the best.

Generally, the higher your score, the lower the interest rate you pay. You can qualify for an FHA loan with a score as low as 500. However, to come in with only 3.5% down, you must score at least 580. And while you can get a loan with a score of 500, it will require a 10% down payment.

Income is another factor. Lending institutions all have ratios they work off of when calculating your debt-to-income ratio (DTI). Any lender will want to make sure that you will make enough money to pay your debts and live. FHA has the most forgiving ratios. FHA allows you to use 31% of your income towards housing costs and 43% towards housing expenses and other long-term debt.

Down payment Assistance

As if it weren’t enough that you can go from 20% to 3.5%, FHA also allows the borrower to take money to cover that 3.5% in the form of gifts from family and even government assistance programs. If your parents or a rich uncle wanted to kick in some money to help you come up with that 3.5%, they could.

If you don’t have a wealthy family member, no sweat. According to Down payment Resource (DPR), exactly 2,351 programs offered this money back at the beginning of 2023. While the majority is funneled to those buyers looking to buy a single-family home, 636 of those programs could be used by someone looking to buy up to 4 units, so long as they occupy one.

Up to 6% Closing Cost Assistance from the Seller

One of the significant drawbacks of FHA is Mortgage Insurance Premiums (MIP). While mortgage insurance is not exclusive to FHA, it tends to have stricter guidelines and higher costs than in conventional loans, where it is known as PMI. So, the reason that the government will offer insurance to banks is because they charge a portion of that insurance premium to the borrower.

FHA will charge an Upfront MIP fee of 1.75% of the amount borrowed. You can pay this fee in your closing costs, or it can also be wrapped up in the loan. Then, there is the Annual MIP, which is billed monthly through your mortgage payment.

Recently, FHA also reduced this fee. If you put down less than 5%, that fee is roughly $46/month for every $100,000 borrowed.

So, what is the perk? We have been focused on coming up with the down payment. But to buy a house and get a loan, you will also have closing costs that you must account for. Typically, you can plan on anywhere from 2-3% of the purchase price for closing costs.

Although you can try to get the seller to kick in some money to help you cover these, most investment loan programs will only allow you to use at most 2% for these costs, leaving you to fend for yourself on the rest. Luckily, FHA will let you use up to 6%, ensuring you can cover the average 3% plus the upfront MIP that FHA requires. Bam!

Use 'Future' Rent Money to Qualify

This perk is a double-edged sword.

Some loans require a property management track record before they extend credit. You might run into issues if you are not a seasoned investor with property management experience, but that’s not the case with FHA.

FHA will still allow you to use up to 75% of that income, whether those units are rented or not and whether or not you have prior property management experience. That sounds awesome, right? Well, if you buy a duplex, yes.

FHA Rule 75

Now, unique to 3 and 4 units is what FHA calls FHA Rule 75 or the self-sufficiency test. This rule states that for you to qualify for that loan, 75% of the rent must cover the whole mortgage expense (PITI), allowing you to live in your unit for free. Hence, the autonomous part.

So, what’s the problem? If you run the numbers and still have a balance left on your monthly payment that this 75% doesn’t cover, you can’t simply charge yourself rent as you would in a duplex. You can’t live for cheap — you must live for free.

The hard part in this market has been finding fourplexes that will generate enough rental income from 3 units to cover PITI in its entirety with only 3.5% down. The deal breaker for this FHA financing has often been meeting this self-sufficiency test. And that is where our next program comes in.

Option 2: 5% Down Investor Owner-Occupied Loan

Enter the 5% down owner-occupied conventional loan offered by Fannie Mae. Friends, this is a newer program introduced in November 2023. Hands down, the major perk of this type of loan is keeping your down payment cost low while no longer having to meet that self-sufficiency test.

In the past, if you were not taking out an FHA loan, the only other option for a 2-4 unit purchase was to make a hefty down payment of 15%- 25%, even if you planned to occupy one of the units.

With this new program, you can come in with as little as 5% down. If you want to cover the mortgage balance yourself because it’s more critical for you to start your investment journey than living for free, then you can do it with this new loan program. As with any loan, you must qualify for it.

Conventional Loan Guidelines

As I mentioned, one of the perks of FHA was the lower credit score. Conventional financing will require a higher score. You must have a 620 credit score to qualify for a traditional loan. For a while during COVID, I heard that many local lending institutions were requiring a 660 score, and the ratios for conventional are a little stricter. Total debts cannot be more than 36% of income vs 43% allowed in FHA.

Down payment assistance does exist for conventional financing as well. However, the maximum amount of closing costs credit that a traditional loan will allow you to use on an investment property is 2%. That being said, one of the significant perks of coming in with that extra 1.5% of your own money is that you will not have the upfront MIP that FHA requires.

On a conventional product, you will still have mortgage insurance, known as PMI. However, the good news is that PMI falls off automatically once you have about 22% equity in your property.

You have it for the life of the loan in an FHA product. The only way to eliminate it is to refinance into a conventional loan. Refinancing also costs money, so you would have to run some numbers to see if the MIP savings are worth the refinance’s cost. You can still use up to 75% of the rental income to help you meet your ratios.

Major Con of FHA

One con of going with FHA is the stricter guidelines they place on the property itself.

If you think back to what FHA was intended to do, you can see that it was meant to help those with lower credit and less money get into homeownership. FHA tried to help further by ensuring that the homes these buyers were purchasing were in good condition and would not be bogging down the buyer with tons of repair work on their new house shortly after purchase. Thus, FHA will require any repairs before closing the property.

If the seller is not inclined to foot the bill, and you have no money to do it yourself during the transaction, you might have to cancel the agreement. So, if you’re looking for a handyman special in your next investment, conventional will be the better option in certain markets.

In Conclusion

Friends, I hope you found this information inspiring! For ages, getting into the investment market seemed impossible for most investors as they struggled to determine 20% of the purchase price to put down. These two loan programs lower the barrier, allowing entry with as little as 3.5% down. This opens up opportunities to start building wealth through real estate investment.

As always, our team at Wealth Builders Realty is here to help. We’re ready to answer your questions and connect you with the right resources to start your investment journey. Contact us for further assistance.

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