If you are in the market to buy real estate, you have probably realized that it’s not exactly easy to buy your first home, so here’s a suggestion that hopefully may help you. Instead of buying just one house, buy several. You’re thinking What? No, this has nothing to do with those late night ‘No Money Down Real Estate’ infomercials or books that promise instant and fast wealth virtually over night from buying or flipping houses. Instead, for a lot of first time buyers, you can benefit from an interesting twist in the mortgage system.
When most lenders or people talk about “real estate financing”, they are generally dividing mortgage lending and borrowing into two categories: loans for ‘owner occupants’ and loans for ‘real estate investors’.
“Real Estate Investment Financing”, is for those buyers who do not nor want to physically reside at the property. “Owner-occupant” refers to mortgage loans for houses where the buyer will actually live in the building as well as rent out the other units.
So Here Is The Wrinkle
Owner-occupant mortgage financing is available with little down payment and low interest rates, for buyers who purchase more than a single unit family home. Normally, banks will give you ‘owner-occupant’ mortgage financing for properties containing two to four units, provided you use one of the units as your prime residence.
So, in other words, using your status as an ‘owner-occupant’, allows you to purchase more than just a condo or a house. You can actually buy property that can produce income for you, as well as increasing your tax deductions.
When you buy a multi-unit property (two-to-four units), the real estate mortgage financing category changes. What the mortgage lenders will do is apply most of the rent to your income for loan qualification purposes. This simply means that you can borrow more, and it also allows you to offset the associated loan costs with the income the properties produce, as in rent income.
Buying Multi-Unit Properties
So suppose then that you decide to buy a property with four units. You will live in one of them and rent the others out. Say each of the three units available for rent has a fair market rental value of $1,000 per unit.
If you take advantage of this, it will give you two benefits. First, the mortgage lender will take into account a portion of the rent, in this case, three-quarters of the building as income, when determining your loan qualification amount. For this example, $2,250 a month will be included to your income. ($1,000 x 3 units = $3,000. $3,000 x 75% = $2,250)
Why just $2,250 and not the entire $3,000? That’s because the mortgage lender assumes that you will have vacancies, insurance, repairs, taxes and other miscellaneous costs for the rental units.
The mortgage lender will also assume that: For income tax purposes, 3/4 of the property will be classified as real estate “investment income”. On your income tax, you will include the rental income as well as the associated costs for these units as income. One of these “associated costs” will be depreciation, which will actually lower your taxes, but will not take actual cash out of your pocket.
What the mortgage lenders do with depreciation is, they will “add back” that cost in the calculation when looking at your monthly income. The end result is your monthly income for loan qualification purposes will actually increase even more than $2,250 in this example.
The Advantages Of Owner Occupant Properties
There are obvious advantages in buying 2, 3 or 4 unit properties, especially if you are a first-time buyer. First of all, you will have “help” in meeting your monthly mortgage obligations, especially in the first couple of years of ownership, when things are usually the most difficult. You may eventually decide to move on and thus sell the property, or you can just hang on to the proper for rental income, thus becoming an investor.
Keep in mind that with all investments, there are risks associated with them, such as the rental income being too low, property taxes incresing, property values not increasing enough or even decreasing. There are also concerns of the tenants having insufficient funds, frequent vacancies or big repair bills.
Also, make sure you don’t go too big. While up to 4 units is okay, five or more units automatically classifies you and the property as an “investor”, under most mortgage loan programs. This ‘investment’ title means you can no longer use owner-occupant financing, even if you live in the property.
The good news however, is that you as an owner/occupant and as a landlord, you will learn a lot about the nuances and practicalities of real estate investing, if you ever plan to venture that way.
Real estate ownership and investing requires ongoing maintenance and constant oversight. You as an ‘owner-occupant’ owning a few units, will gain invaluable experience by learning “on the job”. Things like repairs, dealing with the tenants, hiring contractors and general maintenance of the property. It’s pretty obvious that a lot of people who have become successful real estate investors, often started with just one small rental property, using owner-occupant financing with very little down and two to four units.
If you need further details, speak with your mortgage lending professionals. These lenders will be more than eager to tell you about the available financing available to you. Real estate brokers can provide valuable information regarding neighborhood rental conditions and patterns, as well as other benefits such as tax saving when owning a multi-unit housing complex.