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Jim Quist is the president and founder of NewCastle Home Loans. He has 20+ years of mortgage lending experience as a business owner, mortgage underwriter, and loan officer. Jim's goal is to help people buy homes.

Jim Quist is the president and founder of NewCastle Home Loans. He has 20+ years of mortgage lending experience as a business owner, mortgage underwriter, and loan officer. Jim's goal is to help people buy homes.



Why you should consider a multi-family home as a first-time homebuyer


Let me give you a piece of advice I wish I’d had when I was looking for my first home: Consider buying a multi-family property as a first-time homebuyer. 

Back then, I didn’t know that multi-family properties are a great way to collect passive income, build wealth, and benefit from tax breaks that aren’t available when you buy a single-family home. And I didn’t know that these two-, three-, and four-unit homes are surprisingly easy to buy. 

You don’t have to have perfect credit or a huge down payment to buy a multi-family home. Your future tenants will help you pay for your monthly mortgage, and your lender will factor this in as income when you apply for your loan.

In cities like Chicago, where 2- to 4-unit properties make up 26% of the rental market, first-time home buyers have a unique opportunity to invest and build wealth. 

That said, any investment has its risks, and a 2- to 4-unit property is no exception. Check out the resources below to learn more about the pros and cons of buying a multi-family home:

What is a multi-family home?

A multi-family home is a single building with space for multiple families to live in entirely separate units. Each unit must have a separate entrance, kitchen, and bathroom to be considered a multi-family residence. 

In most cases, living units are divided by floor. They may also be divided by side, sharing common walls with neighboring units. Chances are you've heard of multi-family homes already, just under a different name. In some parts of the U.S., people call them:

  • duplex, or property that contains two legal living units
  • triplex, with three units
  • fourplex, with four units

In Chicago, we refer to 2- to 4-unit buildings as “flats,” especially when the building has a separate residence on each floor.

  • 2-flats are two stories and have 2 legal units
  • 3-flats have 3 units 
  • 4-flats have 4 units

No matter what you call a multi-family home, remember that the most important distinction is the separation of units. Each unit must be a standalone living space, completely separate from neighboring units.  

 

Why should I buy a multi-family (2- to 4- unit) home? 

There’s no other potential investment for first-time homebuyers like a 2- to 4-unit property. It’s an affordable investment that can generate income, build wealth, and earn you tax breaks along the way.

For starters, you don’t need much money upfront to buy a multi-family home. If you’re going to live in one of the units, you’ll need a down payment of just 3.5% of the purchase price. This means you could qualify for a mortgage to buy a multi-family home with the same cash you’ve saved for the down payment on a single-family home: 

2- 4-unit live-in

 

To take advantage of the potentially low down payment, you’ll need to live in your multi-family home, establishing one of the units as your principal residence. Within 60 days of purchasing your multi-family property, you must move in and continuously reside at the property for at least one year. After a year, you can move outand potentially consider buying another multi-family home.

As the owner, you’ll choose the unit you’d like to live in, then rent the other unit(s) out to tenants. Collecting rent from your tenants for the second, third, and/or fourth units will generate income, helping you pay back your home loan.

If you buy a triplex, you live in one unit and rent out the other two for $1,600 a month, generating $3,200 in gross rental income per month.  

More people are renting these days, and this higher demand means higher rental rates. Plus, mortgage interest rates are near all-time lows. Because you’ll have a low interest rate on your loan, your monthly mortgage payments will be low, too. This combination of high rents and a low monthly mortgage cost creates the opportunity to generate a steady stream of income. 

See current interest rates and payments

 

Suppose you aren’t planning to live in your multi-family property. In that case, the home is considered an investment property by your mortgage lender. You can still buy the home, but you’ll need more money for the down payment: at least 25%. That’s a big cost difference:

2- 4-unit Investment

 

Whether you live in your multi-family home or rent it out entirely, a steady stream of rental income combined with property appreciation and tax breaks can help you build significant wealth. Of course, one multi-family home won’t make you a tycoon. Still, landlords do tend to be about four times as wealthy as the average American.

Your wealthseparate from your incomeis the money you have in the bank, along with your investments, properties, and assets, minus liabilities like your mortgages. A multi-family home all but promises appreciation, as it’s very likely to increase in value over time.

As your property increases in its value, you’ll continue using your rental income to pay down the mortgage loan. This is how your wealth grows over time.

Your $500,000 3-flat appreciates at a rate of 5% annually, your wealth then grows from $500,000 to $525,000 in just one year. In addition, because you paid $17,500 for the down payment, you will have earned a 43% positive return, based on the property’s $25,000 appreciation.

On top of the potential to earn income and build wealth, rental properties come with some significant tax breaks, too. Because renting comes with lots of associated costs, you can deduct some of your related expenses from the rental income you report on your tax return. Things like interest, insurance, depreciation, property taxes, repairs, utilities, and even lost income from vacancies can be deducted from your rental income, offsetting these costs.

 

What are the drawbacks of owning a multi-family home?

Like any investment, buying a multi-family home comes with potential risks you'll want to consider before signing the final sales contract.

In certain economic situations like recession, real estate can take a big hit. Investing in a multi-family property means that your wealth could shrink if the property value drops. Depending on market conditions, it could also be tough to resell your multi-family home. Chances are, you won’t be able to sell it quickly if you need the cash during an economic downturn. 

When you set out to buy a multi-family home, it could be trickier than searching for a condo, townhome, or single-family home. Finding an affordable multi-family property in good condition and in a neighborhood you want to live, will be more difficult. 

Chances are you’ll have to make some compromises like a longer commute, or living through renovations, in exchange for the property’s investment potential. Partnering with an excellent real estate agentone with lots of experience with multi-family propertiescan help you find the home that best fits your wish list.

Then, of course, there are the obvious drawbacks associated with renting out part of your home. Finding renters, collecting rent payments, and handling repairs will add to your to-do list each month. Managing tenants and handling repairs could present unique challenges or cost more than expected.

While these concerns are shared and surmountable, it's important you understand and prepare for some complications. These potential drawbacks are the flipside of the investment perks if you choose this type of home. 

 

How can future rental income help me buy a 2- to 4- flat? 

Because you’ll collect rent from one or more of the units in your multi-family home, you can use this future rental income to increase your purchasing power.

Using this additional income from your tenants, you’ll be able to afford a higher monthly housing payment. This increase in what you can afford means that you can borrow more for your mortgage, allowing you to purchase a more valuable property. 

“Future rental income” refers to the amount of money you expect to receive from a home you rent out rather than live in. We use the term in the mortgage biz to represent the estimated income a rented property will bring in. We use this number as part of our calculations when we qualify you for a home loan.

You can use the rent from a multi-family home to help you qualify for the mortgage. Adjusting for maintenance costs and possible vacancies, the lender will add 75% of the rent to be collected to your monthly income. 

Let’s say that Ada earns $7,500 per month from her job as a software engineer. She’s thinking about buying a triplex, with plans to live in one unit and collect rent from the other two. Based on similar units in her area, each will rent for $1,600 each, or $3,200 total each month.

When we qualify Ada for her loan, we use 75% of the monthly rental income, subtracting 25% for vacancy losses, maintenance costs, and management expenses:

$3,200 x 75% = $2,400 

Then, we add that $2,400 in adjusted rental income to the $7,500 Ada makes from her job. That total, $9,900, is the income amount we use to qualify Ada for her mortgage.

As a general rule, your monthly housing payment should be no more than 31% of your monthly income. With $9,900 coming in each month, this means Ada can afford a monthly housing payment of $3,070:

$9,900 x 31% = $3,070

For comparison, if Ada were to purchase a condo, the most she could afford to spend each month would be $2,325. Without the additional triplex units to bring in rental income, the amount Ada can borrow decreases considerably. 

Because Ada is interested in a multi-family home, the future rental income increases her purchasing power, allowing her to borrow more with her mortgage.

 

How much will a multi-family property cost up front?

Figuring out how much a multi-family property will cost you is a crucial first step in home buying. Buying a home requires more than just your monthly mortgage payment. Before you can seriously consider purchasing a multi-family home, you’ll need to determine how much your down payment, closing costs, and monthly payments will be.

For borrowers, mortgage costs are often broken down into two broad categories: your monthly payment and your cash to close. “Cash to close” refers to the down payment and closing costs due when you close on your home. Your monthly payment is the amount due each month to your lender as you repay your loan.

To buy a multi-family home, you’ll need 3.5% of the purchase price for the down payment. You’ll pay your down payment to the seller as you close on your new property, and the remaining amount of the purchase price is what you borrow from a lender. 

If you buy a 3-flat for $500,000, you’ll need $17,5003.5% of the purchase priceas a down payment, due to the seller at closing. This will mean you borrow $482,500 from a mortgage lender like newcastle.loans.

 

The money used to cover the down payment and closing costs have to come from an acceptable source. Cash from your personal checking, savings, and brokerage accounts, vested retirement, and gifts from relatives, are all acceptable. The lender will request documentation like account statements to prove that you have the cash to close.

You can’t borrow money to pay for a down payment, and you can’t take out a cash advance from a credit card. Generally, if you can’t prove where you got the money, the lender won’t count it toward the cash you’ll need to close on the home.  

In addition to the down payment, closing costs are the fees you pay when purchasing a home. While many different fees fall under this umbrella, you should expect the closing costs to range from 2-5% of the purchase price.           

See mortgage rates and closing costs

 

When you and your real estate agent negotiate your sales contract, ask the seller to pay some or all of your closing costs. While sellers may be willing to cover these closing costs, they cannot pay any part of the down payment. The seller cannot, however, pay any amount of the down payment. 

When you apply for a mortgage, the lender will send you a loan estimate that breaks down closing costs for your loan. So even if you’re not quite ready to apply for the mortgage just yet, it’s a good idea to get an estimate of your closing costs when you have a property in mind.

                                      

If you buy a property with 3 or 4 units, you’ll need reserves. Reserves are funds left over after the down payment and closing costs. The lender will want to see that you have at least 3 months of the housing payment in reserve before closing. This way, you can afford unexpected vacancies, repairs, or costs you incur as a new owner.

 

Choose NewCastle for your multi-family mortgage. 

At NewCastle, we’ve got the industry knowledge and experience to help you close on your multi-family home in record time. We’re proud to provide our customers with stellar service, lower rates, fewer fees, and lower monthly payments. 

If you’ve got questions or are ready to get started, schedule a call today. Let’s get you moving toward your homeownership goals.

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