Introduction to Multifamily Loans
If you and your spouse have been regularly adding to your savings, you might have enough to consider buying an apartment building to earn a better return than the interest rate at your bank. Buying an apartment building might be the right investment for you. You need a multi-family loan for housing with more than four units. Qualifying is different than for the mortgage on your personal home. Make sure you understand the process and requirements before you commit to the purchase.
Qualifying for a multi-family loan might differ from lender to lender. However, a few similar requirements are common to the process. Typically, you need a down payment of at least 25 percent to 30 percent. More will be required if there are areas of concern to a lender, such as a building that needs major repairs. In addition, multi-family loans carry a higher interest rate and fees than traditional, single-family loans. Qualifying for the loan might depend solely on the income the property generates. Or, for smaller buildings, you might be required to qualify on the merits of your personal credit history and score.
Recourse vs. Non-Recourse
Multi-family loans can be obtained as recourse or non-recourse mortgages, depending on lender requirements. If the financial institution has recourse on the loan, it might pursue your personal assets and collateral, if placed, in repayment if you don't pay the mortgage. For non-recourse loans, mortgage companies can take possession of the apartment if you default, but they do not have a claim for your personal possessions, unless you fall under a negligent clause outlined in your loan documents.
Debt Service Coverage Ratio
A multi-family property is usually reviewed as a business operation from a lender's perspective. For an apartment complex to qualify for a mortgage, it must prove income worthy. This determination is referred to as a debt service coverage ratio, or DSCR. If the DSCR is 1, it means you will collect enough rent only to cover your mortgage payments. Typically, lenders require a 1.2 to 1.5 DSCR on a property before approving a loan. Net operating income (NOI), the total after subtracting all expense and vacancy estimates from rent collected, is divided by the annual mortgage payments. For example, an NOI of $150,000, divided by loan payments of $100,000, gives you a DSCR of 1.5 for qualifying purposes.
To be approved for a multi-family loan, you must provide documentation for you and your spouse and for the property. You'll complete forms detailing your own financial situation. You must submit information about the apartment building, too. Ask the seller to give you copies of the profit and loss statement, tenant list, number of vacancies, signed leases, real estate tax bills, property bank accounts and tax returns and any contracts with vendors, such as the pest control and washing machine service.
What is Commercial Property?
Generally, commercial property is property that is zoned for and/or used for commercial purposes; that is, property where business is operated. Commercial property includes things like stores, shopping malls, warehouses, factories, office buildings and any other real estate that is used for generating income.
Apartment buildings may be considered commercial property, even though the space is used for residence. Typically, an apartment building with five or more units is considered "multi-family" and is commercial property for purposes of obtaining financing.
What Is Mixed-Use Property?
Mixed-use property is real estate that has both residential units and commercial units within the building. A good example of a mixed-use property is a row house or brownstone with a residence on the second and third floors and a business on the first floor, or on a smaller scale, a beauty salon that you run out of your house.
Securing a Commercial Mortgage Loan
Lenders are more aggressive in securing their interests when making commercial loans. If the borrower is a business entity, the lender will likely require one or more of the business owners to personally guarantee the loan – that is, sign a document saying that if the business doesn't pay, the owner will be personally liable.
The lender may also require additional security if the corporation's finances aren't strong enough such as an additional residential mortgage on the owner's personal residence or a lien on personal property like equipment and inventory.
Commercial Loans Lack Consumer Protections
Commercial loans are also not subject to certain consumer protections that are available for residential loans. For example, collections on a commercial loan likely do not fall under the Fair Debt Collection Practices Act (FDCPA).
Some states have special laws that protect homeowners facing foreclosure, such as New Jersey, which has the Fair Foreclosure Act. Among other things, the Fair Foreclosure Act requires mortgage lenders to give homeowners 30 days' notice of intent to foreclose and provide a laundry list of information about their rights at the same time. Commercial mortgage lenders are not required to take any of these steps and can foreclose right away.