This is an interesting concept and at first glance it might seem a bit misleading. The obvious way to buy a fourplex and live mortgage free is to pay cash for it. But many don’t take that route because it can put a dent in a bank account and tied up into a relatively non-liquid asset. Yes, you can tap into the equity in a property with an equity loan but to recover the amount invested in the property a complete sale is in order. That’s why many real estate investors do finance a multi-unit property, to free up capital for other purposes. So, if someone takes out a mortgage on a fourplex, how can someone live there mortgage-free?
When real estate investors evaluate a potential purchase one of the primary tasks is to make sure the property cash flows. The total amount of rent received each month must be enough to cover the costs of financing including property taxes, insurance and closing costs along with a set aside for maintenance. If the market rent for the property doesn’t show enough monthly income to cover these costs, then the investor typically moves to another property. However, the rental income can be enough to not only cover costs of ownership but also provide a monthly net income for the investor. This is the ideal situation.
One quick note here, though. While the property might indeed cash flow and allow the investor to live in one of the units, first time investors won’t be able to use the rental income from the units to help qualify. This is a standard guideline. Landlords must have at least two years of owning and managing rental properties, verified by tax returns.
Taking it a step further, there can be enough cash flow to not just provide some income for the investor but also allow the investor to live in one of the units. This, in effect, means the tenants are paying the landlord’s ‘rent.’ This strategy also works with a two-unit property, or a duplex, but the income from one unit is much less compared to a four-unit.
How much rent can you charge for each unit? That’s completely up to you but you’ll likely want to follow what other investors are charging. If the units have extended leases that have yet to renew, it’s quite possible the rents being charged are below-market. This means it can soon be time to raise the tenant’s rent to market standards. You can do your own research along with your real estate agent regarding current market rental amounts and you can also hire an appraiser to assess current market rents as well. Once you do make an offer and start the financing process, the appraiser will begin this task.
Renters won’t like to see a rent increase but if they’ve been paying below market rent for a while they’ve not only been getting a great deal but they’ll also find out that other similar units in the area charge higher rents than what they’re currently paying. There can be some fallout but depending upon the market it shouldn’t take very long to replace the vacating tenant.
As it relates to financing, mortgages for multi-unit homes are readily available. Residential loans want to cap the number of units at four. Any property with more than four would be considered a commercial property which means a larger down payment and higher rates. Down payment requirements for four-unit homes start at 25% down for most loan programs. Down payment requirements for conventional loans ask for a minimum 15% down for a duplex.
There are government-backed options of VA and FHA programs that will ask for a lower down payment, but in many places the loan limits exceed FHA guidelines and while the VA no longer establishes loan limits, most lenders do follow the conventional guidelines in this regard.
If you’re looking at buying a fourplex and like the idea of having your tenants pay your mortgage for you, let’s have a conversation about what you’re thinking of doing. We can help run the numbers for you to make sure the property will indeed cash flow using today’s current market rates. In most cases, the math works out in your favor.