Favoring 2-4 Units (financing)

I’ve touched on this before, but another compelling reason why 2-4 units can be more desirable is because of the types of loans you can get.

We’ve discussed the down payment before:

– 25% for 2-4 units (20% if you’re an owner-occupier) vs. 30% for 5 or more units.

But in this market, with interest rates so low, you want a 30-year fixed loan whenever possible. If you have 5 units or more, you can’t get more than 5-10 years guaranteed, and your interest rate might even be half a point higher.

This is why we call 5 units the no-man’s land for income property financing.  Unless you’re buying with cash (and hope to sell for cash), you’re better off going bigger or smaller.

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FHA Loans + & –

The FHA gives hope to many future homeowners who are short on cash.

What is it?

The FHA is a government organization that insures loans. It doesn’t give loans; it insures them. This makes FHA-backed loans very safe for banks because the FHA assumes the risk. But since it acts like an insurance company, you pay a premium and the FHA might not want to insure your loan if they don’t think the property is worth what you’re paying.


– You can put down as little as 3.5% of the purchase price.

– You can go through a normal (FHA-approved) lender.

– You have certain move-in rights as an owner-occupier, and can sometimes relocate low-paying tenants and therefore raise the value of your property.

– You get good interest rates.


– You technically have to live there for two years.

– If no unit is vacant, you have to pay the tenants to move out (between $8,000-$20,000).

– Because the FHA appraiser is strict, there’s a chance your deal might not go through. This means many sellers will overlook  your offer in favor of an all-cash or conventional loan offer. And that means your pickings are slim in Los Angeles.

– You pay an insurance premium:

– You pay a 1.25% upfront premium (UFMIP). Luckily, this can be added to your loan amount.

– Additionally, you pay 1.25% of the total loan per year as a recurring premium.

– You pay 0.25% extra if the loan amount is above $625,500.

– Thankfully, you stop paying the premium when your loan-to-value ratio lowers to 78% (and you’ve already been paying for 60 months).

So yes, there is hope. But you have to know what you’re up against. Let me know if you’re in this market because this is what I specialize in.

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Why buy?

In most good income property deals these days, you can expect to make between 5-8% on your money, if you can afford a conventional loan. If you put down $100,000 cash (20% of purchase price), you’ll get between $5,000 and $8,000 cash back every year. That’s pretty nice on its own.

The exceptional thing about buying leveraged property is that your rents are also covering your mortgage, so in addition to the cash in your hand, you’re earning equity in your building. That means in 30 years, you’ll have earned an additional $400,000 bonus in your building.  And that’s not counting appreciation.

{Next post: What’s the least cash I can use to buy an apartment building?}

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Sweet 2-4 Units

You might be thinking “why limit myself?” And you certainly don’t have to. If you have a lot of cash and you plan to flip your property, buying bigger buildings is a great way to invest.

However, the reason I recommend buying a 2-4 unit apartment building is because of the financing options.  Right now, with a 2-4 unit building, you can get a 30-year fixed mortgage with around 3.5% interest rate, depending on your credit and when you read this blog.  If you have 5 or more units your building is considered commercial property and you’ll likely be stuck with a 7-year adjustable rate, and who knows where interest rates will be in 2020.

If you’re on the cusp, remember that the same rule applies for your future buyer, who will be looking for his/her own financing options to buy your property. The more options, the more available buyers, the higher the price. If you don’t care about the resale value, you can pay off your loan fast, and you plan to collect rents into your grandchildren’s retirement, then 5-10 units may be more interesting to you. If you have any questions, contact me or click the “read more” button to leave a comment.

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