Mortgage loans can be classified into two major categories. The loans offered to owner-occupants and the more expensive and tougher ones for real estate investors. Usually owner-occupant financing for real estate with one to four units is readily available provided that you use one of the units as your residence. In other words, your status as an owner-occupant allows you to buy more than just a house or condo. You can actually buy property that produces rent and increases your tax deductions.
Lenders will apply most of the rent to your income for eligibility purposes. This means you can borrow more — and also that you can offset loan costs with the rents such properties produce.
Suppose you buy a property with four units. You’ll live in one and rent the others. Each of the three rental units has a fair market rental of 1,000.
In this situation you’re likely to get two benefits. First, the lender will count some portion of the rent — say three-quarters — as income for you when determining your qualification standards. In other words, 2,250 a month will be added to your income. (1,000 x 3 units = 3,000. 3,000 x 75% = 2,250)
Why 2,250 and not the whole 3,000? Because the lender assumes you’ll have vacancies, repairs, insurance, taxes and other costs for the rental units.
The lender also assumes something else: For tax purposes, three-quarters of the property in this example will be “investment” real estate. When reporting your income taxes you’ll list your rents and costs for these units. One of these “costs” will be depreciation, an accounting device that will lower your taxes but take nothing in cash from your pocket.
When lenders see depreciation they “add back” that cost when looking at your monthly income. The result is that your effective monthly income for loan qualification purposes will increase even more than 2,250 in this example.
Buying two-, three- and four-unit properties can make great sense, especially for first-time buyers. You’ll have “help” meeting monthly mortgage payments, especially in the first few years of ownership — the time that’s often the most difficult. Later on, if you elect to move you can sell the property or you might choose to keep it and just rent out the unit had been your residence.
As with all investments, neither annual income nor rising property values can be guaranteed. Some owners may feel uncomfortable having tenants so close and there’s always the potential for insufficient rents, excess vacancies and big repairs.
It is advisable for you to take up to four units and below. Anything above four is classified as a real estate `investment under guidelines for most loan programs.