How to Finance a 5-Unit Property

Financing a five-unit property involves distinct considerations compared to acquiring a single-family home or smaller multi-unit dwelling. Lenders generally categorize these properties, with five or more residential units, as commercial real estate. This classification significantly shifts the financing landscape, dictating available loan products and lender evaluation criteria. The process requires focused financial preparation and awareness of the specialized market for multi-unit investment properties. This guide clarifies the nuances of financing a five-unit property, from initial considerations to securing a loan.

Unique Aspects of 5-Unit Property Financing

Financing a property with five or more units differs substantially from securing a mortgage for a one-to-four unit residential property. Lenders classify these larger multi-unit dwellings as commercial or multifamily properties. This means financing is assessed based on the property’s income-generating potential, in addition to the borrower’s financial standing.

Lenders primarily focus on the property’s ability to produce consistent rental income. This income is central to determining the property’s financial viability and its capacity to cover debt obligations. Lenders scrutinize existing and projected rental revenue, along with operating expenses, to gauge profitability. The property’s intended use, such as solely for investment or if an owner plans to occupy a unit, can also influence financing options.

Available Loan Products for Multi-Unit Properties

Several types of loan products cater to the financing of five-unit properties, each with unique characteristics and eligibility criteria. Traditional commercial bank loans are a common avenue for financing multi-unit properties.

These mortgages, offered by banks and credit unions, typically feature terms from five to twenty years, with amortization periods extending up to thirty years. Commercial loans usually require a loan-to-value (LTV) ratio between 65% and 80%, meaning a borrower needs a 20% to 35% down payment.

Portfolio loans represent another flexible financing option, where the lender retains the loan rather than selling it on the secondary market. This allows for customized terms and qualification requirements, particularly for properties that may not fit standard lending guidelines. Often provided by private lenders, these loans can have higher interest rates compared to other multifamily loans.

For rapid funding or properties needing significant rehabilitation, private and hard money loans serve as alternative, short-term solutions. These loans generally have terms from one to five years and come with higher interest rates, often 7% to 15%. Hard money loans are asset-based, with LTV ratios typically between 50% and 75% of the property’s value, and can close faster than traditional financing, sometimes within ten to twenty-one business days.

Government-backed programs also provide substantial financing for properties with five or more units, distinct from residential FHA or VA loans. Fannie Mae’s Delegated Underwriting and Servicing (DUS) program and Freddie Mac’s Optigo program offer competitive interest rates, higher LTVs (up to 80%), and non-recourse options. These agency loans are designed for stabilized properties, with terms extending up to thirty years. The Federal Housing Administration (FHA) also insures multifamily loans for five or more units, offering lower down payments, sometimes as low as 3.5% for owner-occupied properties, and more flexible credit requirements.

Lender Requirements and Property Evaluation

Lenders thoroughly evaluate both the borrower and the property when considering financing for a five-unit dwelling. This assessment involves specific financial metrics and extensive documentation to determine the loan’s viability and associated risk.

Borrower qualifications are a key component. Lenders look for a strong credit score, generally 680 or higher, though some FHA programs may accept scores as low as 580. The borrower’s debt-to-income (DTI) ratio is assessed, and lenders examine cash reserves to ensure liquidity, often requiring reserves equivalent to six to twelve months of mortgage payments. This demonstrates the borrower’s capacity to manage the property and its debt service, especially during vacancy or unexpected expenses.

The property undergoes detailed underwriting to assess its income-generating potential. Net Operating Income (NOI) is a primary metric, calculated by subtracting operating expenses (such as property taxes, insurance, utilities, and management fees) from the property’s gross rental income, excluding debt service, depreciation, and capital expenditures. Lenders use NOI to calculate the Debt Service Coverage Ratio (DSCR), which measures the property’s ability to cover its loan payments. A common minimum DSCR for multifamily properties is 1.20x to 1.25x, indicating NOI should be at least 120% to 125% of annual debt service. Lenders also factor in vacancy rates, often assuming a 5% to 10% vacancy when projecting future income.

A comprehensive set of documents supports the loan application. This includes personal financial statements, two to three years of personal and business tax returns, and recent bank statements. Property-specific documents, such as current rent rolls detailing tenants and lease terms, and operating statements (profit and loss statements), are also necessary. These financial records provide lenders with a clear picture of the borrower’s financial health and the property’s historical performance.

Finally, specific property assessment reports verify the property’s value and identify potential risks. An appraisal, which employs income, sales comparison, and cost approaches, determines the property’s market value. A Phase I Environmental Site Assessment (ESA) is often required. This non-invasive report identifies potential environmental contamination liabilities associated with the property’s current and historical uses.

Navigating the Loan Application and Closing

Once a borrower has gathered the necessary financial and property details, the next phase involves engaging with lenders and progressing through the formal application and closing procedures. Identifying suitable lenders is an initial step.

Borrowers often seek commercial real estate brokers, local or regional banks with commercial lending departments, or credit unions specializing in multifamily or commercial loans. These institutions handle the complexities of five-unit property financing.

The process often begins with pre-qualification or pre-approval, an initial assessment by the lender to gauge the borrower’s eligibility and the property’s general suitability. This provides an early indication of potential loan terms without committing the borrower or lender. The formal loan package, including all prepared financial and property documentation, is then submitted to the chosen lender.

Upon submission, the loan enters the underwriting and approval process. The lender’s internal team reviews the package, verifying information and potentially requesting additional details. This review ensures the loan meets the lender’s risk criteria. During this period, the lender initiates their own due diligence, including ordering a third-party appraisal, commissioning environmental reports like the Phase I ESA, and conducting title searches to confirm clear ownership.

After underwriting is complete and the lender is satisfied with the risk assessment, a loan commitment letter is issued. This letter outlines the final terms and conditions. The final steps involve closing, where all parties sign the necessary legal documents, and loan funds are disbursed. This marks the culmination of the financing process, allowing the borrower to finalize the acquisition or refinancing.