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Ask Dr. Don

Multi-family home-financing

Dr. Don,
I own a one-family home and am in the process of looking for a multi-family home. I will sell the one family after I find a two- or three-family home. My question is, how do I go about financing the multi-family, since I will be buying it before I sell my one-family. I would like to use the equity in the one-family to buy the multi-family. Would it be a good idea to take out a home equity line of credit and use that for a down payment on the multi-family? Or would a bridge loan be better, and what kind of interest do you pay for a bridge loan? Do you pay a higher interest rate for a multi-family home?
Maureen Multi-family

Dear Maureen,
Even though you are looking for a property with two to four residential units, in terms of mortgage lending the loan is considered a single-family loan. As an owner-occupied property, your loan will have a lower interest rate than a non-owner occupied property.

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There is a FHA program for one to four unit dwellings, but the loan limits are fairly restrictive. You can look up the FHA loan limits in your county on this HUD Web site.

With conventional financing, the lender will assess the risk of the loan based on your credit score, income, and the property's projected rental income based on an operating income statement. The status of the lease agreements for the rental units will also influence the lending decision.

Loans originated under Fannie Mae guidelines require two months of reserves for principal, interest, taxes and insurance (PITI) while a Freddie Mac origination requires six months worth of PITI reserves.

A bridge loan can provide the financing you need while waiting for your current home to sell, but you should try to avoid using a bridge loan. When you use a bridge loan to close on the new home you'll be responsible for two mortgage payments plus interest payments on the bridge loan. The bridge loan is collateralized by the equity in your current home. You use the proceeds of the bridge loan to cover the down payment and closing costs on the new home.

Bridge loans are meant to be short-term loans. They typically have an initial term of six months with the ability to extend if required. The ability to extend is important if the house doesn't sell.

The interest rate on a bridge loan should be between the rate you would pay on a first mortgage and a home equity loan. Since it's a short-term loan, managing the fees and closing costs can be more important than worrying about a rock bottom interest rate. It's easier to get a bridge loan when your home is under contract, but if your home is under contract you should be able to arrange the two closings so you don't need a bridge loan.

Don't just assume that owning a one to four family unit is right for you. Develop a business plan, examine cash flows, and evaluate maintenance issues to be fairly certain that this investment will work for you. Use your real estate professional and tax adviser to help you make the best possible decisions concerning this investment. Good luck.

-- Posted: Aug. 10, 2001

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