The 2 for 1 deal: Buying a duplex with bad credit

By Gina Pogol
Mortgage Credit Problems Columnist

Dear Gina, In my town, I could buy a home and pay less than I do in rent. I'd also like to buy investment condos and be a landlord, but my credit problems won't let me qualify for a loan on rental property. Do hard money lenders finance condos with small down payments? - Jeff, Las Vegas, Nev.

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Dear Jeff,

If you have bad credit, mortgage lenders won't be interested in lending to you on investment property, especially condos (risky!) with small down payments (mucho risky!). However, even with mediocre credit, you can become a landlord.

FHA multi-unit property loan

If you tried to buy rental property (even without needing mortgage loans for people with bad credit) with conventional financing, you'd have to put at least 20 percent down and more likely 25 percent to 35 percent. You'd also be hard-pressed to find anyone willing to make investor loans on condos in Las Vegas these days.

However, you can buy rentals with a small down payment and not-so-great credit by purchasing a duplex, triplex, or fourplex and living in one of the units. Your down payment requirement is only 3.5 percent.

How rental income helps with qualifying

FHA allows you to use the rental income from the property to help qualify for a loan. Here's how:

  • Duplex: Take 75 percent of the rent from the second unit and add it to your gross income. This equals your income for qualifying purposes. So if your income before tax is $3,000 per month, and the second unit of your duplex would rent for $800 per month, you'd get to add $600 (75 percent of $800) to your $3,000 for a total income of $3,600 per month. You can run this income and your payments through a mortgage prequalification calculator or simply ask lenders to prequalify you.
  • Triplex or fourplex: You'd add 75 percent of the rent from the two or three units to your gross income, like the duplex example above. However, FHA also requires that three- and four-unit properties pass a self-sufficiency test. You'd take 75 percent of the total estimated rents (per the appraisal) for all units. This amount can't be less than the total payment (principal, interest, taxes, insurance, HOA dues). If it is, you'd have to reduce the monthly payment by buying the rate down or increasing your down payment until the property passes the test.

Credit scores and qualifying

Qualifying is the same as for a single-family residence with FHA. You'll want to have your credit squared away with on-time payments for at least the last 12 months, and a credit score of at least 620 for a 96.5 percent loan (guidelines say 580 but most lenders require at least 620). At least three years must have passed following a foreclosure and two since a Chapter 7 bankruptcy.

The FHA mortgage for multi-unit property is probably the easiest way to go from renter to landlord. Good luck!

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