Affordable target price comparison between business and residential loan
Member since 2018 · 72 posts · 25 votes
Affordable target price comparison between business and residential loan
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Lender · CA · Member since 2018 · 638 posts · 393 votes
1yQuote from @Bill B.:
If it's 4 units you'd always want the residential loan with the 30 year fixed rate, especially if you plan to live there. The commercial loan will be 3-5 or 7 years then you'll need to refinance. Can you imagine your interest rate doubling like it did a couple years ago? Even if it's a 30 year fixed DSCR that allows you to live in it the interest rate will make the "residential" loan a far better choice
Oh the other hand if it’s 5+ you’ll have to go commercial. I’ve often seen 5 units sell for the same or less than 4 units because there are less buyers and the financing is worse. Heck I bought a “four plex” where there was an “owner’s storage area” exactly the same size as the other 4 units. :-).
.
But especially if you plan to live in one unit I would assume you’d save another full point in interest. Almost like being paid to live there.
10 Replies
- Lender · CA · Member since 2018 · 638 posts · 393 votes1y
This is generally correct, DSCR loans do not look at all at your personal income. We only look at the income the property is generating for those. For the high cost areas like Palo Alto it is difficult to get a property to cashflow out the gate because rents have not caught up with the cost. I've helped a lot of investors in your area, and I find that many of them end up purchasing rentals in the Central Valley for the very reason you mentioned.
- Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes1y
If it's 4 units you'd always want the residential loan with the 30 year fixed rate, especially if you plan to live there. The commercial loan will be 3-5 or 7 years then you'll need to refinance. Can you imagine your interest rate doubling like it did a couple years ago? Even if it's a 30 year fixed DSCR that allows you to live in it the interest rate will make the "residential" loan a far better choice
Oh the other hand if it’s 5+ you’ll have to go commercial. I’ve often seen 5 units sell for the same or less than 4 units because there are less buyers and the financing is worse. Heck I bought a “four plex” where there was an “owner’s storage area” exactly the same size as the other 4 units. :-).
.
But especially if you plan to live in one unit I would assume you’d save another full point in interest. Almost like being paid to live there. - Member since 2018 · 72 posts · 25 votes1yThank you, Clayton.
Quote from @Clayton Silva:
This is generally correct, DSCR loans do not look at all at your personal income. We only look at the income the property is generating for those. For the high cost areas like Palo Alto it is difficult to get a property to cashflow out the gate because rents have not caught up with the cost. I've helped a lot of investors in your area, and I find that many of them end up purchasing rentals in the Central Valley for the very reason you mentioned.
- Lender · CA · Member since 2018 · 638 posts · 393 votes1ySo to clarify, you CANNOT live in a DSCR property as DSCR is business purpose only and that is not allowed. 5-10 units can also qualify for 30 year fixed DSCR loans as well. Just a heads up
Quote from @Bill B.:
If it's 4 units you'd always want the residential loan with the 30 year fixed rate, especially if you plan to live there. The commercial loan will be 3-5 or 7 years then you'll need to refinance. Can you imagine your interest rate doubling like it did a couple years ago? Even if it's a 30 year fixed DSCR that allows you to live in it the interest rate will make the "residential" loan a far better choice
Oh the other hand if it’s 5+ you’ll have to go commercial. I’ve often seen 5 units sell for the same or less than 4 units because there are less buyers and the financing is worse. Heck I bought a “four plex” where there was an “owner’s storage area” exactly the same size as the other 4 units. :-).
.
But especially if you plan to live in one unit I would assume you’d save another full point in interest. Almost like being paid to live there. - 1yKo KashiwagiPro MemberLender · Los Angeles, CA · Member since 2022 · 967 posts · 445 votes
Hi Zhengyang,
Conventional loans (residential) look at your personal income (like tax returns) while DSCR loans (business purpose) look at the rental income. Yes, in states like CA you can often find better leverage using conventional loans and this is a strategy that can be employed. However, it is important to note that if a leverage you're looking for doesn't qualify with DSCR, it means that your cash on cash return is negative (because it means your NOI or Rent is lower than rent -in most cases).
So if you want to maximize leverage and are less cash flow sensitive (okay being negative), then conventional makes sense. If you want to vest under LLCs and not affect your DTI, you'd generally want to go DSCR.
- Lender · Long Beach, CA · Member since 2013 · 496 posts · 296 votes1yAre you going to live in one of the units, or is this investment only? Makes a difference.
Quote from @Zhenyang Jin:
I am a software engineer working in Bay Area. I found out that:
Case 1. When doing business loan for 4+ units multifamily, my W2 can not be used to calculate DSCR. For the top tier area like Palo Alto where cap rate is 4.0%, LTV can only be limited to 40%~45%. For the 1.5M downpayment, the target price is only 2.5~2.73M.
Case 2. When doing residential loan for fourplex, my W2 + my partner's W2 can be used to calculate DTI. LTV can reach 70~80% even the cap rate is only 4.0%. For 1.5M downpayment, the target price can reach 5~7.5M if DTI is allowed.
Due to the big difference on target price, I raise this topic to confirm whether my understanding is correct or not. I wonder whether expert can confirm this?
Because my DIT is low, maybe Case 2 for fourplex is my preferred loan type than Case 1 if I want to invest locally. Any advice is welcome.
- 1yErik EstradaBusiness MemberLender · Member since 2022 · 6k+ posts · 1k+ votes
Quote from @Zhenyang Jin:
I am a software engineer working in Bay Area. I found out that:
Case 1. When doing business loan for 4+ units multifamily, my W2 can not be used to calculate DSCR. For the top tier area like Palo Alto where cap rate is 4.0%, LTV can only be limited to 40%~45%. For the 1.5M downpayment, the target price is only 2.5~2.73M.
Case 2. When doing residential loan for fourplex, my W2 + my partner's W2 can be used to calculate DTI. LTV can reach 70~80% even the cap rate is only 4.0%. For 1.5M downpayment, the target price can reach 5~7.5M if DTI is allowed.
Due to the big difference on target price, I raise this topic to confirm whether my understanding is correct or not. I wonder whether expert can confirm this?
Because my DIT is low, maybe Case 2 for fourplex is my preferred loan type than Case 1 if I want to invest locally. Any advice is welcome.
Hi Zhenyang
It sounds like you are looking to determine which kind of loan will allow you to afford a higher price point based on a $1.5 Mil down payment?
Case 1 sounds like a DSCR loan. Lenders do not look at your personal income or debt and will use the current market rent or lease (up to 120% if the lease is significantly higher than market rent or vice versa) as qualifying income. Generally, most DSCR lenders will want a 1.00 Ratio or higher using the PITI as the monthly expense. There are some instances where you can still get a higher LTV loan being below a 1.00 DSCR; however, the rate and cost will be much higher. You also should be aware of the Pre Payment Penalties on this loan, especially if you are incorporating a BRRRR strategy. The benefit to this option, however, is that you are able to hold the property in an LLC orCorp and you will not be limited by your personal DTI.
Case 2 sounds like a conventional loan. You should generally be able to afford a higher price point if your W2 income is strong, and you and your partner have low debt. Unlike the DSCR loan, there is no prepayment penalty on this loan, so you will not be stuck in a high-interest-rate loan for 3-5 years. Rates are generally better on a conventional loan when accounting for all fees and prepayment penalties. The drawback is that you are not able to close the property in an LLC or corporation.
LuxePrivate Investments LLC 572 Reviews - Member since 2018 · 72 posts · 25 votes1yThank you, Erik. Good comparison.
Quote from @Erik Estrada:
Quote from @Zhenyang Jin:
I am a software engineer working in Bay Area. I found out that:
Case 1. When doing business loan for 4+ units multifamily, my W2 can not be used to calculate DSCR. For the top tier area like Palo Alto where cap rate is 4.0%, LTV can only be limited to 40%~45%. For the 1.5M downpayment, the target price is only 2.5~2.73M.
Case 2. When doing residential loan for fourplex, my W2 + my partner's W2 can be used to calculate DTI. LTV can reach 70~80% even the cap rate is only 4.0%. For 1.5M downpayment, the target price can reach 5~7.5M if DTI is allowed.
Due to the big difference on target price, I raise this topic to confirm whether my understanding is correct or not. I wonder whether expert can confirm this?
Because my DIT is low, maybe Case 2 for fourplex is my preferred loan type than Case 1 if I want to invest locally. Any advice is welcome.
Hi Zhenyang
It sounds like you are looking to determine which kind of loan will allow you to afford a higher price point based on a $1.5 Mil down payment?
Case 1 sounds like a DSCR loan. Lenders do not look at your personal income or debt and will use the current market rent or lease (up to 120% if the lease is significantly higher than market rent or vice versa) as qualifying income. Generally, most DSCR lenders will want a 1.00 Ratio or higher using the PITI as the monthly expense. There are some instances where you can still get a higher LTV loan being below a 1.00 DSCR; however, the rate and cost will be much higher. You also should be aware of the Pre Payment Penalties on this loan, especially if you are incorporating a BRRRR strategy. The benefit to this option, however, is that you are able to hold the property in an LLC orCorp and you will not be limited by your personal DTI.
Case 2 sounds like a conventional loan. You should generally be able to afford a higher price point if your W2 income is strong, and you and your partner have low debt. Unlike the DSCR loan, there is no prepayment penalty on this loan, so you will not be stuck in a high-interest-rate loan for 3-5 years. Rates are generally better on a conventional loan when accounting for all fees and prepayment penalties. The drawback is that you are not able to close the property in an LLC or corporation.
- Real Estate Agent · San Jose, CA · Member since 2023 · 182 posts · 104 votes1y
Quote from @Zhenyang Jin:
I am a software engineer working in Bay Area. I found out that:
Case 1. When doing business loan for 4+ units multifamily, my W2 can not be used to calculate DSCR. For the top tier area like Palo Alto where cap rate is 4.0%, LTV can only be limited to 40%~45%. For the 1.5M downpayment, the target price is only 2.5~2.73M.
Case 2. When doing residential loan for fourplex, my W2 + my partner's W2 can be used to calculate DTI. LTV can reach 70~80% even the cap rate is only 4.0%. For 1.5M downpayment, the target price can reach 5~7.5M if DTI is allowed.
Due to the big difference on target price, I raise this topic to confirm whether my understanding is correct or not. I wonder whether expert can confirm this?
Because my DIT is low, maybe Case 2 for fourplex is my preferred loan type than Case 1 if I want to invest locally. Any advice is welcome.
In my opinion, if you can go conventional, most of the time it is a better choice due to the better interest rate and terms. In your case of a fourplex, option 2 should get you a better deal.
I would also agree with Bill on how the number of units may not correlate with the value of the property unless it is a large multifamily complex, and sometimes a fourplex or several single family houses would give you better returns.
- Lender · CA · Member since 2018 · 638 posts · 393 votes1y
Quote from @Wilson Lau:
Quote from @Zhenyang Jin:
I am a software engineer working in Bay Area. I found out that:
Case 1. When doing business loan for 4+ units multifamily, my W2 can not be used to calculate DSCR. For the top tier area like Palo Alto where cap rate is 4.0%, LTV can only be limited to 40%~45%. For the 1.5M downpayment, the target price is only 2.5~2.73M.
Case 2. When doing residential loan for fourplex, my W2 + my partner's W2 can be used to calculate DTI. LTV can reach 70~80% even the cap rate is only 4.0%. For 1.5M downpayment, the target price can reach 5~7.5M if DTI is allowed.
Due to the big difference on target price, I raise this topic to confirm whether my understanding is correct or not. I wonder whether expert can confirm this?
Because my DIT is low, maybe Case 2 for fourplex is my preferred loan type than Case 1 if I want to invest locally. Any advice is welcome.
In my opinion, if you can go conventional, most of the time it is a better choice due to the better interest rate and terms. In your case of a fourplex, option 2 should get you a better deal.
I would also agree with Bill on how the number of units may not correlate with the value of the property unless it is a large multifamily complex, and sometimes a fourplex or several single family houses would give you better returns.
100% We always recommend conventional first until you can no longer qualify for those. Better rates and no PPP makes them the best options (generally). Unless the borrower is self employed and takes a lot of expenses to show lower income on their returns then it usually makes sense to pay a couple thousand a year in higher interest (you can pay like 4,000 a year in additional interest for DSCR if you are saving 30+k on your tax bill kind of math lol)
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