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Owning a duplex is a path to real estate investing with a low barrier to entry versus other options. It gives buyers an opportunity to earn rental income without having to come up with the funds to purchase a dedicated rental property.And financing for a duplex is easier to obtain than one may assume. With a loan from the Federal Housing Administration, buyers have access to the same flexible loan terms as buyers of single-family homes in the same program.
Financing a duplex with an FHA loan
With FHA financing, buyers can put down as little as 3.5% of the loan amount. Additionally, credit requirements are flexible, with a minimum score as low as 500, depending on the size of the down payment. (Buyers who put down only 3.5% will need a score of at least 580.)
An important factor to consider, though, is that FHA financing requires duplex buyers to occupy one of the two units for at least one year.
Buyers who seek to purchase a duplex exclusively for investment purposes with no intention of living in one of the units are limited to conventional loans, which typically come with higher interest rates, larger down payments and other buyer requirements.
That being said, you can still leverage owning a duplex to your advantage while staying within the confines of an FHA loan.
“If you have a duplex and you can get sufficient rent from one half of it to cover a significant part of your mortgage, you’re coming out ahead,” according to Tendayi Kapfidze, chief economist for LendingTree, the parent company of MagnifyMoney.
While flexible borrower requirements help make financing a duplex more accessible, buyers should keep in mind that there are FHA limitations on the prices of the property that can be financed.
Limitations vary by state and county and are calculated annually, based on the market value of homes in a particular area. In 2019, maximum price limits for two-unit properties range between $403,125 and $930,300, with the higher end of those limits reserved for areas that FHA considers “high cost.”
Exceptions to these limits include Alaska, Hawaii, Guam and the U.S. Virgin Islands, where maximum limits reach $1,395,450.
In addition to the loan limits established by the FHA, lenders look at a borrower’s debt-to-income ratio (DTI) to determine what size mortgage they qualify for. Your DTI represents how much of your income goes toward debt repayment.
To calculate your DTI, a lender will add up the monthly payments of all your debt obligations (credit cards, auto loans, student loans, etc.) as well as the prospective payment on the mortgage, and divide it by your gross income. Typically, lenders look for your DTI to be under 43%. So, if your monthly income is $5,000, your total debt payments including the mortgage will need to be under $2,150.
Fortunately, lenders also include a percentage of the expected proceeds from the rental unit when calculating your income, which ensures qualifying for a larger mortgage than if just your non-rental income sources were used.
FHA owner-occupied residency requirements
As mentioned, FHA guidelines require that borrowers live in one of the two units when financing a duplex with an FHA loan. However, this requirement doesn’t mean you’re destined to live in the duplex as long as you own it.
The guidelines state that borrowers must intend to occupy the residence for at least one year, so there is flexibility in the requirement, should your circumstances lead you to move out of the property after a year.
Keep in mind that FHA loans also typically require a property to be a borrower’s primary residence, so if you do move out of the duplex and are looking for a mortgage on a subsequent property, you wouldn’t qualify for another FHA loan, in most cases.
The bottom line: FHA does not finance investment properties, so do not intentionally try to work around this guideline.
Total costs of a duplex mortgage
When weighing the affordability of financing and owning a duplex, the purchase price of the property is just one factor to consider. Prospective buyers should do their due diligence before committing to a mortgage and stepping into the role of landlord.
Just as with purchasing a single-family home, borrowers should know the cost of homeowners insurance as well as real estate taxes.
Furthermore, all FHA loans require mortgage insurance. Borrowers pay an upfront premium of 1.75% of the loan amount, which they can roll into the mortgage or pay in cash. Additionally, borrowers pay an annual mortgage insurance premium, or MIP, calculated on a monthly basis and included in the mortgage payment.
Duplex owners have further costs to consider.
Before purchasing a duplex, you’ll want to find out from the current owner whether the rental unit is currently occupied. If so, you’ll need to learn the details of the rental agreement, including how much time remains on the tenant’s lease and how much they are paying.
If the current tenants are paying below-market rates, that will eat into your projected profits for the rental. And similarly, if the unit is vacant, there is no guarantee you will be able to fill it immediately.
It’s a good idea to find out the average monthly utility expenses for the property, especially if the lease agreement for the rental will include utilities. In addition to asking the current owner for monthly costs, you may be able to get the information by calling your utility providers directly.
Maintenance and repairs
Like any homeowner, maintaining your home will help increase the property’s value. As a landlord, though, doing so is even more critical.
Make sure you have a firm grasp of the routine maintenance and services necessary for the property, as well as upcoming improvements and repairs. If the roof will need to be replaced in a few years, that’s something you should know going in.
Be prepared for making repairs on the property in a timely fashion, which can be costly if something needs to be done on an emergency basis.
Some duplex owners who prefer a hands-off approach with their tenants choose to hire a property manager to oversee the rental unit. Research the costs for this in your area, as paying a property manager will affect your bottom line.
Many new landlords assume they’ll be able to keep tenants in their property without lapses, but unfortunately, that is not always the case. For this reason, Kapfidze said buyers should be able to afford the mortgage on the duplex without relying on the rental income.
“Make sure you can independently take on that financial obligation,” he said. “You don’t want to end up in a situation where because you’ve been unable to rent out the other unit, you’re risking losing your own home.”
Beyond planning for anticipated expenses, duplex owners should be prepared for the unforeseen and even worst-case scenarios. Costs you may encounter include emergency repairs, damage to the property and legal fees, if necessary.
“You’re taking a risk when you become a landlord,” Kapfidze warned. He said buyers should make sure they are comfortable with those risks and should have strategies in place to mitigate them. Kapfidze suggested buyers become familiar with the landlord-tenant rights in their state.
Fortunately, some of the additional costs that go into owning and managing a duplex can be offset by some of the tax advantages.
In addition to being able to deduct a portion of the interest paid on your mortgage annually, many of the expenses you incur or your tenants incur on your behalf are also tax deductible, including repair costs and operating expenses (for example, hiring a property manager). A tax professional can help you identify which expenses are deductible.
Other things to consider
While the prospect of receiving rental income is appealing, Kapfidze said potential duplex buyers should answer an obvious but important question: “Do you want to be a landlord?” Second, buyers should carefully consider whether they want to be a landlord whose tenants live next door.
Kapfidze advised that prospective owners should consider the “lifestyle factors” even before weighing the potential financial benefits.
Owning a duplex can be a great way to enter the world of real estate investing, but it’s not a decision you should make on a whim or just because you can afford the mortgage payment.
It’s essential that if you plan to take on the responsibilities of being a landlord, you have a realistic picture of what that entails, and at what cost.