Understanding FHA Multi-Family Loan

Looking to purchase or finance a multi-family property? You may want to consider an FHA multi-family loan. Multi-family properties, such as apartment buildings, provide housing for multiple tenants in individual units on a single property. Financing these types of properties can open up opportunities for real estate investors, but it requires a different loan approach than single-family homes.

One option is an FHA-insured loan through the U.S. Department of Housing and Urban Development (HUD). FHA offers competitive financing terms targeted specifically at multi-family properties through its Multifamily Accelerated Processing (MAP) and Traditional Underwriting programs.

Key Terms and Concepts in Multi-Family Lending

What is a Multi-Family Property?

A multi-family property refers to any residential property designed to house multiple families or tenants at a single location. Common multi-family property types include:

• Apartment Buildings – Typically 2+ units with separate entrances in a single structure. It can range from low-rise to high-rise buildings.
• Condominium Complexes – Multiple residential units owned individually with common areas maintained by an association.
• Co-ops – Housing cooperative where occupants own shares in the overall property corporation.
• Duplexes/Triplexes – 2-3 residential units in a single structure, sometimes referred to as 2-4 unit properties.

To qualify as a multi-family property for FHA lending, the property must contain five or more dwelling units. Duplexes, triplexes, and 4-unit properties fall under a different loan category called FHA Section 214.

Debt Service Coverage Ratio

An important financial metric used in multi-family underwriting is the debt service coverage ratio, also known as DSCR. Simply put, the DSCR measures the property’s net operating income compared to annual debt payments.

Specifically, it’s calculated as the net operating income divided by the annual debt service. A DSCR above 1.0 indicates the property generates sufficient income to cover annual mortgage payments, fees, taxes, and insurance. FHA typically requires a minimum DSCR of around 1.11 for loan approval.

This ratio gives lenders confidence the property cash flow can sustainably support the mortgage and expenses, even during lean economic periods. It’s a key factor in evaluating the viability and risk level of the loan.

Loan-to-Value Ratio

The loan-to-value (LTV) ratio compares the mortgage loan amount to the appraised value or acquisition price of the property. It represents the percentage of the property’s worth being financed versus the down payment amount.

For conventional multi-family loans, the maximum LTV from a single lender may top out around 80%. FHA multi-family loans, however, can loan up to 97.75% of the appraised value through a single mortgage. The higher LTV expands access to capital for low-down payment borrowers and acquisition financing.

Now that we covered some baseline terminology, let’s dive into the specifics of FHA multi-family loans.

Details of FHA Insured Multi-Family Lending

Eligibility Requirements

To qualify for an FHA multi-family loan, the property and borrower must meet certain requirements:

• Property Type – As mentioned, must be a 5+ unit apartment complex, mixed-use with 5+ residential units, condo project, co-op, or residential component of a mixed-use building. Manufactured housing communities also qualify.
• Dedicated Use – Property must be used solely for multifamily residential purposes. No commercial or retail space is permitted on the title.
• Minimum Affordability – Borrower must agree to rent restrictions keeping at least 20% of units affordable to low/moderate income tenants for an initial 20-year mortgage term.
• Creditworthy Borrower – Minimum 620 FICO score. Individuals and sophisticated entities like LLCs, partnerships, corporations, and nonprofits can qualify.
• Good Standing – Borrower cannot be suspended or otherwise prohibited from participating in FHA programs.

Provided all requirements are met, most multi-family properties with 5+ units located in eligible metropolitan statistical areas (EMSAs) qualify for FHA insurance.

Standard Loan Features

Here are some of the standard features of FHA multi-family loans:

• Maximum Term – Up to 40 years for new construction or substantial rehabilitation (gut rehabs). 35 years otherwise.
• Low/No Down Payment – Can finance up to 97.75% LTV for purchase and refinance. No down payment is required on small refinances under $200k.
• Competitive Interest Rates – Usually better than conventional, especially for high LTV loans. Fixed rates.
• Prepayment Options – Flexible for refinancing as property values rise. No prepayment penalties first 10 years.
• Assumable – Qualified buyers can assume the remaining loan balance, subject to lender approval.
• Streamlined Process – Faster closing through proprietary FHA MAP/Traditional Underwriting programs.
• Consistent Standards – Uniform national guidelines vs. local bank underwriting variations.

FHA aims to expand multi-family investment opportunities through relaxed requirements compared to conventional loans. Their standardized products promote liquidity and availability nationwide.

Comparing MAP vs Traditional Underwriting

FHA offers two basic pathways for insuring multi-family loans – MAP and Traditional Underwriting. While the overall programs are similar, there are some important differences in the underwriting process:

Multifamily Accelerated Processing (MAP)

• Faster pre-approval timeline, often 30 days or less
• Uses standardized forms, submissions allowed year-round
• Pre-approved lender completes full underwriting upfront
• Streamlined conditional approval if underwriting criteria met
• A final firm commitment issued after closing
• Appropriate for repeat or sophisticated borrowers

Traditional Underwriting

• Slower 45-90 day pre-approval process
• Applications are only accepted Jan-Apr annually
• FHA completes full underwriting review
• Conditional approval decisions may include items to clear
• Firm commitment before closing required
• Better for complex transactions or 1st-time borrowers

While MAP offers more flexibility and speed, Traditional Underwriting provides an extra check of loan and property quality directly by FHA. Most experienced multi-family lenders are MAP-approved.

Additional Financing Programs

In addition to standard purchase and refinance loans, FHA also offers niche programs tailored for specific multi-family situations:

223(a)(7) Refinance Loans

Allows refinancing existing FHA-insured loans to a new lower fixed rate without risk assessment. Streamlines process to reduce one mortgage into another.

223(f) Refinance Loans

Refinance existing debt on property with 5+ years of operational history. Can include repairs in the new loan. Assists properties transitioning out of conventional loans.

223(a)(7) Refi w/ Repairs

A hybrid that lets 223(f) refinance perform capital improvements. Combines refi benefits of both programs into one transaction.

Small Balance/Small Refinance Loans

Expedited process and reduced paperwork for refinances $5M or less. Ideal for small properties and capital preservation.

Affordable Housing Programs

Special incentives exist for properties restricting rents longer for elderly, disabled, or supportive housing tenants.

This variety of offerings enables FHA to adapt to many multi-family finance scenarios over a property’s lifecycle. Lenders can help identify the best fit based on individual needs.

Understanding FHA’s Underwriting Process

Now that the essential features and programs are clear, let’s break down FHA’s multi-family underwriting methodology step-by-step:

Origination and Initial Review

Borrower works with approved FHA MAP or Traditional lender to complete application forms and submit required items like rent rolls, operating statements, budgets, appraisals, licenses, and building plans.

Environmental Risk Assessment

FHA evaluates any hazardous materials risks through a Phase I report. Phase II testing may follow depending on initial findings.

Market Study and Appraisal

Third-party analysts assess local rental market conditions, average occupancy, rent comparables, and income/expense projections to value the property.

Submission Package Review

Completed application materials are reviewed by FHA to ensure all data required is accounted for and in compliance with submission standards.

Underwriting Processing

FHA or lender underwriter analyzes details like historical NOI/DSCR trends, rent rolls, budgets, payables, reserves, and management experience. It may require clarification.

Firm Commitment Decision

Provided all review stages receive satisfactory results and required ratios like minimum 1.11 DSCR are met, FHA issues firm commitment for mortgage insurance. This locks in the rate and terms for closing.

Closing Process

The lender works with its closing attorney to coordinate signing final loan documents, obtaining title insurance, recording the mortgage with county records, and disbursing funds.

Post-Closing Requirements

FHA monitors annual financial reporting like audited financial statements. Property owners must maintain at least 20% affordable rents for 20 years. The lender oversees escrow for taxes and insurance.

That covers the basic FHA underwriting workflow. To summarize some key advantages:

• Streamlined nationwide process versus local bank variation
• Low down payments and flexible terms compared to conventional loans
• Standardized forms and consistent due diligence criteria
• Broader program offerings like refinances, small loans, special needs housing

FHA aims to promote greater access to multi-family funding across different property types, locations, and borrower situations.