Multifamily Loan Comparison

A detailed multifamily loan comparison of 3 common apartment loans: Local Bank Loans vs Fannie Mae Loans vs DSCR Loans. Discover the pros and cons of each and their best use, plus a practical example that will compare the differences between the loans. This thorough comparison will help you better understand what your multifamily loan options are when financing apartment deals.

 

Multifamily Financing

Lenders have raised interest rates and tightened up requirements for both the investor and for the property, making qualifying for a loan more difficult. Since financing is a crucial component of multi-family investing, now more than ever, it’s important that you understand the complexities of each loan, how they work, and which loan is best suited for your deal. After comparing all three, you can decide which loan is best for you because every multi family deal won’t fit into every loan. Also, you as an investor won’t fit every loan program.

3 Most Common Multifamily Loans

• Local Bank Loans
• Fannie Mae Multi Family Apartment Loans
• Debt Service Coverage Ratio (DSCR) Loans

In addition to the pros and cons and the best use of each of these 3 loans, you’ll also get a practical example to compare the differences in the terms. Knowing these terms is essential when financing your multifamily properties with conventional loans. When looking at a loan for a commercial property, these are the terms you must know: loan amount, interest rate, years fixed, amortization, payments, pre-pay penalty, recourse/non-recourse, and assumable. Once you know the terms of the loan and how they are used, you can apply them to your own multi family portfolio.
 

1. Local Bank Loans

These are the small regional banks in your local area.
Pros: It’s easy to qualify and get approved for the loan. Plus, you don’t need to be an experienced investor.
When our Protégé students need to use conventional financing, they often use a local bank. And those that are inexperienced investors have no problems qualifying.
Cons: The downside of multifamily financing from local banks is they’re not flexible. Small regional banks are confined in a box, and because they’re terms aren’t flexible, they may not be the best. Although you don’t need to be an experienced investor to qualify for a loan, they may require a higher down payment or charge you a higher interest rate.
Best Use: Local bank loans are best suited for those just starting out in multifamily investingmultifamily investing or for small multi family investments. They’re a great option for a property up to twelve units because smaller multi family properties have a smaller loan amount.

Local Bank Loan Example

Loan Amount: $750,000
Interest Rate: 7%
Years Fixed: 7 years fixed
Amortization: Amortized over 25-years
In commercial real estate it’s unusual to have 30-year fixed loans like you have in residential. Instead, commercial real estate lenders like to renew their loans every 5, 7 or 10 years. So a typical commercial loan for $750,000 is going to balloon in 7 years, but the payments are amortized over 25 years at 7%.
Payment: $5,300/month
Pre-Pay Penalty: 3 years
Commercial real estate loans include pre-pay penalties, meaning if you pay off the loan before the 7 years, there’s a penalty fee to pay. In this case, it’s a 3-year pre-pay penalty. If you pay it off or decide to refinance or sell the property and get rid of the loan within the 3 years, you owe them 1% on the balance.
Recourse/Non-Recourse: Recourse
The term recourse means that you are personally guaranteeing the loan. If you default on the loan and foreclose, you have personally guaranteed the loan and the lender can pursue your personal assets if the sale of your property doesn’t cover the defaulted loan. For the most part, local banks issue recourse loans.
Assumable: No
Most multi family loans from local banks are not assumable, meaning you can not transfer the loan to a buyer. So if you want to sell your property and have your buyer assume your loan, most local banks will not allow it.
 

2. Fannie Mae Apartment Loans

Fannie Mae Apartment Loans are government insured loans. So, even though your bank will be the lender, the loan is a backed or guaranteed by the federal government. The benefit of this is that if for some reason you fail, the government will pay off the loan.
Pros: They’ll give you the most competitive rates. If we compare all three loan programs today, Fannie Mae loan rates are the lowest. Plus, they allow the lowest down payment, usually requiring 20% down on a multi family investment.
Cons: Fannie Mae might give you the best rates, but a big disadvantage is that the minimum loan size is $750,000. And often Fannie Mae lenders won’t loan on anything below a million dollars. The other problem with a Fannie Mae loan for multi family is they want you to be an experienced investor. Now, there are exceptions to this rule; many of our proteges were able to overcome this requirement by dealing with lenders that we know. And there are other ways to get around this, but for the most part, if you’re coming in off the street without our help, you won’t be able to utilize this loan because you need to know how to maneuver things.
Best Use: If you’re planning a long-term hold on a potential property, a Fannie Mae loan is a good choice. But it’s especially well suited for a syndicated deal because the terms are great and if you structure it so you have interest-only payments for a few years, combined with the low interest rates, it’ll really increase your ROI.

Fannie Mae Apartment Loan Example

Loan Amount: $750,000
Interest Rate: 6%
Years Fixed: 7 years fixed
Amortization: 30-year amortization
Payment: $3,750 (interest only)/$4,496 (full principal and interest payments)
Let me explain the two different payments. The $4,496 a month is the full principal and interest payments at 6% and 30 years. With Fannie Mae, you can get one or two years paying interest only, which will really help you with your cash flow. Often when our students are structuring deals, there’s a value-add period of renovation and repairs to improve the units and maximize the cash flow. So, having a lower monthly mortgage payment in the first couple years allows us to catch up the property until we get the higher cash flow and then we can start paying the higher payment. This option isn’t usually available from your local bank.
Pre-Pay Penalty: Yield Maintenance
Yield maintenance is a form of a pre-pay penalty, and it is a bit more complicated. Again, if you were to get out of this loan before the years fixed is up, in this case 7 years, you are required to pay a penalty fee. In fact, depending on the loan, this penalty can sometimes extend the full 30 years. It’s complicated because the prepay penalty fee is helping the investor who bought your loan on Wall Street to maintain their profit. So if they buy your loan and you get out of it early, you must compensate them for the loss of interest and pay a hefty penalty so they can maintain their profit or their yield. Which means you don’t want to get out of this loan within a year or two because the prepay penalty is exorbitant! Sometimes 8% of the loan amount. Ouch!
Recourse/Non-Recourse: Non-recourse
Fannie Mae loans are non-recourse, meaning you do not personally guarantee the loan. If you default on your loan, the bank can’t try to seize your personal assets if the sale of the property doesn’t cover the defaulted loan. The bank can only collect on the asset named in the loan. I personally prefer non-recourse loans for my deals because I don’t want to personally guarantee a loan for $13-14 million. This is the beauty of a Fannie Mae Apartment Loan. You have this safe guard if something were to go wrong.
Assumable: Yes
Most Fannie Mae loans are assumable. So, two years down the road, if you want to get out of the loan, instead of paying the large pre-pay penalty your investor can assume the loan for a 1% assumption fee.
As you can see the Fannie Mae multi family loan is bit more complicated, but it may be worth it because interest rates are lower. And again, this is ideal for a long-term hold or a syndicated deal.
 

3. Debt Service Coverage Ratio (DSCR) Loan

DSCR or debt service coverage ratio loan is financing based on the property’s ability to service the loan. The loans are qualified by the property (investment) and not you the investor. How it works is the lender will make sure that the property’s NOI is at least 1.2 times greater than the mortgage. If it is, then they’ll approve you.

Pros: It’s based primarily on your property’s net operating income. You don’t need to show any personal income or personal income tax returns.
Cons: The biggest downside to DSCR loans are the higher interest rates and more stringent debt coverage ratio (DCR) requirements. The higher your credit score and the better the DCR, the better terms you get.
Best Use: If you’re self-employed, this loan can be helpful because often self-employed people don’t show any income on a tax return. This is especially true for commercial real estate investors because we have so many tax benefits. Even though we pocketed a bunch of cash flow, on paper we show very little income. So, if you show no income, or even if you have no income because you aren’t working, but you have good credit, and the property has a solid DCR, this DSCR loan may be the way to go for you.

DSCR Loan Example

Loan Amount: $750,000
Interest Rate: 8.5% (when I looked today it’s 9.5 to 10% – it went up that much across the board!)
Years Fixed: 30 years fixed
Amortization: Amortized over 30 years
Payment: $5,312 per month (interest only)
This sum is an interest only payment. Often with a DSCR loan you can do 10-years interest only and that payment would be $5,312.
Pre-Pay Penalty: 3-year step down pre-pay penalty fee
A 3 year step-down pre-pay penalty is this: If you get out of the loan in the first year, the fee is 3% of the loan amount. The second year, the fee is 2% of the loan amount. And the third year, if you want to get out of this loan, it will cost you 1%.
Recourse/Non-Recourse: Recourse – you personally guarantee the loan.
Assumable: No
 

Multifamily Loan Quiz!

Now, that you have this comparison of the three primary multifamily loans, it’s time to test your knowledge with a real deal. Which loan would you choose for this deal?

• 24-unit multifamily property in a great neighborhood
• Purchase price is $1.8 million.
• The down payment is $450,000. You only have $50,000 of the down payment and you need to raise the remaining $400,000.
• You found an investor who not only has the remaining $400,00, but they also have experience. So, they’re going to sign on a loan with you.
• Your exit strategy is to hold it long term.

You’re bringing in a partner and you want to hold it long term for cash flow. Which loan would you choose? Let me know in the comments!

Every successful multifamily investor has a mentor! Get you mentor here: https://www.commercialpropertyadvisors.com/protege-program/