Buying a duplex as a first home

In short

A friend of mine once said he bought a duplex because he wanted the tenant next door to help pay his mortgage. That is a fair reason, and it is worth understanding how it works. If you are thinking about a duplex as your first home, you can live in one side and rent out the other. A lender may count part of the expected rent when it decides how much you can borrow. The loan rules for a home you live in are friendlier than the rules for a pure rental. You will still owe the full mortgage even when the other side sits empty. Plan for repairs and vacancies before you plan for profit.

The whole of it

What it is

I once watched a neighbor of mine paint his porch rail while his tenant carried groceries up the other set of steps. They waved like old friends. That is the picture most people have of an owner occupied duplex. It is one building with two homes under one roof. You live in one unit, and a renter lives in the other.

The word that matters is owner occupied. It means the buyer promises to live in the property as a main home. Lenders treat that promise seriously. A buyer who lives in the building looks safer to a lender than an investor who does not. So the loan terms are often better.

Nobody calls this a common first home. It is unconventional, and that is the honest word for it. You are buying a house and a small business at the same time. The business is being a landlord. That deserves a clear look before you sign anything.

How it works

You have probably heard that a first home takes a big down payment. That is not always true. The Federal Housing Administration, or FHA, insures loans that let a buyer put down as little as the current figure, which the official source publishes each year when the buyer lives in the property. The FHA also sets a cap on how large a loan it will insure. That cap is higher for a two unit building than for a single home, and it changes by county. HUD, the Department of Housing and Urban Development, posts the current limits for each county on its website.

Here is the part that surprises people. A lender may count a share of the rent you expect to collect. The lender does this through a rental income rule, and the share it counts is often smaller than the full rent. It leaves room for empty months and repairs. Your own pay still carries most of the weight in the lender's math.

Conventional loans work in a similar way. Fannie Mae publishes a Selling Guide that lays out what lenders may count and what they must document. A lender may ask for an appraisal that includes a rent estimate. It may also ask for a lease, or proof of what similar units rent for nearby. Each lender has its own extra rules, so ask early.

Once you close, the building is both your home and your income property. You pay one mortgage. You also pay for insurance, property tax, and upkeep on the whole building. The renter pays you rent, and you decide what to do with it. Most sensible owners set some aside for repairs first.

The numbers, and where to find yours

I know how it feels to stare at a pile of numbers and wonder which ones are yours. Start with a few. The FHA minimum down payment is the current figure, which the official source publishes each year for a borrower who qualifies. The FHA loan limit for a two unit home in your county is the current figure, which the official source publishes each year. Find the exact figure on the HUD website for your county.

The next number to find is your credit score, because it changes the rate a lender offers. After that, find the local rent for a unit like the one you would rent out. A real estate agent can help, and so can a look at current listings. Be careful here. A hopeful rent guess can wreck a budget.

The loan itself will carry an interest rate, mortgage insurance, property tax, and homeowners insurance. Each one is a monthly cost. The Consumer Financial Protection Bureau, or CFPB, has free tools and plain explanations for reading a Loan Estimate. That form is the standard three page summary a lender must give you after you apply. Read it slowly.

A worked example

Let me tell you about a woman named Dana. She earns $52,000 a year and wants her first home. She finds a duplex listed at $300,000. She plans to live in one side and rent the other.

She puts down 3.5 percent. That is $300,000 times 0.035, which is $10,500. Her loan is then $300,000 minus $10,500, which is $289,500. She will also pay closing costs, which she estimates at $9,000. She keeps that cash ready too.

Her lender expects the rental side to bring in $1,400 a month. The lender counts only 75 percent of that for qualifying. So $1,400 times 0.75 is $1,050 a month. That counted rent adds $12,600 a year to her income picture, since $1,050 times 12 is $12,600. Her income for the lender's math becomes $52,000 plus $12,600, which is $64,600.

Now look at her real monthly bills. Suppose her mortgage payment, taxes, and insurance add up to $2,350 a month. The renter pays $1,400. That leaves Dana paying $2,350 minus $1,400, which is $950 a month out of her own pocket. That is a good deal if the rent keeps coming.

Dana is careful, so she tests it. Suppose the unit sits empty for two months. She loses $1,400 times 2, which is $2,800 in rent. Suppose a water heater fails and costs $1,300. Her bad stretch costs $2,800 plus $1,300, which is $4,100. If she has no cushion, she is in trouble. So she saves a repair fund before she buys.

Where it goes wrong

I have watched good people get tangled up in this, and I never think less of them for it. The first trouble is the empty unit. Rent stops, but the mortgage does not. A borrower has to repay the loan whether a renter lives there or not.

The second trouble is a bad renter. A tenant who pays late, damages the unit, or leaves suddenly can cost real money. Evictions follow local law, and they take time. Learn your state and city rules before you buy.

The third trouble is living close to your renter. Thin walls and shared yards can strain a friendship fast. You are now the person who fixes the sink and also the person who asks for the rent. That is a hard mix for some folks. It suits others fine.

The fourth is the owner occupancy promise. The lender requires the borrower to live there for a set stretch of time, and the loan papers spell out how long. Breaking that promise is a serious breach of the mortgage agreement. The loan papers may let the lender demand the full balance early, and the exact terms depend on the contract and on state law.

The fifth is the numbers. People sometimes count the rent as free money. It is not. Repairs, insurance, taxes, and vacancies all take a bite. Rent also counts as taxable income, so keep good records and talk with a tax professional about what you may deduct. The IRS explains rental income and expenses in Publication 527, which is titled Residential Rental Property.

Questions to answer before you leave this page

Have you looked up the FHA loan limit for a two unit home in your county on the HUD website, and does the price of the building you want fit under it? Do you know what a unit like the one you would rent actually brings in nearby, and not just what you hope it brings in? Could you pay the whole mortgage for two or three months if the rental side sat empty? Have you saved a repair fund, so a broken water heater does not become a crisis? Are you comfortable being a landlord to a neighbor who lives ten feet away? Do you know your state and city rules about leases, deposits, and evictions? Have you asked your lender how much of the rent it will count, and how long the occupancy promise lasts? And have you read the Loan Estimate line by line, with the CFPB guide open beside it?