Is a 5 Unit Building Residential or Commercial for Financing?

You found a six-unit building. The numbers work, the rents are real, and you call your lender expecting the same process you went through on your last duplex.

Instead you get told it is a commercial loan.

That answer catches a lot of investors off guard, and it changes the deal more than most people realize. Here is where the line actually sits and what happens when you cross it.

The line is drawn at four units

For financing purposes, a property with one to four units is residential. Five units and up is commercial. It does not matter that a six-unit building looks like a big house, sits on a residential street, and rents to ordinary tenants. Four is the line.

Everything familiar about a mortgage lives on the residential side of that line. Thirty-year fixed terms. Standard appraisal forms. Underwriting built around a borrower. Cross into five units and you are in a different system.

What changes when the deal goes commercial

Commercial financing is not worse in every way, but it is different in ways that cost money and time.

• The term gets shorter. Commercial loans commonly run five, seven or ten years with a balloon payment at the end, amortized over twenty or twenty-five years. You are not locking a rate for thirty years. You are agreeing to refinance on someone else's schedule.
• The rate is usually higher. Commercial pricing tends to sit above residential pricing for a comparable borrower.
• Personal guarantees show up. Many commercial lenders want recourse, meaning you are personally on the hook beyond the property.
• Your tax returns come into it. Commercial underwriting typically wants full financials, business documentation and global cash flow analysis.
• The timeline stretches. Commercial files move at commercial speed, which is slower than a residential closing.

For a stabilized six-unit building generating steady rent, that is a lot of friction for a fairly simple deal.

There is a residential-style path for 5 to 8 units

This is the part most investors never hear about, because most loan officers do not offer it.

Certain DSCR programs finance five to eight unit residential properties on residential-style terms. Thirty-year fixed is available. There is no balloon. And qualifying is based on the property, not on you.

DSCR stands for debt service coverage ratio, and it is exactly what it sounds like: the property's eligible rents divided by its full monthly payment, including principal, interest, taxes, insurance and association dues. If the building covers its own payment, it qualifies. A ratio of 1.00 means it covers the payment exactly, and that is the typical minimum.

No tax returns. No W-2s. No debt-to-income calculation. The rent roll does the work.

I finance 1 to 8 units on DSCR, which is why a five, six, seven or eight unit building does not have to become a commercial file when it lands on my desk.

What these programs actually require

Qualifying on the property does not mean qualifying on nothing. The areas that decide most 5 to 8 unit files:

• Investor experience. These programs are generally built for people who have owned and managed non-owner-occupied rental property before. First-time investors usually are not eligible on 5 to 8 units.
• Credit around 680 and up. Better scores buy better pricing and higher loan-to-value.
• Reserves after closing. Roughly six months of payments, more on larger loans, and cash-out proceeds normally cannot be used to satisfy it.
• Signed leases. Executed leases with a six-month or longer initial term, not projections. A limited number of vacant units can count at a percentage of market rent.
• Property condition and location. Rural properties, leaseholds, large parcels and buildings with health or safety deferred maintenance are usually ineligible.

The short-term rental question

This one comes up constantly and the answer surprises people.

On 5 to 8 unit residential DSCR programs, short-term rental income is generally not permitted. A unit you are running as a short-term rental is typically treated as vacant, which means no income counted from it.

If your plan for a six-unit building is to furnish half of it and list it nightly, that plan and that loan usually do not fit together. It is a solvable problem, but it has to be solved before you write the offer, not during underwriting.

How to figure out which path your deal belongs on

Send me the address, the unit count and the rent roll. That is enough for me to tell you whether the building fits a residential-style DSCR program or genuinely belongs in commercial financing, and roughly what each would look like.

If a commercial loan is actually the better answer for your deal, I will tell you that too.

More on the program, including what the ratio has to be and what documentation the file needs: DSCR investor loans for 1 to 8 units.

Dan Frio is a federally registered mortgage loan originator with PBT Bancorp, NMLS #257781. Able to assist borrowers with mortgage financing nationwide. Serving Chicago, Kane County and the Fox Valley.

Dan Frio | NMLS #246527 | PBT Bancorp | NMLS #257781 | 524 Main St, Hazard, KY 41701 | Equal Housing Lender

Program guidelines are general, vary by investor and property, and are subject to change without notice. This is not a commitment to lend and not all applicants will qualify.