Vacancy – loss of income when a tenant is not living there
Repairs – income spent on fixing items for tenants
Cap Ex – Also known as capital expenditures. These are long term repairs that need to be saved for that only happen every 10-20 years, but are usually large expenses. Examples are roof, siding, mechanicals, ect. We put money aside every month to pay for these large one-time expenses.
Reserves – Savings account used to cover unexpected expenses
Residential property – A property with 1-4 units and qualifies for a residential loan
Commercial Property – A property with 5+ units or a combo of apartment and business space that requires a commercial loan.
Cap Rate – This is how commercial property is valued. It is the annual profit of a property (not including the loan) represented as a percentage of the cost of the property. A 10% cap rate property means that the annual cash flow before the loan equals 10% of the total value. (Example. A $100k property that has $10k a year cash flow would be a 10% cap rate) Cap Rates is not applicable in determining value with properties with 1-4 units. I use cap rate with properties in 1-4 units to provide apples to apples comparison. I use it so you can see the overall profitability of a properties that have different price points or different expenses, as an overall representation of the profitability.
Water – utility that the owner pays as there is only one bill per property. Bills can be metered, where you are charged every other month for the amount of water you use. Bills can be unmetered, where you receive a bill every six months for unlimited water. The city has a program at www.metersave.org where you can get a free water meter installed. They provide a 7 year guarantee that your metered bill will not exceed the cost you were paying before it was metered. Most people see a decrease in their bill when they get the meter by 30% – 40%.
Electric – Each building is set up differently for electric, generally there is one electric meter per floor. If electric was updated recently it will require 1 meter per unit plus a meter for common areas like laundry room, hallways, and garage.
Gas – Each building is different for gas, generally there is one gas meter per legal unit. It is common with in-law/garden units to be on the same meter as the first floor, so in that situation the landlord would pay gas and the tenant’s rent would be increased to include free heat and cooking gas.
P&I – Principle and interest. Your loan payment for the amount you borrowed and the interest payment the bank charges.
PITI – Principle, Interest, Taxes, and Insurance – or commonly referred to as your mortgage payment. This is the monthly payment the bank charges you to pay for your loan and to escrow your taxes and insurance.
Loan Limit – The maximum amount of the loan you can get for a property type. There are different loan amounts for legal 2, 3, and 4 flat properties.
|FHA Loan Limit||Max Purchase 3.5%|
|Conv Loan Limit||Max Purchase 5%||Max Purchase 10%||Max Purchase 15%||Max Purchase 20%|
Pre-Approval – Something you need to get before looking at property. The lender reviews your income and debts and gives you an approved budget to buy a house.
Equity – The difference between the value of the property and debts against the property.
OO / Owner Occupied – You will be living in the property and therefor get the most favorable lending terms. Loan options include 3.5% FHA, 5% Conventional, 10% conventional, 15% down conventional, and 20% down conventional. You must occupy the property for 1 year but may be able to move after 6 months if you had a qualified life event (adding a dependant, moving for a job, getting a bigger space)
NOO / Non-Owner Occupied – You will not be living at the property. This loan requires 25% down and will have a higher interest rate.
PMI – Private mortgage Insurance, a fee you are charged by the bank by using a low money down program.
3.5% Down FHA Loan – An owner-occupied loan that only requires a 3.5% down payment. You can use this loan at any time as long as you only have one at a time. You are charged PMI every month for the life of the loan. To get rid of PMI you must refinance the loan when you have 20% equity in it. You are also charged an upfront fee of 1.75% of the total loan amount and this is typically added to the loan balance when you purchase the home. FHA has its own loan limits which are about $200k-$300k less than a conventional loan. If it is 3 or 4 units it must pass the “self sufficiency test” which is that 75%of current rents must cover the mortgage payment, and property very rarely pass this test. If the tenants are in long term leases we have to use that rent. If they are month to month or the unit is vacant we can use market rents.
203k Loan – A rehab loan under the FHA program that allows you to put 3.5% down on the purchase price + rehab costs of a property. If a property is $200k and needs $200k of work your down payment would be 3.5% of $400k. All other FHA loan terms apply.
5% Down Conventional – An owner-occupied loan that only requires 5% down payment. There are no upfront fees and it has the highest loan limits, and slightly higher interest rate. This program has specific areas of the city where you can use, only low or moderate income areas, no matter what your income is.
10% Down Conventional – An owner-occupied loan that is offered through a credit union and has a max purchase price of $825k. It has no PMI and a program fee of $1,570. Rates are slightly higher and you can only use it once.
15% Down Conventional – An owner-occupied loan that requires 15% down payment, it is only available on legal 2 unit properties. You can use this loan anytime and can have up to 10 per person. There is no PMI, no upfront fees, and no restrictions on what property you purchase.
20% Down Conventional – An owner-occupied loan that requires 20% down payment. You can use this loan anytime and can have up to 10 per person. There is no PMI, no upfront fees, and no restrictions on what property you purchase
25% Down Conventional – A non-owner-occupied loan that requires 25% down payment. You can use this loan anytime and can have up to 10 per person. There is no PMI, no upfront fees, and no restrictions on what property you purchase.
DTI / Debt to Income Ratio – What the bank uses to determine how much house you can afford. Take your household income before taxes and divide that by 12, this is your monthly household income. Multiple that by 45% and this is the maximum amount the bank will allow for your payments. Write down all of your monthly bills that would appear on your credit (student loan, car loans, credit card minimum payments. Not things like auto insurance, groceries, cell phone bills. Pull your free credit report with creditkarma.com if you need to – just don’t pay attention to the score they give you, that is a different scoring system then the ones banks use) Subtract your monthly bills from the 45% of your monthly income, this is the maximum PITI payment you can have. Example – You make $120k a year before taxes / $10k a month. Your max monthly payments are $4,500 a month (45% of your monthly gross). Your car payment is $200 a month and your student loans are $300, that means your max PITI is $4000 a month.
Rental Income – Can be used to increase your approval. The bank will use 75% of the rent from legal (zoned units) units that you will not occupy. Example – You are buying a legal 2 flat with an in-law/garden unit. The garden rents for $1000, the first floor is vacant, the second floor rents for $1500. They will add $1,125 (75% of $1500) to your monthly gross income. Using the previous example that makes your monthly gross income $11,125. Your max monthly payments are $5,006 a month (45% of your monthly gross). Your car payment is $200 a month and your student loans are $300, that means your max PITI is $4,506 a month. (increases the approval $100k if using a 20% conventional, $91k if using 5% conventional, $87k if using a FHA)
Closing Costs – Fees required to purchase a home. This can be covered by making an offer with a closing cost credit. For example if your offer is $500k and you want a $10k closing cost credit, you make the offer for $510k with a $10k credit and the property must appraise for $510k to receive the credit, so it is not a guarantee. If it appraises for $505k the seller still gets $500k and your credit is reduced to $5k. Typical closing costs include:
- Origination – $1,600
- Recording Charges – $150
- Transfer Taxes – $750 for every $100k in price – example $500k / $100k = 5 * $750 = $3,750
- Title Fee – $3,300
Other costs associated with purchasing a home and included in your closing costs are:
- Insurance – $2,000 – $3000
- Appraisal – $500 – $700
- Home Inspection – $500 – $700
- Lawyer – $500 – $700
You will also need to make a deposit into your escrow account at the time of closing, those fees are typically:
- 3 months of insurance premium payments
- 45 days of interest payments
- 2-8 months of property tax payments (depending on the time of year and when the next tax bill is due)
You will also receive a tax credit from the seller since we pay our property taxes a year in arrears, so it depends on the time of year and when the next tax bill is due
Escrow – A savings account the bank holds for you to pay for your taxes and insurance. This is configured annually depending on the actual costs of your taxes and insurance. They will always want 3 months of a cushion + the anticipated monthly amount. If there is a surplus in the account at the end of the year you will get a refund. If there is a shortage then your payment will increase. When you refi or sell the property the balance is given back to you.
- Inspection – if the buyer and the seller do not agree to all the repair items after we get the inspection you can cancel the contract and get your money back.
- Attorney Review – Your attorney will make the offer contingent on a few things (example, it is legally zoned for 4 units, the leases match the information they gave us, the title is clear of any issues, ect) so if any of that comes up as an issue, the contract is cancelled and you get your money back.
- Loan – If something comes up and you do not get approved for the loan, you an get your money back. This only applies if you make a “good faith effort” to secure financing and then get denied.
Insurance – Replacement cost policy – covers the cost to rebuilt the property if it is destroyed (typically used). Actual Cash Value Policy – A set limit coverage. You get insurance before closing and pay for the entire year upfront before closing, then the bank collects monthly payments for you so that when the next annual bill comes there is enough in escrow to pay for it.
Title – Title is reviewed by your lawyer to ensure there are no liens on the property and that the seller has the legal right to sell the property.
Property Taxes – Chicago taxes are paid in arrears, meaning in 2018 we are billed for occupying the property in 2017. First installment tax bills are always 55% of the previous year’s bill and due March 1. The second installment tax bills take into effect exemptions, tax rate changes, assessed value changes, ect and are due August 1. If you close on a property October 1st 2017 the first tax bill will be due March 1 2018. Since you did not occupy the property for 75% of 2017 you are given a tax bill credit at closing from the seller. We cannot know what the tax bill is going to be in the future so we negotiate a proration based on the most recent tax bill we have, typically this is 100% – 110%.
Property Assessment – This is the value given to the property and what your tax bill is based off of. Every year the city of Chicago sends out a notice telling you the property value and what is used for determining the tax rate. Depending on your district you will receive the notice in spring or summer. If you want to appeal the value you only have a short timeframe to do so after you receive the notice, deadlines are included in the notice. Every 3 years the county does their reassessment and this is typically where we see the largest value increases. The last county assessment was 2018 and the next one is 2021. We run our calculations assuming your property will be reassessed to the purchase price and therefore you will have an increase in property taxes.
Tax Appeals – it is common to appeal the value of your property. Many law firms in Chicago focus only on this and charge 40% – 50% of the tax reduction you receive, but do not get paid if the value is not decreased. If your taxes are $6000 and they get the value reduced so your taxes are $5000 they will charge you 40%-50% of $1000. If you value remain the same next year you do not pay anything and get the benefit of the full $1000 reduction.