Welcome to the 5 Minute Prime Podcast. Quick actionable tips to master personal finance and real estate investing. In just five minutes a day, we'll help you build wealth and achieve financial freedom. Hey Prime Investors, Martin Maxwell here. Welcome back to the 5-Minute Prime podcast. Picture the version of this you've probably already run in your head. You spent a year fixing your credit, you saved the down payment, you walked into a lender's office, and you walked out pre-approved. And now you're looking at a fourplex, thinking the hard part is behind you. On a three or four unit FHA purchase, it isn't. There is a second test. And the second test is not about you at all. It's about the building. Here's the rule, and I want to give it to you almost the way it's written because the wording is where people go wrong. On a three or four unit property, the rent that building can produce after a haircut has to cover the entire mortgage payment. Principal, interest, taxes, insurance, and the mortgage insurance premium too, which on FHA is not optional and is not small. Not most of the payment. All of it. Two units? The test doesn't apply. Three or four? It does. That's the line. So what does that actually require? Let's turn it into a number you can use, because a rule you can't run isn't a rule. It's trivia. Take the rate as it sits right now. 6.71% on the 30-year fixed as of September 3rd. That is, by the way, the highest it has been in about 13 months, which is a separate conversation. Put 3.5% down, add the annual mortgage insurance, which at that loan to value runs 55 hundredths of a percent. Add taxes and insurance at a percent and a half of value a year, which is a fair middle-of-the-road assumption. Run all of that through, and the building has to gross about 1.06% of its purchase price every month in rent. Now, some of you just did a double take, and you should have, 1.06% of price monthly in rent. That is the 1% rule. The oldest, most argued about, most dismissed screen in this entire business, the one every beginner learns in week one and every experienced investor rolls their eyes at. A federal underwriting standard, written to manage insurance risk, landed on the same number as a rule of thumb from the 1970s. Nobody planned that. It just falls out of the arithmetic. Which brings me to the part of this that actually matters. And it is not the trivia. Because there is a second number, and it is not the same one. We've built a floor on this show for what a deal has to clear before it's worth a second look. A cap rate, a set number of points above the 10-year treasury. The 10-year is sitting at 4.77%. Run that floor, put it through the 50% rule, and the rent to price you should be asking for today is about 1.63% a month. 1.06 is what the loan requires. 1.63 is what you should require. The loan's floor is roughly 35% below your bar, which means FHA will happily approve a building that your own screen would throw out. And I want to be careful here because this is the thing I most want you to take away. That is not FHA being careless. The test isn't asking your question. It is asking whether the property can carry the debt well enough that the insurance fund probably doesn't eat a loss. That is a completely reasonable question. It is just not, will this be a good investment for me? We've made this exact point before about lender coverage ratios, that the number a lender needs and the number you need are two different numbers, and that pricing your offer to the lender's number guarantees you a deal that works for them. This is the same animal wearing a different coat. Approval is not underwriting. Three things to actually do something with. First, and this one surprises people, the rent that counts includes the unit you're going to live in, all of them. The appraiser estimates market rent for every unit in the building, including yours, and that's the pool the haircut comes out of, which has a consequence worth sitting with. The bar works out the same whether it's a triplex or a forplex. It's a building level number. More units doesn't make it easier, and it doesn't make it harder either. Second, that haircut. I said the rent gets reduced before it's compared to the payment, and the number people quote is 25%. But the rule is the greater of 25% or the appraiser's own estimate of vacancy and maintenance. If the appraiser writes 30, you get 30. So read that again and notice who's holding the pen. The figure that decides whether your loan closes is produced by somebody hired by the lender whom you did not choose and cannot negotiate with. We have a rule on this show about numbers the other side generates. You don't get to treat them as diligence. This is that rule, showing up at the worst possible moment, which is after you're under contract. Third, and this one turns entirely on timing. There's a well-known move where you buy a duplex, add a second unit in the basement or over the garage, and now you've got three income streams on a two-unit loan. So does FHA count that as a three unit? One unit plus an added dwelling stays a one unit. Two units plus an added dwelling is a three unit. But the test runs once, at origination, on the property as the appraiser finds it. So buy that duplex with the garage apartment already built, or finance the conversion into the loan and you're buying a three unit. The test applies. Convert it yourself after closing, and that loan was underwritten on two units. It never sees the third door. The next FHA refinance will. Now, if you already own a three or four unit, or you're sitting in one right now, nothing here is a warning about a decision you already made. If you closed, it cleared. This isn't about that building. It's about the next offer you write. And if you're earlier than that, if you're still in the saving and reading phase, I'd rather you learn this now than at day 30 of an escrow. Because the version of this that hurts is the one where you find out late. So here's tonight's work, and it's about 10 minutes. Take whatever three or four unit is currently open in your browser. Add up the asking rents for every unit, including whichever one you'd live in. If a unit's vacant, use what the comparable ones get. Divide that total by the asking price. If the answer is under 1.06%, the loan is going to have a problem with it, and you should know that before you write anything, not after. And then do the second thing, which is the one almost nobody does, compare it to 1.63. Because if it lands between those two numbers, the honest read is that the loan will let you buy it and your own screen says you shouldn't. That gap is not a technicality. It is the entire distance between being allowed to do something and it being a good idea. If your building clears both, go find out what the appraiser thinks the rents are before you're emotionally attached to the place. That's your next step, and it's a phone call, not a project. I'm Martin Maxwell. This has been the Five Minute Prime Podcast. I'll see you next episode.