Disclaimer: This is designed to provide general information regarding the subject matter covered. It is not intended to serve as loan, legal, tax, or other financial advice related to individual situations. Consult with your own lending professional, attorney, CPA, and/or other advisor regarding your specific situation.
Oftentimes, first-time real estate investors struggle with finding enough capital to make their first rental or flip purchase, thinking they must have a down payment of 20 percent or more to get into a property.
What if you could drop your price of entry to 3.5 percent down by using an FHA loan?
Sound too good to be true?
Let me explain…
What Is an FHA Loan?
Let’s start with some facts. FHA loans as compared to Conventional loans, are a mortgage issued by the Federal Housing Association (FHA), which is a U.S. government agency. These loans are insured by the FHA and have smaller down payments than conventional loans.
Like any loan, they come with lender qualifications (1), such as:
- FICO score 580+ for 3.5% down payment
- FICO score between 500-579 for a 10% down payment
- 2 years of steady income and proof of employment
- 43% or less debt to income ratio (DBTI)
And if you were to ask the FHA, they would say you cannot use an FHA loan to buy a rental property due to the last qualification that the home must be owner-occupied.
Related:
So, you might be asking yourself, “I thought you said you could buy a rental with an FHA loan?”
Hang with me here. 🙂
Why Would Using an FHA Loan Make Sense for an Investment Property?
If you are just starting out in real estate investing, leveraging your own primary home (or living situation) is a great place to start while you save for larger down payments on future properties. Since you can put an FHA loan on a primary home, why not make your primary your first real estate investment?!
The pros of using an FHA loan are:
- Great interest rate (As of today, rates are hovering close to 4%.)
- High loan to value (96.5%)
- You can buy up to a fourplex
The drawbacks of using an FHA loan are:
- You must move into the property in under 60 days and live in it for up to 1 year
- You can only by up to a fourplex
- You will owe mortgage insurance, in most instances for the life of the loan
- You cannot do short-term rentals
How Can You Invest in a Rental With an FHA Loan?
Now that we have covered what an FHA loan is, plus the pros and drawbacks of using an FHA loan, let’s put the puzzle pieces together.
Below are a few ways one could use an FHA loan to invest in a real estate property.
- The live-in flip: Buy a single family house as a primary, live in it one year, fix it up as needed, sell it. Then, find another single family primary and get another FHA loan!
- The rental: Buy a single family house as a primary, live in it one year, move out, and rent it. Then, find another single family primary and get another FHA loan!
- The single family house hack to rental: Buy a single family house as a primary, pack it full of roommates, fix it up as needed, live in it one year (hopefully for close to free), move out, and rent it. Then, find another single family primary and get another FHA loan!
- The multifamily house hack to rental: Buy a multifamily, live in one unit, rent the remaining units, have renters help pay your mortgage, move out, and rent your unit. Then, find another multifamily primary and get another FHA loan!
- The BRRRR hack to rental: Buy a single family house that needs a considerable rehab as a primary, do a special type of FHA loan called a 203K loan (2) to cover your rehab costs, live in it one year, move out, and then sell it or rent it. Then, find another single family primary and get another FHA loan!
Related: An FHA-Financed Duplex is an Ideal First Investment Property: Here’s Why
As you can see, we can keep going for quite a while on the different ways you can combine investing tactics. And we haven’t even talked about using a cash-out refinance or HELOC to access your equity to go do your next deal!
Case Study
In 2002, I purchased my first primary home with an FHA loan. The home needed a cosmetic rehab, and I was willing to put in much of the sweat equity over the next few months. I also was able to rent the additional rooms to people who didn’t mind a little construction dust.
Fast forward one year later, $8K in materials costs, and some elbow grease, I netted the following:
- $300/month after all monthly expenses were paid
- I was living for free!
- I pushed the value of the property, and sold it 1 year later for $52,000 more than I put into it
Here was my only mistake: In hindsight, I wish I hadn’t sold it. Rather, I wish I’d done a tax-free cash-out refinance to pull equity from the property for my next down payment and kept a cash-flowing rental. Lesson learned!
Conclusion
Clearly, there are several ways you can leverage FHA loans. Combine this powerful lending tool with a little time and hustle, and nearly anyone can build a real estate empire.
- https://www.fha.com/fha_loan_requirements
- https://www.hud.gov/program_offices/housing/sfh/203k/203k–df
Disclaimer: This is designed to provide general information regarding the subject matter covered. It is not intended to serve as loan, legal, tax, or other financial advice related to individual situations. Consult with your own lending professional, attorney, CPA, and/or other advisor regarding your specific situation.
Have you heard about other creative ways to leverage FHA loans? Do any of the above methods appeal to you? Why or why not?
Let’s talk in the comment section below!
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
