One of the biggest hurdles to investing for newcomers is having cash for the down payment. They see low money down loans advertised and wonder if they can use them to purchase an investment property.
This is America! We like debt. It keeps us buying. Of course, there is good and bad debt. Good debt is used to help you make more money (an investment). Bad debt is used to make you happy now and sad in the future (a new boat). There’s not a lot of good debt options, but buying a property is one of them. If you are looking to purchase that first home or that first rental home, then you need to read further.
What is an FHA Loan?
The federal government has many levers with which to gently (or firmly) get its citizens to do what it wants. They usually involve money in some way. The government wants you to get married, so it gives married couples a tax break. Same with having children. The government wants you to own a house, so it allows you to claim a deduction on your income taxes based on the interest you payed on your mortgage.
The government also really wants people to buy their own home. So, way back in 1934, it passed a law allowing the Federal Housing Administration, or FHA, to help. You see, people often have a habit of not paying back their loans. Banks don’t like this. So, they implement stringent qualifying criteria, higher interest, and more money down in an effort to make loans only to those who would pay them back. That meant that a lot of people without access to cash for the down payment could not buy a house.
The ‘FHA loan’ is a loan that meets certain criteria put forth by the FHA. If the loan meets them, then the government insures the loan – so banks can be comfortable making the loan – if the borrower doesn’t pay it back, the bank can collect from the government. In return, the loan has to have a low down payment, low interest rate, low and closing costs.
This is great for buyers of modestly valued homes (up to 115% of the area’s median home price). You can have as low a down payment as 3.5%. But the government doesn’t really want people to be making investment money off of this deal. So there are a few restrictions:
- You must live in the home as your primary residence for a year
- You can’t use it to purchase multifamily properties greater than 4 units
- Often you have to pay for mortgage insurance
If you want to use the FHA program for investing, you have a few options.
- Rent it out after a year. You will need to purchase the property and live in it for a year. There are some exceptions, for instance, if you have to relocate for a job or you have a family change. After that year, you can usually purchase a new property and rent out the old one – ask your banker up front about this plan. A person can only have one FHA loan at a time (with some rare exceptions), so this can only be used to get started and isn’t really sustainable as an investment strategy.
- Buy a small multifamily. This is for 2-4 units. This is a great way to get into investing. Some call it house-hacking, where you live in one unit and rent out the rest. You have to be willing to share a wall with your tenants, though.
If you can’t do either of these, then you are stuck with a conventional loan. Often, these will require 20% down. They can have less or more, though. These are great loans to negotiate with multiple banks to find the best one.
If you meet the FHA criteria, then go for it. If not, now is a great time to begin saving the money needed to get that down payment.
