For most people interested in rental property investment, the biggest hurdle is the amount of capital it takes to acquire a property. Here’s why it can be so hard to find the money to buy your first investment property – and how I was able to buy my first with only a few thousand dollars down.
With practically all traditional means of financing, investment properties require down payments of 20 to 25% of the purchase price. This is in addition to the typical requirement of at least six months of reserves and the set-up and other closing costs you have to pay. For an investment property of $ 150,000, it is common to need $ 50,000 or more in available cash to close. And that’s not to mention the fact that investment home loans tend to have significantly higher interest rates than the same borrower might get for a primary residence mortgage. In many cases, the difference can be two whole percentage points or more.
The bottom line is that while rental properties can be great ways to build wealth and generate passive income streams over time, capital requirements create a barrier to entry for many investors. potentials. Here’s how I got around that – and how you can too.
Home hacking with an FHA loan
An FHA loan is a popular choice among first-time home buyers, and it’s easy to see why. With as little as a 580 FICO credit score, you can buy a home with as little as 3.5% down. There is just one small problem for investors. FHA loans are exclusively for properties occupied by their owner. In other words, you have to live in the house.
However, there is a big loophole. FHA loans can be done on a property with up to four residential units. As long as you plan to live in one of the units after the purchase closes, you can potentially use an FHA loan to purchase the property. For example, you could buy a triplex, live in one unit, and rent the other two – and with just 3.5% off.
Additionally, FHA rules only require you to live in the property for 12 months after closing. After this period, you can leave the property, rent all units, and repeat the process with a new property if you choose to do so.
My first real estate investment was a house purchased with an FHA loan. At the time, my then-fiancé and I were living in Key West, Florida, a very expensive real estate market, especially for a teacher and nurse in their mid-twenties.
On the advice of my excellent real estate agent, we started looking for a multi-unit property to generate income to offset the high cost of owning a home. We found a great duplex with a two bedroom main unit we could live in comfortably and a one bedroom unit we could rent a few blocks from the school where I was teaching, and we concluded the purchase with an FHA ready a few months later. We quickly found a tenant for the smaller unit and ended up living in the house for less than what we would pay in rent for a typical one bedroom apartment in the area.
Disadvantages of Home Hacking with FHA Loans
To be fair, home hacking isn’t for everyone. Not everyone wants to be a homeowner, and those who don’t feel comfortable with their own the tenants being right next door. And I can tell you firsthand that it can create uncomfortable situations. It is important to have your own backyard and the general privacy that comes with a single unit property.
Plus, there is no such thing as a perfect loan product, and the FHA mortgage is certainly no exception. Although the down payment and credit requirements are low, FHA loans have expensive mortgage insurance premiums (both initial and ongoing) which can make these loans much more expensive than their interest rate. involved.