House Hacking: Your Entry Into Real Estate Investing
By JD Esajian on December 28, 2018
Every real estate investing path is different. Will yours be house hacking?
Some investors get into the business right out of college while others wait until they are well into their forties to get started. Some build their portfolio by renting out their primary residence while others stumble into a deal. There are investing options regardless of experience, credit, capital and resources. There is truly no right or wrong path to success.
You don’t even need to own your own home to start building a portfolio. With an FHA loan you can buy your first home with little money down, reduced credit scores and increased debt to income ratios. You may not even need the whole down payment and you can even make money on the property. If you are currently renting an FHA loan may be the ideal way to get starting in real estate. Here are five benefits of an FHA loan option for a first-time investor.
- Reduced payment. An FHA loan is a loan that is backed by the US government and offered by almost every lender or mortgage broker. It has a specific set of underwriting guidelines and parameters that are much less strict than conventional loans. Perhaps the most significant guideline is the reduced down payment. Instead of the traditional 20% down requirement, borrowers can get into the property for as little as 3.5% of the purchase price. Additionally, some of this can be offset by a seller credit. They can essentially give back up to 6% for closing costs and property tax escrows. This will massively reduce the total out of pocket amount needed and make buying a home almost less than what is needed for a security deposit.
- Gift funds. FHA loans do not follow conventional loan guidelines. With conventional loans all the down payment and closing costs must be in your existing bank account for at least 60 days. With an FHA loan you do not need all the money to close. FHA allows some, or all, of the down payment to be a gift from an eligible source. There are a handful of family members who can gift you the money. The thinking behind this is to get more borrowers who can afford the payment but may not have all the down payment into a home. As long as the debt to income ratio and other guidelines are met, the cash to close can be supplied by an eligible source. For the buyer, this allows you to purchase a property with little, to no, out of pocket expense except for the appraisal and inspection.
- Below market interest rate. FHA loans are not perfect, by any stretch of the imagination. For starters, they have strict property guidelines and requirements that must be met. The subject property cannot have any peeling paint on the interior or exterior, there must be hand railings on all entryways and the overall condition must be above average. If there are any issues or concerns with the appraisal, they must be satisfied before the loan will be approved. There is also an upfront mortgage insurance fee that is either added to the loan amount or added to the closing costs. Additionally, the private mortgage insurance (PMI) is on the monthly payment for the life of the loan. Where most conventional loans allow the PMI to be eliminated once the equity hits 20%, FHA PMI is for the entirety regardless of equity. The offset is that the interest rate is generally at least a half point below conventional loan rates. Depending on the size of the loan this could be a significant factor in the payment. These reduced rates are available on either a 15- or 30-year fixed rate.
- Multiple units. Here is where an FHA loan makes the most sense for a prospective investor. FHA loans are good for any property one to four units. With additional units, there are increased requirements for credit score and assets. However, the requirements for a single- or two-family property are generally the same. What this means is that you can buy a two-family property, live in one unit and collect rent on the second unit. In most cases this will greatly offset, or even eliminate, the bottom line monthly payment. Additionally, if you have considered owning rental property this will give you a real-world taste of what you would be in for. With an FHA loan you are required to live in the property as your primary residence for at least one year. After twelve months you can move out and rent both units or keep things as they are and rent out any additional units you own. With multiple units it will give your investing an instant jumpstart and put your portfolio growth in motion.
- Options. There are many benefits to property ownership. Not only are you building equity, but you may be able to take advantage of some sizable tax breaks. Regardless of your plan with the property, you will have a handful of options in a short period of time. If you live in the property for a few years and want to get your own place you may have equity to use as a down payment or you can continue to rent and generate cash flow. Either way, you will get more out of the property than if you spent the last few years renting.
FHA loans generally require a minimum 600 credit score and 3.5% down payment. If you are looking to get started in real estate, an FHA loan may be the ideal vehicle to do so.