Real estate investors in most cases need at least 25% of the purchase price as a down payment and possibly 35%. But investors willing to occupy one unit of a duplex or similar small multifamily property can get Federal Housing Administration insured loans for as little as 3.5% down. FHA loans are also suitable for borrowers with lower credit scores, and people just getting started in real estate investing.
In November 2014, Scott Trench, a recent college graduate and operations manager for real estate investing social network BiggerPockets, bought a Denver duplex. He put 5% down, moved into one unit and rented out the other. Rental income covered $1,150 of the $1,500 mortgage. A roommate contributed $550 more.
Trench wasn’t just living rent- and mortgage-free. He was also getting started as a real estate investor. In March of this year, he moved out and rented the other side as well. “I’ve got a new set of tenants in there and collect roughly $2,500 per month, on a mortgage of $1,500 per month,” says Trench, who is now renting a place to live while contemplating his next move.
In addition to $1,000 a month income on an investment, he pegs at $20,000 including down payment, he gets tax write-offs, is paying off the mortgage and benefits from any price appreciation. “This is a stepping stone in my real estate portfolio,” Trench says. “It was my home, but it was really an investment property I worked on and lived in.”
What made Trench’s foray into real estate investing work is the Federal Housing Administration’s government-backed mortgage program. FHA will make multifamily loans to borrowers with far lower down payments than almost all other loan programs.
“If you’re buying for investment, it’s going to be minimum 25% down payment,” Bill Brown, president-elect of the National Association or Realtors, says of conventional and most other multifamily mortgage. “If you get 25% down, you’re actually getting a decent deal.”
In addition to accepting lower down payments, FHA will lend to borrowers with less- perfect credit. “FHA only requires a down payment of 3.5% for owner-occupied properties with credit scores down to 580,” says Erin Lantz, vice president of mortgage with Seattle-based Zillow. “With 10% down, FHA will insure loans for borrowers with credit scores as low as 500.” Conventional lenders typically require, along with much larger down payments, a minimum score of 620, Lantz says.
Another important factor is that FHA lets borrowers include projected rental income on mortgage applications. “This means the future income from the rental can help you qualify for the property,” Lantz says. “For conventional financing, rental income from a primary residence may not be used in qualifying.”
Of course, FHA has some gotchas.
First, it is only for owner-occupants. Borrowers must move into the property within 60 days and live there at least one year. That can be an issue for buyers of properties in undesirable areas.
Another drawback is that FHA requires mortgage insurance when lending more than 80% of property value. The costly insurance includes an upfront payment equal to 1.75% of the loan plus monthly premiums of $200 or so on average, for the life of the loan. These added costs can significantly affect economics of a real estate investment.
Brown advises any borrower to check out all available mortgages before settling on one. For buyers who have the money for a large down payment and don’t want a lot of leverage, a conventional mortgage can be better, he says. Veterans Administration-backed loans can be better yet, allowing zero down payment for qualified veterans.
Still, FHA duplex financing makes sense for those new to real estate investing, according to Lantz. “It provides a great opportunity for those beginners who may not have a large amount of money saved up to start investing,” she says. “It gives them the investment experience with less risk, as they have less of their own money invested.”
Trench is making plans to refinance with a conventional lender to eliminate mortgage insurance, and hopes to buy another property soon. “If I can get another $1,000 a month in cash flow,” he says, “I’m pretty far along in my search for financial freedom.”