Use An FHA Mortgage To Buy Your First Investment Property
Want to get started in real estate investing? Consider an FHA mortgage for your first income-producing property.
Fledgling real estate investors often find themselves stuck in a chicken/egg scenario. You can’t get a mortgage because there’s no history of managing property, and you can’t manage property until you get a mortgage to finance the home.
FHA mortgages solve this problem.
FHA mortgages allow real estate investors to purchase multi-unit homes with just 3.5 percent down and, so long as the buyer lives in one of the units of the home, the other units can be rented.
The strategy works for 2-unit, 3-unit, and 4-unit homes.
The own-and-rent combination gives real estate investors real-world landlord experience that can be claimed on a future mortgage application, and which sets them up for long-term real estate investment success.
Even first-time home buyers can be real estate investors via the FHA.
What Is An FHA Mortgage?
The Federal Housing Administration (FHA) was formed in 1934 to help the nation’s renters become homeowners.
The agency is a mortgage insurer — not a lender — which means that the FHA doesn’t make mortgage loans. Mortgage loans are made by mortgage lenders. The FHA’s role is to insure those lenders against losses on their loans.
Because of FHA mortgage insurance, home buyers can do use FHA mortgages to do things which aren’t possible via other loan types, such as with conventional loans.
For example, FHA loans allow for a down payment of just 3.5% and require a minimum credit score just 500. Most other loan types require a 620 FICO score or better.
FHA loans can also be more restrictive than other loan types.
In order to use FHA financing, you must live in the property being financed. This means that you cannot use FHA mortgages to finance a second home or a rental property — with one important exception!
When you buy a multi-unit home and occupy one of the units as a primary residence, with the FHA, you can claim the entire building as owner-occupied.
This means that you can build your landlord experience and collect rent on your primary home.
Buy An Investment Property With A 3.5% Down Payment
FHA loans are popular for many reasons, but the program’s best-known feature is its allowance for a low-down payment.
With an FHA mortgage, your down payment requirement is just 3.5 percent and this holds true irrespective of the number of units in the residence.
- 1-unit : 3.5 percent down payment minimum with the FHA
- 2-unit : 3.5 percent down payment minimum with the FHA
- 3-unit : 3.5 percent down payment minimum with the FHA
- 4-unit : 3.5 percent down payment minimum with the FHA
Compare this to conventional mortgages which can require 20% down on a 2-unit purchase; and 25% down on the purchase of a 3-unit or 4-unit home.
If you’re going to buy a multi-unit home and live in it, using an FHA mortgage will minimize your upfront investment.
And, because the FHA allows cash gifts for down payments and the use of down payment grants from a municipality, it’s possible to get into an FHA-financed home with no money of your own at all.
Buy An Investment Property With Low Credit Scores
Another draw of the FHA mortgage program is its leniency for low credit scores.
According to FHA mortgage guidelines, the agency will insure loans for which the borrower’s credit score is 500 or higher. This is more than 100 points below the minimums for the conventional, VA, and USDA mortgage programs.
Furthermore, the FHA makes allowances for home buyers who have experienced a recent foreclosure, short sale, or bankruptcy because of “extenuating circumstances”, such as illness or loss of employment.
Via its Back to Work program, the FHA requires home buyers to wait just 12 months after a major credit event before re-applying for a mortgage. The industry standard is closer to 4 years.
The ability to buy a home with low credit scores can be a boon to new real estate investors whose credit scores may be below-average because of a failed business; and, also to first-time home buyers who may not have sufficient credit “experience” to show excellent credit ratings.
The FHA won’t penalize borrowers for showing below-average credit.