Why FHA Loans Makes Better Sense to Finance Investment Property

After you have located a property that you would like to invest in, the next step is to come up with ways to pay for the property.  For a lot of new investors, especially the new ones, purchasing a home requires putting money down and closing costs.

Sometimes, the money you need to put down can be significant. This requirement is a barrier for many prospective investors. There are several ways to finance investment properties.

One can finance an investment property by using conventional, traditional loans, FHA loans, VA loans, Rehab loans, private mortgage insurance, No Money down, Cash Only Deals, etc. In this article, however, I will discuss two: traditional loan and FHA loan.

The other types are viable options, but they tend to be complicated and riskier for entry-level investors.

Traditional loan

Almost every homeowner or potential real estate investor is familiar with the traditional, conventional loan. To make it simple, a traditional loan, is financing where investors or future homeowners put up 20 percent of the price of a property ( it can be a single-family home, a multi family home like  a triplex, shopping mall, etc.) and the bank supplies the balance.

Let’s say a house is listed for sale for $100,000. A potential buyer puts $20,000 down, 20%, and the lender supplies $80,000.  These loans typically offer a 30 or 15 year terms and equal monthly payments. This type of loan is easy to understand and applies to not only homeowners but also to investors.

Plus, it’s good leverage. You don’t actually use your money to purchase a $100, 000 property. You use other people money–in this case, the lender. You borrow 80 percent (or $80,000) of the purchase price. Using a traditional loan to purchase a home, you can make excellent profits.

The question then becomes, can everyone afford the 20 percent down? Buying a property for $100,000 with traditional loan , you need $20,000. It can be tough for an entry-level investor with no to very little money to come up with that initial $20,000.

Plus, there are additional cost such as closing costs that a new investor has to take into account. Those cost can be pretty significant depending on the purchase price of a property. Another alternative for a new investor then is to put as little money down as possible. A low down payment alternative includes FHA loans.

FHA loans

FHA loan is another way to finance investment properties, putting as little money down as possible. Instead of paying the traditional 20 percent down of the purchase price, with FHA loan you can pay as little as 3 percent of the purchase price.

So what’s the catch?

The catch is that a FHA loan is not available to investors buying single-family homes. The investor has to occupy the single family home in order to qualify for a FHA loan. To put it in another way, an investor cannot use a FHA loan to buy a purely investment property. You cannot buy a single family home and then rent it to someone else. You have to live in it.

This restriction makes it hard for the investor to take advantage of this low down payment vehicle. But there are ways in which FHA loans can be helpful to the investor.

First, since FHA loans require the buyer to live in the home, a would-be investor can use that loan, buy a property, live in it, build equity, and sell or rent in the future.

Illustration:

  • Bob buys a single family home using FHA financing for $100,000. He puts 3% percent down, $3,000. He lives in it for 3 years, and he fixes it up and repairs it at a cost of $8,000. At the end of year 3, the single family home is worth $ $160,000. He sells it. Bob generates a pretty good profit.

Another way to use FHA loans to your advantage is to buy a multi-family home (for example a duplex, triplex, a four-unit property), live in one unit and rent the rest. Because you live in one unit, you are an owner-occupant, and therefore qualified for FHA financing.

  • Bob buys a three unit building, which he paid $200,000 for. Rent from two units total $2000 a month, just enough to cover mortgage payment, tax, and insurance. The third unit, which Bob occupied, is essentially his on a rent free basis.

Conclusion

In sum, unless you have a lot of money, buying a home for investment purposes requires money down. A 20% money down can be a lot to entry level investors with no to little money.

FHA financing is very appealing for a would be investor with very little money, because it requires very little money down.

Do you agree? Share your thoughts in the comments below.

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