How I Used an FHA Loan to Invest in Rental Real Estate In My 20sReal Estate
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Many people think that investing in real estate is impossible, or at least impossible to do in their area.
They often think they need hundreds of thousands of dollars in the bank to get started.
But you don’t! I got started investing in real estate in my 20s, and I certainly didn’t have hundreds of thousands of dollars in the bank — in fact, I was still paying off my student loans — nor did I have crazy connections or family money to help me get started.
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My FHA Deal in a Nutshell
My first property was a 4-unit using FHA 3.5%-down financing in a suburb of Los Angeles.
The purchase price was $435,000 with a $15,000 seller credit.
I lived in one unit and rented out the other three. Single at the time, I also rented out the bedroom in my unit and slept on a mattress in the living room.
This is what is known as “house hacking” in the real estate world, and it proved to be a major boost to my net worth. I’ll give you 4 reasons:
- I was living for free while my friends were paying through the nose for L.A. rent,
- I was building equity as my tenants paid down my mortgage,
- I was cash flowing hundreds of dollars a month, and
- I got 4 units an hour from Downtown L.A. for a mere $15,000 out of pocket.
And because I only put 3.5% down, I still had a lot of money saved up (+ cash flow from the tenants) to put into other real estate deals like these:
- A single-family home purchased from a distressed seller (he purchased for $210,000 during the boom; I got it for $75,000 cash and then sold it for $125,000).
- A beachside luxury spec home development deal along the California coast, and
- A buy, rehab, retenant, refi apartment syndication in Arizona.
Those last two deals were syndications.
Anyway, back to house hacking…
It’s a No-Brainer!
The FHA fourplex strategy really is a no-brainer for single Millennials. If one does nothing else in real estate, they will have succeeded by getting into a fourplex as a young man or woman with only 3.5% down.
Assuming they bought good property whose rents exceed the monthly expenses, then in 30 years when they’re in their 50s and the mortgage is paid off, and they’ve done the smart thing by raising the rents over the years, they will be sitting on a million-dollar asset that cash flows thousands of dollars per month at the cost of a measly $15k or so out-of-pocket when they were 20-something.
I can’t think of any better way for young people with limited resources to prepare for their future so early on in life with so little cash out-of-pocket.
And yes, you do have to live in an FHA-financed property, but only for a year.
In the grand scheme of things, it’s really not that bad at all.
FHA Self-Sufficiency Rule
One thing to keep in mind when looking for an FHA owner-occupied triplex or fourplex is that 75% of the sum of the market rents on all units (including the one you will be occupying) need to cover your monthly payment (principal, interest, taxes, insurance, and mortgage insurance).
This is known as the self-sufficiency rule. It only applies to 3- and 4-unit properties (not SFRs or duplex) bought using FHA financing.
There are other FHA requirements, but determining whether or not a triplex or fourplex meets the self-sufficiency rule is a good place to start as this rule will immediately eliminate many properties from your search, especially in expensive markets like mine.
The fact that the self-sufficiency rule only applies to triplexes and fourplexes in no way means that you cannot purchase a single-family home or duplex using FHA financing.
It just means there’s an additional requirement that 3- and 4-unit properties must meet because as these are typically larger, more expensive properties with bigger mortgages and bigger monthly payments and hence pose a greater insurance risk to the FHA, which, by the way, is a mortgage insurer, not a mortgage lender.
As FHA’s credit and income requirements are not as strenuous as they are for conventional mortgages, it seeks to mitigate its risk of insuring a 96.5% loan-to-value mortgage on a larger property by making sure that the rental income is high enough in relation to the mortgage.
Logan is a practicing CPA and founder of Choice Tax Relief and Money Done Right. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.