What is the single biggest barrier to entry for new real estate investors? Cash! In the next few paragraphs I explain house hacking.
Understandably, it can be difficult to save a full 20% of a home’s purchase price given all of life’s other expenses. But what if I told you that you can put as low as 3.5% down to purchase up to a 4-family home in which you can live and collect rents, drastically changing your ability to save? This is all possible with a government-insured FHA loan.
Let’s begin by discussing what an FHA loan is. The Federal Housing Administration (FHA) provides mortgage insurance on loans made by FHA-approved lenders. The insurance provides a safety net to lenders that otherwise wouldn’t lend under given circumstances. While the goal is to increase the number of people who can afford homes, there are still restrictions.
Basic Requirements for an FHA Loan
- A credit score of at least 580
- Proof of steady income
- Intent on living in the residence for a defined period
- Mortgage Insurance Premium (PMI) payment
These are the basic requirements in order to put as low as 3.5% down. There are other requirements such as purchasing a safe property (no chipping lead-based paint, up to safety code, etc.), having money left over after closing to cover some future mortgage payments, and more.
Despite these requirements, many can qualify. To illustrate the benefits of purchasing an FHA loan financed multifamily property, I will compare it to renting. For this example, we will assume your budget is $2,000/month and you have the 3.5% down payment plus closing costs available.
If you were to rent an apartment for $2,000/month, you’d likely have to come up with first and last month’s rent and a 1-month or 2-month security deposit. The total rent out of your pocket over the course of a year (an expense and money that you’ll never get back) would be $30,000.
Cost of renting a $2,000/month apartment on the first year
Now let’s say that instead of renting, you decide to purchase a 3-family home that costs $300,000. Your 3.5% down payment would be $10,500 and closing costs might be around $5,000. You’ll need to pay close to $16,000 in this example to purchase this 3-family home.
Let’s also assume that each of these 3 units rent for $1,000 and that your total monthly payment including your mortgage, interest, PMI, and escrow for property tax and insurance is $2,000/month. Being that you’re required to live in the property at first, you’d be receiving $2,000/month in rent from 2 units, covering your total monthly payments for the property. In this case, you’d essentially be living for free (although you’re subject to required property upkeep).
Cost of purchasing a $300,000 3-family home on the first year
By choosing to purchase and live in a multifamily home using an FHA, the $30,000/year that you will be spending on rent is now kept in your pocket. Not to mention, you’re subject to property appreciation which will allow you to leverage your equity or sell for a profit down the road. Furthermore, part of that $2,000 payment each month being paid by your tenants is paying down your principal, increasing the amount of equity you have in the property each month. This allows you to drastically change the amount you’re able to save while giving you experience in owning and leasing a property. Start house hacking now!
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