What is an FHA loan?
Before we discuss how you can use an FHA loan for an investment property, let’s talk about what an FHA loan actually is.
You may recognize that the FHA stands for the Federal Housing Administration. The title ‘FHA loans’ might imply that the loans are issued by the federal government, but this isn’t the case. Instead, FHA loans are loans that are issued by lenders that are federally qualified. The loans are insured by the Federal Housing Administration.
FHA loans are intended for low-to-middle income and low credit home buyers. The loans help home buyers by requiring a minimal down payment, which can be as low as 3.5%! The down payment can even come in the form of grants or gifts.
Since FHA loans target home buyers, they are considered owner-occupied mortgages. In other words, the home buyers must use the property as a primary residence.
Is an FHA loan for investment property possible?
As previously mentioned, FHA mortgages are meant for primary residences, not for investment properties. FHA loans, however, can be used by investment property buyers.
Real estate investors can use an FHA loan for investment property on only one condition: The property must become the investor’s primary residence. The only way this can happen, of course, is if an investor purchases a multiunit property, such as a duplex or a triplex. This puts single-family properties out of the picture.
By using this strategy, real estate investors can rent out a unit(s) and live in another. After a year’s time, real estate investors can begin to rent the entire property as a rental.
Benefits of an FHA loan
There’s no doubt that an FHA loan for investment property has plenty of benefits, especially for new real estate investors:
- Very low down payments compared to conventional mortgages
We can’t stress it enough. The down payments for FHA loans can be really low. How little the down payment will be depends on a buyer’s FICO credit score. If borrowers have a credit score of 580 or more, they are eligible for a 3.5% down payment. If the credit score is lower than 580, a borrow qualifies for a 10% down payment. The return on investment of such properties can be very high, all due to the low down payment.
An FHA loan for investment property will always beat out a conventional mortgage in terms of low down payment. Conventional loan financing for investment properties has a 20% down payment standard. That is much more than either of the FHA loan down payments.
- No need for good credit
Buying investment properties, like buying any major investment, requires a good credit score. Conventional mortgage financing for investment properties often demands a credit score of 620 or more. An FHA loan for investment property, however, doesn’t need a great or even good credit score.
Obviously, the better credit a borrower has, the more likely he/she is to meet the FHA loan requirements. Still, if one’s credit isn’t as strong, he/she can still qualify for low down payments, as mentioned previously. Even borrowers with no credit history can potentially qualify for FHA loans. A lender would review the borrower’s payment history in this case, as opposed to a credit report.
- Excellent strategy for young and new property buyers
FHA loans are very well-suited for home buyers who cannot make a large down payment. More often than not, young real estate investors fit this category. FHA loans are a match made in heaven for young investors, especially those still in or just coming out of college. There’s even a specific type of FHA loan for college students, called the FHA Kiddie Condo Loan. The Kiddie Condo Loan allow investors to buy a rental property at a young age by using their guardians as cosigners.
- Live in a property and earn rental income
An FHA loan for investment property can kick off a real estate investor’s career by buying investment properties with less-than-ideal finances. It also adds in another plus: having a free primary residence.
While the residence is obviously not completely free, it is much less expensive than living in another property. For one, the mortgage payment of the entire property covers the residence. The second pro is a topic on its own, and will be mentioned next.
- Easy access to property management
A major concern when buying investment properties is property management. This is especially true when investing in real estate that is out of town, or simply far away from your primary residence. But when you’re investing in real estate through an FHA loan for investment property, management is not a concern. After all, your tenants are just a knock away. Any upkeeping or maintenance issues won’t last long by the time you hear of them.
FHA loan requirements and considerations
FHA loan requirements are generally not as stringent as conventional mortgages. You can find a comprehensive list of the requirements on the FHA website. There is one unique requirement, however, that sets an FHA loan for investment property apart from conventional investment property financing options:
- Mortgage insurance
Investment property financing with an FHA loan requires mortgage insurance. As previously mentioned, the FHA insures the loan for a borrower to minimize the risk for a lender, in case the borrower defaults on the loan. As a result, the borrower must pay two types of mortgage insurance:
1.) Upfront Mortgage Insurance Premium – a onetime payment of 1.75% of the loan
2.) Annual Mortgage Insurance Premium – monthly payment (despite the name) that will depend on the loan amount, loan length, and loan-to-value ratio
- Cheaper in the short term, not necessarily in the long term
An FHA loan for investment property is definitely less expensive and more profitable than other investment property financing methods in the short term. However, with the accumulation of insurance payments, it can potentially become more expensive in the long term. Still, much of this can be handled well with sound financial planning, especially if you are making rental income from other properties.
All in all, an FHA loan for investment property is one of the best techniques to begin investing in real estate. It allows property buyers with substandard qualifications to purchase primary residences and eventually use them to generate rental income. For more information on FHA loans, contact your local FHA office. For more information on how to buy a rental property, visit us at Mashvisor!