How To Use An FHA Loan To Get Started In Real Estate
By JD Esajian on December 2, 2016
There are many different ways to get started as a real estate investor. In most cases your age, goals, income and capital reserves dictate where, when and how you will invest. Many investors feel they have to wait to enter the business until they establish a portfolio or have tens of thousands of dollars in reserves. However there is a way you can get started without having to break the bank. By using an FHA loan to purchase your first property you can take advantage of the low down payment option and collect rental income. For many new investors this is the perfect scenario to help break into the business they love. Here are five reasons why an FHA loan is a great option to help you get started in real estate.
- Minimum Down Payment. An FHA (federal housing administration) loan is simply a mortgage that is backed by the government. They offer specific rules and guidelines based on loan amount, zip code, property condition and income level. An FHA loan is often considered the best way for a borrower with average credit and minimal down payment to purchase a house. With just a 620 credit score and 3.5% down payment you may be eligible for an FHA loan. This is a great alternative to conventional loan programs that require 10-20% down payment as well as higher than average credit scores. Additionally some or all of the down payment and closing costs can come in the way of a gift. One major stipulation is that these loans are only used for homeowners buying the property as a primary residence. Any single or two family properties is eligible, assuming the condition meets FHA standards. For just 3.5% of the purchase price you may have enough to start building your portfolio.
- Rental Income. An FHA loan is such an attractive option because it allows you to enjoy the best of both worlds. As a new buyer you can live in one side of a two family property while renting out the other unit. Even if you have never considered being a landlord or collecting rental income this option is available. The rental income you receive is often enough to offset any mortgage payment you make on the property. If you are lucky enough there may even be some residual cash flow left over. Even if the rental income received is close your monthly payment is reduced and you gain valuable landlording experience. This experience will often give you a good idea of whether or not rental properties are something you want to pursue in the future. It also provides a great alternative to renting. Instead of throwing money away every month on rent you can keep your monthly housing payment low, build equity and gain real world experience in the real estate business.
- Tax Benefits. Owning a rental property has a number of benefits. When most people think of rental properties they think of all of the cash flow they can generate. However there is more to rental properties than simply cash flow. A hidden benefit that experienced investors are aware of is the tax benefit. As a property owner you can write off any interest you pay on your mortgage. This alone can greatly reduce your annual tax burden. What makes owning rental property so appealing is that you can also write off rents received as well as repairs, maintenance as well as several other items associated with the property. Even if you are breaking even on the property the tax benefit can make rental ownership worth it for you. If this is an option you are even remotely considering you should reach out to a local accountant and discuss your situation. You should never buy a rental property for tax benefits alone but they could sway the decision in your favor.
- Low Interest Rates. There are a few distinct features of an FHA loan. As we mentioned the minimum down payment is the most common but there are other benefits as well. With an FHA loan the interest rates are typically anywhere from a half to three quarters of a point lower than conventional programs. This can make a big difference depending on the size of the loan. For this reduced rate you will pay slightly more for your monthly PMI (private mortgage insurance) payments. In the end the lower interest rate usually has a bigger impact but for the ability to lower your down payment it is worth it.
- “Landlording” Experience. The fact that you can gain landlord experience should not be overlooked. For practical purposes this can give you some idea of whether or not rental properties are an area which you would like to pursue. For business purposes there are several loan programs which require landlord experience to qualify. If you are ready to take the next step to two or three family properties you may need a minimum of one to two years’ experience. Any rental income received will be documented on your tax returns to get the clock started.
FHA loans are not necessarily strictly for first time homebuyers but they must be used for a primary residence. This allows you to get started in real estate at a young age and gain an advantage on your competition.