An Introduction to FHA Loans for Real Estate Investors
A common misconception is that to buy real estate, you need to have 20% or more of the purchase price in cash for a down payment.
This is unfortunately the furthest thing from the truth and stops so many people from getting into homeownership.
The FHA loan is one loan program that allows buyers to get into properties for as little as 3.5% down. Meaning if you want to buy a house, even in a fairly expensive market for let's say $500K, your down payment would only have to be $17.5K. That's way less than the price of a brand new car, yet it seems most people will buy new cars before they buy houses.
What is FHA
The FHA is the Federal Housing Administration. This is an organization that backs and insures loans so that if the borrower defaults and doesn't repay the loan, the FHA will pay the lender back.
This removes a ton of risk for mortgage lenders, giving them more confidence in lending to higher-risk borrowers who bring smaller down payments.
As a result, FHA loans are incredible tools for buying real estate with little money and even a lower credit score.
Downsides of FHA Loans
I am a big fan of FHA loans, but if you decide to go this route you should talk with your lender and consider the following details.
Private Mortgage Insurance
One of the biggest drawbacks of an FHA loan is that it requires private mortgage insurance (PMI). Meaning, in addition to your mortgage payment, you will also be responsible for a mortgage insurance premium (MIP). It's a monthly payment to your mortgage insurance provider which again reduces the bank's risk if you were to default on your mortgage and stop making payments.
With conventional loans, you will typically see mortgage insurance when borrowers make down payments of less than 20%. Usually, this mortgage insurance premium can be removed during the life of the loan for a number of reasons depending on your state and local laws. For instance, when the remaining balance of your loan reaches 78-80% of the original purchase price, typically you will be able to remove PMI.
With FHA loans, your mortgage insurance premiums remain for the life of the loan. Meaning even when your loan is paid down to 80% or more, you still have to make mortgage insurance payments.
I see savvy investors frequently getting around this by refinancing out the FHA loan. The idea is to buy the property initially with an FHA loan and a low down payment, and as you pay down the loan and hopefully property values appreciate, you might be able to refinance the property with a conventional loan that doesn't have the same mortgage insurance requirements.
Buyers are Limited to One FHA Loan
Simply put, you are only allowed to have one FHA loan at any given time. Also, FHA loans require the property to be occupied by the owner.
If you are an investor wanting to buy multiple properties this year, the FHA loan program can only help you buy one property. The other properties you want to acquire will have to be purchased with other forms of financing.
If you purchase a home with an FHA loan and then try and go to a lender to get another FHA loan, you simply won't qualify given you have an existing FHA loan.
The solution to this is the same as above. If you want to get another FHA loan, you can sell or refinance the property with the existing FHA loan on it. If you refinance and get a conventional loan this time around, you won't be bound to the same terms requiring mortgage insurance forever either.
And that's the gist of the FHA loan program. There are a million more subtle details, but these are things your lenders should cover with you when you're ready to purchase your next property.
The FHA loan program is an incredible tool, allowing you to get into properties for a tiny fraction of the total cost.
I'm personally working on getting an FHA loan myself for my next property, so if you have any questions or want to talk about your strategy feel free to connect with me.