Many real estate investors use financing to buy an investment property in order to make money from rental income and to see the value of the property increase over time.
An FHA loan with low credit score requirements can be used to purchase a rental property.
This article provides readers with information on how to qualify for an FHA loan, the different types of single-family FHA loan programs available, and ways to get an investment property loan with 10 percent down.
What is an FHA loan?
A mortgage that is backed by the Federal Housing Administration. If you’re looking for a mortgage loan but have a low credit score or limited funds for a down payment, an FHA loan might be a good option for you. It’s also a popular option for first-time homebuyers.
There are several important differences between an FHA loan and a conventional loan issued by a bank or credit union that is not backed by a government agency:
- Down payment as low as 3.5% of the property purchase price.
- Credit score requirement is a minimum of 580 for a down payment of 3.5%.
- However, if a borrower makes a down payment of 10%, a credit score may be as low as 500 to qualify.
- Interest rate on an FHA loan may be 0.15% to 0.20% higher than the interest rate on a conventional loan.
- Mortgage insurance is required for the entire loan term if the down payment is less than 10%, and may include a one-time up-front premium plus a monthly insurance payment.
- Closing costs with an FHA loan may be partially financed and included as part of the monthly mortgage payment.
Can an FHA Loan Be Used for Investment Property?
There are several ways an investor could potentially use an FHA loan to finance the purchase of a rental property. This type of loan is not usually intended for buyers who are looking to invest in property, but there may be some exceptions that could make it possible.
1. Primary residence for 12 months.
The borrower is required to move into the home within 60 days of closing and occupy it as a primary residence for a minimum of 12 months according to the FHA. In some cases, an investor may be able to purchase a single-family home using an FHA loan. The investor must agree to live in the home as a primary residence for at least 12 months before turning it into a single-family rental property.
FHA loans may allow a borrower to relocate for job reasons or to accommodate a growing family, and use their existing home as rental property.
2. Purchase a small multifamily property.
An FHA loan may also be used to purchase a multifamily property with 2-4 units. An investor would need to live in one of the units of the property while renting out the other units in order to meet the requirements for the primary residence.
The rental income from the property can help to cover the mortgage and any additional costs associated with operating the rental. After one year, an investor who has FHA financing may use the duplex, triplex, or fourplex as a rental property.
3. FHA streamline refinance.
The purpose of a streamline refinance is to lower the monthly principal and interest payments on the mortgage, or to shorten the loan term. Streamline refinancing is the process of refinancing an existing FHA-insured mortgage loan in order to lower the monthly payments or shorten the loan term. A process called “streamlining” exists which generally requires less documentation, according to HUD. Although a borrower may still expect to pay the cost to refinance the loan, this process is often simpler. An FHA loan may be refinanced with another FHA loan, even if a borrower is no longer using the home as a primary residence.
Different Types of FHA Loans
Did you know that you can get a mortgage loan through the FHA? There are actually a few different types of loans you can apply for. Some of the most popular single-family FHA insured mortgage programs include:
Basic FHA Home Mortgage Loan 203(b)
The loan is for people who want to buy or refinance a home they live in most of the time. An FHA 203(b) home loan is funded by a lending institution such as a bank or credit union and insured by HUD.
To be eligible for a Basic home mortgage loan 203(b) a borrower must:
- Meet standard FHA credit qualifications.
- Approximately 96.5% of the purchase price may be financed, plus the upfront mortgage insurance premium.
- Eligible properties are 1-4 unit structures.
Adjustable rate FHA mortgages
An adjustable rate mortgage has an interest rate that changes at set intervals over the life of the loan. The initial interest rate of an ARM is usually lower than a fixed rate mortgage, making an adjustable rate FHA mortgage a potentially good option for borrowers who plan on holding the home for a short period of time before selling or refinancing.
Adjustable rate FHA mortgage options include:
- 1- and 3-year ARMs that may increase by 1% after the beginning fixed interest rate period and by 5% over the life of the loan.
- 5-year ARM with an interest rate that may increase by 1% annually and 5% over the life of the loan, or by 2% annually and 6% over the life of the loan.
- 7- and 10-year ARMs may only increase by 2% annually after the beginning fixed interest rate period and by 6% over the life of the loan.
Energy Efficient FHA Mortgages (EEM)
The Federal Housing Administration (FHA) offers a type of mortgage called an Energy Efficient Mortgage (EEM) that can help borrowers finance energy saving improvements and renewable energy systems. An EEM can help lower your home operating costs and generate more potential income.
To get an EEM, you will need to get a home energy assessment to find out what energy efficiency opportunities are available and how cost effective they would be.
Rehabilitation FHA mortgage 203(k)
The 203(k) rehab program allows a borrower to finance both the purchase and the cost of rehabilitating a home using a single mortgage.
Short-term loans typically have higher interest rates than longer-term loans. For example, a HELOC or hard-money loan will have a higher interest rate than a traditional mortgage. The 203(k) loan is a single, long-term loan that is used to finance both the acquisition and improvement of a property.
Eligible property rehabilitation activities that qualify for an FHA 203(k) loan include:
- Structural alterations such as adding additional square footage to a home.
- Eliminating health and safety hazards, which are sometimes found when a previous owner is unable to maintain a property.
- Reconditioning or replacing mechanical systems such as plumbing and electric to meet local building codes.
- Adding or replacing floor treatments, roofing and gutters, and making the property accessible for a disabled person.
- Major landscape work and site improvements, such as installing a driveway or building a fence.
Ways to Get an Investment Property Loan With 10 Percent Down
There are other ways to get a lower-cost investment property loan that are not detailed above. Some methods below are out-of-the-box approaches. Others may represent an increased level of risk. You should research any of the options below to make sure you understand what you’re committing to.
House Hacking
The term “house hacking” is used to describe a real estate investment strategy that is often used with multi-family homes. This strategy can be used in order to generate income, as well as to live in the property itself. The investor leases out units in the property they live in to tenants.
The rent money that your tenants give you assists in paying off your mortgage. You may be able to put down as little as 3.5% for a fixed-rate mortgage using this approach.
BRRRR Method
BRRRR stands for Buy, Rehab, Rent, Refinance, Repeat. The strategy describes how house flippers often use their portfolios to grow their investment in real estate.
To start, you’ll need to save up money to buy an affordable rental property – this could be a foreclosure or a home in need of repair. After that, focus on repairs or upgrades that will add the most value to the home. After you have finished preparing the house, you can look for potential renters and start collecting rent. This guide includes 11 steps on how to become a landlord, which may help you complete the first three steps of the BRRRR process.
If you rent out your home for at least 6 to 12 months, you may be able to refinance your mortgage and get cash out of your equity. You can take the money you borrowed with your new mortgage and do the same thing again.
Private Money
Private borrowing from wealthy individuals you know could be considered, even though it is uncommon. You will need to ask your family or friends for a loan or investment in order to use this strategy.
The amount of money you have to put down on a loan can differ a lot depending on your own personal experience. The answer to this question depends on the person you are asking and what they want to require.
There is also a risk that comes with this type of loan, which is the risk of damaging a personal relationship. Make sure to count this cost carefully upfront. If you are unable to repay as agreed, it could create a stressful situation.
Investment property purchases can also be funded by short-term loans from private money lenders. Hard money loans are typically more expensive than traditional loans because they are from private lenders and not banks. These loans usually have higher interest rates and more fees.
Off-Market Properties
An off-market property is one that is not advertised on the MLS or similar online portals. On occasion, there are houses on the market that are being sold by the owner instead of using a real estate agent. There are also times when the owner of a property hasn’t decided whether or not to sell it yet. Sellers may choose to sell their property off-market to create excitement and potentially get a higher sales price.
Real estate investors may also sell off-market properties wholesale. Properties that don’t require a down payment are often hard to come by and usually need to be sold quickly once they become available.
Get a Real Estate License
If you want to be a successful real estate investor, becoming a licensed realtor may give you an advantage. This approach will not save you money on down payments, but it may help you to buy a house. Although it may be more work, working without an agent could get you better deals on property and save you the commission fees that agents charge.
A real estate license gives you access to the MLS. This tool can be used to look for available properties and compare sales prices of similar homes that have recently sold in the same area. A license as a real estate agent gives you an advantage in terms of control over the deal and other potential benefits.
To get your license, you will need to invest both money and time. To earn your license, you’ll need to complete around 100 hours of studying, coursework, and exams. Once you get your license, you will need to work under a broker and pay associated fees. Additionally, you will need to complete continuing education classes every year.
Turnkey and Move-In Ready Rentals
There are two types of rental homes you may come across while searching: turnkey rentals and move-in ready. The goal for an investor when purchasing a property is to not have to put any money into repairs or renovations before renting it out.
Some turnkey providers offer financing with a 5% down payment. But these loans generally feature high interest rates.
The appeal of buying a rental property that you can start earning money from immediately is understandable. Although these types of investment opportunities may seem promising, experienced investors warn that they may not always be what they appear to be.
Instead of properties being in good condition for tenants, sellers of move-in ready or turnkey rentals may skip repairs that are not essential. If a property is not well-maintained, the tenants are more likely to move out frequently, and other problems may occur.
Line of Credit
Are you looking for help in securing a loan for a rental property? If you need money, you may be able to get it by taking out a line of credit.
If you have another property, you may be able to get a line of credit using the equity in that home. Loans that are given by using the equity in your house as collateral are called HELOCs or home equity lines of credit. A loan that is backed by the equity you have in an investment property is called a single property investment line of credit.
Pledging an asset to the lender as collateral may help you secure a lower interest rate. Although lines of credit can be cheaper ways to borrow, they come with added risk, especially with HELOCs. If you’re having trouble making your monthly mortgage payments, the bank or credit union may foreclose on the property you pledged as collateral when you took out the loan.
Refinancing
You may be able to use the equity you’ve built up in one property to finance another property. This is known as a cash-out refinance.
This can give you the cash you need to make home improvements, consolidate debt or make a large purchase You may be able to get a cash-out refinance if you qualify, which would allow you to access a significant portion of your property’s value. This could give you the cash you need to make home improvements, consolidate debt, or make a large purchase. The loan-to-value ratio for non-owner occupied homes could be as high as 75%, depending on the lender and various factors.
However, a cash-out refinance can be risky. If something prevents you from making your monthly payments, you’re at risk of losing the property you pledged as collateral for the loan.
Kurt has gone from the financial lows of the ’08 financial crisis to personal financial success. He is a professional real estate investor, media buyer, faithful Red Sox Fan.
One of his passions is financial education and the pursuit of financial freedom.
You can learn more about Kurt here, or get a hold of him on Facebook or Twitter.
