Real Estate investing comes with a high monetary barrier which is one of the primary reasons most people don’t invest in property. Overcoming this barrier is hard, but if the internet has taught us anything it's that cats are adorable… and anyone can make it big.
There are a lot of blogs and videos out there that claim you don’t need any money at all to start investing in Real Estate. But, as much as we looked, as much research as we did, we could not for the life of us figure out how that would work for inexperienced, first time buyers who don't have the contacts already in place.
Yes, you could potentially borrow 100% of the purchase price - but that’s not necessarily a good idea unless you’ve got plenty of cash to support the bills that come with owning a property. Sure, you can explore seller financingand hard money options. You could fund your minimum down payment and mortgage insurance from a credit card… But all of these options entail taking out high-risk loans with high-interest rates, and without a track history of successful investments, or an exceedingly good credit score you can forget about it.
So, instead of promising you the golden goose we thought it would be more useful if we explored one very tangible and real strategy that you could utilize to get your foot in the door - literally.
This strategy is based around leveraging an FHA loan. With a little patience and some good decisions, you should be able to launch yourself up the property ladder with all the elegant dexterity of Spiderman.
In this article, we will outline what exactly an FHA loan is, plus the strategy and its limitations and risks.
We hope you find this article helpful, however, we thought it pertinent to stick our disclaimer upfront. We are not licensed financial professionals and as such this article should not be used as a substitute for competent legal and/or other advice from a licensed professional.
An FHA loan is a mortgage that is insured by the Federal Housing Administration (FHA). They are popular for first time home buyers because they only require a 3.5% down payment. This means for a house of $250,000 you’d only need to put $8,750 compared to the usual 20% which would be $50k.
You must pay a mortgage premium on this loan however, to protect the lender if you default, and to qualify, you need a 580+ credit score.
If your credit score is between 500 - 579 you can still qualify but you will pay more interest as well as need at least a 10% down payment.
As mentioned a credit score of 580+ and a 3.5% down payment are the two main qualifiers for an FHA loan however, that’s not all of the qualifiers.
Here’s a more complete list from the Federal Housing Association of FHA loan requirements:
- Borrowers must have a steady employment history or worked for the same employer for the past two years.
- Borrowers must have a valid Social Security number, lawful residency in the U.S. and be of legal age to sign a mortgage in your state.
- Borrowers must pay a minimum down payment of 3.5 percent. The money can be gifted by a family member.
- New FHA loans are only available for primary residence occupancy.
- Borrowers must have a property appraisal from a FHA-approved appraiser.
- Borrowers’ front-end ratio (mortgage payment plus HOA fees, property taxes, mortgage insurance, homeowners insurance) needs to be less than 31 percent of their gross income, typically. You may be able to get approved with as high a percentage as 40 percent. Your lender will be required to provide justification as to why they believe the mortgage presents an acceptable risk. The lender must include any compensating factors used for loan approval.
- Borrowers’ back-end ratio (mortgage plus all your monthly debt, i.e., credit card payment, car payment, student loans, etc.) needs to be less than 43 percent of their gross income, typically.
- Borrowers must have a minimum credit score of 500-579 for maximum LTV of 90 percent with a minimum down payment of 10 percent. FHA-qualified lenders will use a case-by-case basis to determine an applicants’ credit worthiness.
- Typically borrowers must be two years out of bankruptcy and have re-established good credit. Exceptions can be made if you are out of bankruptcy for more than one year if there were extenuating circumstances beyond your control that caused the bankruptcy and you’ve managed your money in a responsible manner.
- Typically borrowers must be three years out of foreclosure and have re-established good credit. Exceptions can be made if there were extenuating circumstances and you’ve improved your credit. If you were unable to sell your home because you had to move to a new area, this does not qualify as an exception to the three-year foreclosure guideline.
- The property must meet certain minimum standards at appraisal. If the home you are purchasing does not meet these standards and a seller will not agree to the required repairs, your only option is to pay for the required repairs at closing (to be held in escrow until the repairs are complete).
Find out more about an FHA loan and your viability by speaking with a mortgage or finance specialist.
One thing as you will have noticed as you scanned through those bullet points is that an FHA loan is only available for primary residence occupancy making it unsuitable for purchasing a rental property.
However, this is all part of our plan.
So, you can’t use it for an investment property, you need enough cash for a 3.5% down payment and you need to live in it.
The first step is to make sure you have enough cash in the bank to start up. Somewhere between $5,000 - $10,000. Enough for that 3.5% payment as well as a little bit extra for future expenses.
This isn’t a huge amount of money but it’s not always easy to set this kind of money aside. It will require discipline and patience.
The second step is to make sure you have the best possible credit to get the best terms on your loan. Having a bad credit score because you forgot to pay your credit card a couple of times, or simply because you never really thought about it, is leaving money on the table. It will cost you in the long run.
Contact an FHA approved bank and arrange a meeting to discuss your options. Make sure you qualify and make sure you understand the terms, limitations, and possibilities that come with this loan.
This is probably the most important step out of those listed in this process.
The perfect property isn’t easy to come by and may require months of research to find. Once you find it you need to be able to move quickly which is why you went through those first three steps.
First, it has to be in the budget. What is the most that you can raise for your down payment? Second, it needs to meet the minimal standards for the loan.
Third, it needs to be below market value for whatever reason - a motivated seller, perhaps it needs a little work. There are plenty of reasons a property might be on the market for a low price point.
Buy low, sell high. This is vital for the success of your plan. Do your research to determine the average house prices for the area and if you can’t get the property for below that amount then walk away.
It needs a spare room, annex or separate converted basement area. To cover the cost of your premiums you are going to rent out part of the house you are buying whilst living in a separate area. The perfect property would almost be a Duplex allowing you to rent out part of the property as a unit to a tenant.
Finally, the property needs to have potential. It can't be so run down that you’ll never be able to fix it up. It can't be in the worst neighborhood in town. At the end of the day, you need to be able to turn a tidy profit when you sell it.
Get yourself settled in your new home. Redo your finances and check out how much rent you can charge for the spare space you’ve got.
Hopefully, you managed to get a property with a separate space. This, as we mentioned before, you need to rent out to cover your mortgage repayments and premiums.
When you rent you need to treat the rental space like you would any rental. Make sure you have a secure and legally binding lease; you set your rental price appropriately; and you screen all prospective tenants properly.
Related: Screening your Tenants like a Boss
Carry on saving cash like you were before you bought the property.
Make improvements to the property to increase its value.
Carry on building your credit score. Remember the better this is, the better the terms you will get for a future loan.
Finally, after some 2 years of starting out on this road to financial independence, you are ready to sell your first house and make your first real profit.
When you bought the property it should have been below market value. The work you’ve done on it over the time you’ve occupied should have increased the value of the property. When you sell you want to be selling above market value. In monetary terms for a house worth $250k this could mean capital gains of $20 - $30k or even more. If you believe the market will improve if you wait a little longer - wait.
The next perfect property should follow the same rules as the first. Ideally, though you should be looking at a multi-unit at this point as this will increase your rental income.
You will want to get a traditional loan at this point - using the equity from for the first sale - along with your improved viability for loans because of your increased credit and greater starting cash as well as a proven investment history. This will reduce your mortgage and premiums.
Finally, after a period of 5 - 10 years you should be in a position to start approaching investors directly to leverage their money using your winning formula to help everyone make maximum rewards and move ever so slowly into becoming a full-time real estate investor.
We’ve rushed through this and made it as simple as possible. There is a lot for you to still learn. This strategy is proven to work, but it is risky, requires some luck when finding properties and it does need some cash upfront.
Most of all you’ll need patience, you need to keep your long term goals in sight at all times. It can be easy to lose sight of your goal when you're playing a ten-year game - but if you stay on track, make the bold moves at the right time who knows where you could end up!
As the property owner, you’re responsible for non-compliance with snow removal ordinances, so it’s best if you make sure snow removal equipment is available. You may even find if you check the local bylaws that you are required to keep public thoroughfares that cross our property free from snow too...