Ask any first time home buyer how they can afford to buy a house without having the normal 20% down and they will grin from ear to ear and say it was a FHA loan. FHA loans are available with only a minimum down payment of 3.5 percent. But can you use a FHA loan to buy a rental property?
If you were to ask FHA that question, they would say that you cannot use a FHA loan to buy rental properties. They’re programs are designed to help homeowners, not investors. They require that each FHA loan be used for only owner-occupied properties.
How Can You Finance a Rental with a FHA Loan?
I know, I just said that FHA would not let you buy an investment property, but you can use a FHA loan to buy a rental property – if you live there. FHA Loans will cover a 2 to 4 unit rental property as long as you can prove that one of the units will be your permanent residence.
How a FHA Loan to Buy a Rental Can Increase Cash-on-Cash.
Generally speaking, I am not a fan of FHA loans. One primary reason is because though they advertise a competitive interest rate, the ending APR is much higher than traditional loans. In addition, FHA carries their own mortgage insurance which is higher than other lending programs.
Though FHA loans may cost more in the long run, putting a 3.5% down payment on an investment is a great way to increase your cash on cash return. Here is a side-by-side comparison to demonstrate what I mean.
As you can see from this example, using a FHA loan to buy a rental property will dramatically increase your mortgage costs. The mortgage insurance payments are the primary factor. The low down payment, however, can double your cash-on-cash return if you factor in the owner’s rent payment.
What is more, the owner will be able to live rent free with the other tenants covering the mortgage payment, taxes and insurance. This is one way to reduce your living expenses. Often this is a good way to get into the income property business.
Who Should Use a FHA Loan to Buy a Rental Property?
As you can see from the above example, FHA loans are costly in the end. We would recommend that most investors seek more conventional financing in order to reap a larger ROI each month. There are, however, some investors that can benefit from FHA loans.
Low Down Payment Buyers. If as an investor, you are desperate to get into the game and do not want to wait until you have scraped 20% together, then FHA can be a first step into the investment market.
Fixer-Upper Investment Properties. FHA offers a loan which will wrap repairs into the mortgage. It is called a 203(k) loan. Investors who want to fix up their own properties while living in them, but lack the liquid assets to fund both the purchase and the remodel may want to consider an FHA 203(k).
FHA Loans to buy investment properties is not for everyone, but for those who are just starting out, it can be a foot in the door. Just make sure that you accurately factor in the additional costs of FHA financing when calculating the cash flow of your investment property.