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Beginner Investing - Real Estate Investing - FHA Loan For Investment Property

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If you have been reading Beginner Investing for the last few weeks then you know that I am looking to turn my personal balance sheet around by reducing my mortgage payments by purchasing another property. At first glance the thought of gaining debt may not appear to be a viable solution to reducing expenses. But after this post I hope I will have shed some light on a major possibility.

Real quick, let’s recap my current home payments. Every month I pay 1200 for principle and interest (about 200 goes to principle). 200 for taxes, and 150 for the HOA. This totals 1550 a month. Now, taking 1000 as interest I can write that off and regain about 330 after taxes. And if we discount the principle then we can lop off a total of 530. So my overall monthly loss by owning this single home is 1020 a month. That’s pretty steep. I would need an appreciation of 6.35% every year to come out EVEN. Not gonna happen.

So how do I turn this around? I purchase another property, and rent out my current. Now, before I get to purchasing the second property, let me show you why renting out my current home will be so beneficial. We pull up the handy investment property calculator (see link to the right) and plug in the following: purchase price = 190k, down = 0, interest rate = 6.55, insurance = 500, taxes = 2400, expenses (HOA + Misc) = 200, rent = 1100

This tells me that at the end of the year I will have spent 3342 out of pocket (278.5/month). That’s a HUGE jump from 1020. BUT, that doesn’t take into consideration that the principle comes back to me upon sale, and that totals 2039. What this means is that after sale, my real out of pocket loss is 3342-2039=1303 a year. This is just barely over 100/month. For me to cover that 100/month loss the home will have to appreciate by at least .7% Not even 1%!!! And that is JUST renting the home at market rents. Think about if I lease optioned it and had the HOA included, or bumped it another 100.

Ok. So how does buying another property improve the situation even more??? Well, there’s a couple tricks here. First off, the second property must pay for itself to some degree. This means it must be a multi-family home. A quadraplex is the max number of units for a private home (topic for another post), so this kind of property has the biggest chance of paying for itself. The second trick is an FHA loan.

Now the first trick is easy. If I live in one unit of a 4 unit building, I can reduce my monthly payment by the monthly collected rents. Simple enough. In this case, a 4-plex with 2 bedroom 1 bath units would draw in 1800 for three units. So I need a mortgage that is affordable AFTER subtracting that 1800 from it.

Also, since I will be living in the property, I can write off the interest. So the payment is really about 75% the total to begin with. Before I get to real numbers, let me discuss the point of this entire post, and the second trick.

I called my broker and she told me about a loan I might qualify for, an FHA loan for multi-family property. The FHA loan has three requirements. A) 90% of the total potential rents must be greater than the mortgage payment B) you must put 3% down or more C) you must live in a unit.

So let’s look at these points one at a time.

A) 90% of total rents must be greater than the mortgage. This assumes you are NOT living in a unit and have ALL units rented. In my case, that would mean the property has 4×600x.9 = 2160 a month. So the price of the property must lead to a payment that is lower than 2160. The payment will ALSO include the taxes and insurance so keep that in mind. I will give a real number example in a bit.

B) 3% down. This is ridiculous. I am looking at a 300k property, so I would need 9k down? That’s just silly.

C) Live in the unit. no prob.

Now, my broker uses a high ball estimate to see the maximum amount FHA will qualify me for by using rents of 750. Here is the example she sent me.

Example

$750 rent on 4 units

$3000 annual taxes

$600 annual insurance

$750*4*.9=$2700

$3000/12=$250

$600/12=$50

$2700+$250+$50=$3000

The maximum mortgage payment on this unit is $3000

A sale price of $385,000 is the maximum sale price in this scenario for a fourplex

Payment

Principal and interest $2515

Hazard insurance $50

Taxes $250

Mortgage insurance $170

Total $2985

So how does this work in the real world? Well, let’s use the 300k property I am looking at with 600/month/unit rents. I will get qualified for the above amount using the high ball rent estimates. However, I will only be paying a max asking price of 300k. So let’s plug in the numbers to the calculator (300k price, 9k down, 1800 rents, 3k taxes, 600 insurance, 100 misc, and 6.55%).

The calculator then shows that I will have a yearly cash flow of -1765 (150/month). Really? I can buy a 300k property and keep it for only 9000 and 150 a month? Wait. You see what I have left out? Principle. Yup, after one year the principle will be 3116. But I only paid 1765? That means the renters paid the remaining principle FOR me! So by placing 9000 down and paying 150 a month, I will get an extra 1350 a year? That’s right. This second property will give me a NET 100 extra a month upon sale, assuming I only sell it for what I paid for it.

Now lets take a look at the big picture. -250/month after I rent out my current home. -150/month for the second property. A total out of pocket monthly expense of 400. Thats pretty damn low. But, when we figure in the principle returned upon sale, that monthly is really 100-100=0. Thats right. I break even for every month I own both properties, after selling them both with NO appreciation. By buying a second property, I effectively lower my monthly living expense to 0. All for 9k down, and 4.8k a year.

Ok, so my living expense drops to 0. That’s a pretty nifty perk. But I left out one more detail. So I don’t really pay out of pocket (after sale) for my properties, but I DO get the appreciation. In other words, my 500k worth of properties will yield me ~5k for every 1% they appreciate. And I’m paying how much for that? 0

0 dollars a month gets me 5k a year for every % the market appreciates. Pretty nice if you ask me since the average yearly appreciation (over several decades) is about 3.5%

By buying a second investment property, I will be increasing my net worth annually by 3.5*5000 = 17500 on average. What would you do to be worth an extra 17,000 a year? I’d pay 9000 once, and shell out 0 a month

Tags: beginner investing, fha, investment property, loan, net worth, Passive Income, real estate investing