It is common knowledge that a 20% down payment is typical when purchasing real estate, but it’s only an expectation, not a requirement. There is a way to obtain an FHA (Federal Housing Administration) loan for investment with a down payment as low as 3.5%. This is your guide to understanding how to make your real estate investment dream a reality for less.
Understanding the FHA
Before 1934, potential homeowners needed to obtain a loan through a private lender who often required a hefty down payment of 20%. This posed a challenge for many Americans, who had seen their savings evaporate due to the Great Depression, but the government knew that purchases of new and existing homes was a pivotal element in the recovery of the nation’s economy. So, in 1934, Congress passed the National Housing Act as a means of easing the burden of purchasing a home for the average American. As a part of this act, the FHA was created to regulate the lending industry’s practices in regard to home loans. This regulation created guidelines for underwriters in exchange for a guarantee on the loans they granted. As part of these guidelines, lenders were able to offer loans for as low as 3.5% down, knowing that, if the loan went into default, the federal government would back it up by guaranteeing the difference between the 3.5% paid and the 20% (or more) the lender usually required. This contract encouraged more lending by reducing the risk to the lender, which in turn led to more Americans being able to purchase homes.
Understanding the New Economy
From the viewpoint of the lender, a loan for an investment property is a much higher risk than that for a property in which the borrower will reside. Lenders understand that if a person lives in a property, they are more inclined to pay the loan to retain their home versus an investor who may decide to let a property foreclose when faced with financial trouble. Loan institutions learned this lesson the hard way during the 2008 financial crisis, which saw many investors abandon properties which were obtained with easy financing requiring little or no money down. As a result, they are more wary now of granting loans without a large down payment on investment properties (as well as single-family homes).
Real Estate Investing Still Builds Wealth
Real estate remains the premiere avenue for accruing wealth through investment. So long as there are people in the world, they will need a place to live and these places are often owned by other people. If you own real estate, there will always be a market for your product, thereby virtually guaranteeing income and profitability with manageable risk.
The return on investment for real estate is perennially high. The cost of investing in property is limited to the loan and maintenance, which is offset by the rents received on the property. In addition to rental profits, each loan payment creates equity for the investor which can be used to generate even more opportunity for wealth acquisition.
About that 3.5%…
As we discussed, lenders prefer FHA backed loans because of the guarantee the government offered, but they are more reticent to offer an investment loan than a loan for a home in which the borrower will live. The key to manipulating the process is simple; purchase an investment property which will also serve as your residence. This can be achieved by purchasing a duplex in which you can live, while renting out the other side. The more units a property has available for renting, the better, so long as one unit is occupied by the owner. The FHA backs the loan, the lender offers a lower down payment option, and the owner reaps the rewards of being a real estate investor.
A Solid Foundation for Growth
Beginning your investment career as your own tenant is a solid way to build a foundation for growth. You have a place to live, which also serves as a means of income, and the equity you earn from your own home allows you to further invest in more properties. In maintaining your own residence, you are also maintaining your investment and learning how to best manage a property and tenants. With this knowledge you can go forth and purchase more multi-unit properties, increasing your wealth potential with each property obtained.
Image courtesy Shannon Kringen
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