What Type of Loans Allow Investors to Put Less Money Down?
Investing in real estate can bring great returns, but it is not easy to get started. I have many articles on my blog about buying investment property with little money down, buying below market value or financing more than four properties. My article about making one million dollars in real estate touches on how to get started, but does not dive into the details. In this article I want to discuss exactly how to buy your first rental property when you don’t have a lot of cash to invest.
Educate yourself about investing in real estate first
The first step for any investor is to learn everything you can about investing. I have many resources for beginning investors in my article; great resources for beginning investors. I have many more articles that describe advanced techniques in my complete guide to investing in long-term rentals. Once you have figured out what type of property you want to buy, here is how you can buy it without putting down a huge down payment.
How to buy investment property with a small down payment
If I had no houses, little money saved and really wanted to invest; this is what I would do. With little money to put down on a property your options are limited unless you can buy a house as an owner occupant. If you can buy a home as an owner occupant you can put 3.5% down or less on a home! It takes some sacrifice and flexibility to use this method, but it is not always easy to get ahead in life.
Buying an investment property as an owner occupant
I am not advising you should pretend to be an owner occupant when you are an investor. There are serious penalties for pretending to be an owner occupant, especially on HUD homes (up to 2 years in prison and $250,000 fine). But you can buy the home as an owner occupant, live in the home a year (or whatever the owner occupant requirement is) and then rent the home. This process can be repeated over and over as long as you can take moving into new houses every year.
What type of loans allow for a smaller down payment?
There are many owner occupant loans that allow for a small down payment. Most investor loans will require at least 20% down or even 25% down. An owner occupant has many more options.
FHA loan
FHA loans are government insured loans that can be obtained with as little as 3.5% down. You can only have one FHA loan at a time unless you have extenuating circumstances like a job relocation. You do have to pay mortgage insurance on FHA loans, which I will discuss more later in this article. There are limits to the amount a FHA mortgage can be and varies by state and even city.
USDA loan
USDA is a loan that can be used in rural area and small towns. The loans most likely can’t be used in medium sized towns or large towns/metro areas. The loan is a fantastic loan for those that qualify and want to buy a home in the designated areas. USDA loans can be had with no money down, but do have mortgage insurance as well.
VA loans
VA loans are run through the United States Veterans Administration. You have to be a veteran to qualify for the loan, but they also can be had with no money down and no mortgage insurance! VA is a great option for those that qualify because the costs are so much less without mortgage insurance.
Down payment assistance programs
Many states have down payment assistance programs. In Colorado we have a program called CHFA. The program helps buyers get into owner occupied homes with very little money down. CHFA actually uses a FHA loan, but allows for less than a 3.5% down payment. Check with lenders on your state to see if you have any programs that help with down payment assistance.
Conventional mortgage
Even conventional mortgages have low down payment loans available for owner occupants. For owner occupants conventional loans have down payments as low as 5%. You will most certainly have to pay mortgage insurance with any conventional loan that has less than 20% down. Unlike some of the other loan options available you can have as many conventional mortgages in your name as you want as an owner occupant. That assumes you can find a bank who will give many loans to an investor like my portfolio lender.
FHA 203K Rehab loan
A FHA 203K rehab loan allows the borrower to finance the house they are buying and repairs they would like to complete after closing. This is a great loan for homes that need work, but the buyer has limited funds to repair a home. There are more costs associated with this loan upfront, because two appraisals are needed and lenders have higher fees for 203K loans. The same down payments and mortgage insurance will be needed as with a regular FHA loan.
Loan Costs a buyer needs to consider besides down payment
On almost any loan you will have more costs than just the down payment. The lender will charge an a origination fee, appraisal fee, prepaid interest, prepaid insurance and possibly prepaid mortgage insurance. Plus you may have more costs the title company charges like a closing fee, recording fees and possibly title insurance. In most cases the seller pays for title insurance, but with HUD and VA foreclosures the buyer has to pay for title insurance. These costs can add up to another 3.5% of the mortgage amount or sometimes more. When you talk to a lender they can give you an estimate of exactly how much these costs will be before you get your loan.
Reduce the amount of cash needed by asking the seller to pay closing costs
Even though the lenders and title company will charge you more fees than just the down payment, that does not mean you have to pay those upfront. You can ask the seller to pay closing costs for you. If you can get the seller to pay your closing costs for you, loans like VA and USDA may be obtained with no out-of-pocket cash. You may still have to put down an earnest money deposit, but that can be refunded at closing in some cases. When you ask the seller to pay closing costs it reduces the amount of money they are getting from the sale so you might actually be paying more for the home than if you didn’t ask for closing costs. But in my mind paying a little more for the house and financing those costs to save cash is better than paying more money out-of-pocket for a little cheaper home.
How much does mortgage insurance add to mortgage payments?
I talked about mortgage insurance briefly in the loan descriptions above. Mortgage insurance is an upfront fee paid at closing, a monthly premium paid on top of mortgage payments or both. Mortgage insurance is insurance for your lender, because the down payment is less than 20%. Loans with a lower down payment are typically more risky for a lender and that is why mortgage insurance is used. Each loan type has different mortgage insurance amounts and time frames. Below are links to more information on mortgage insurance for each type of loan.
FHA mortgage insurance
USDA mortgage insurance
Conventional loan mortgage insurance
With some mortgage insurance it can be removed after your home has enough equity. If your home raised in value with a conventional mortgage, it may possible to get the mortgage insurance removed.
A lower down payment increases the monthly payment significantly
Whenever you get a loan with less than 20% down, you are going to raise your monthly payment. Not only does your payment increase because the loan amount increases, but the mortgage insurance will add even more to your mortgage payment. Many times the difference between a 20% down loan and a 5% down loan can be hundreds of dollars per month. A main component of my strategy is cash flow and low money down loans do make it harder to cash flow on homes once you rent them out. It is very important you run the numbers on any house you buy that you plan to eventually rent out to make sure the home cash flows after all expenses including vacancies and maintenance. It is vitally important you buy these homes below market value in order to leave yourself enough room to cash flow and sell the home if needed. When you have little money available for down payments and repairs, it usually means you have little money for vacancies and maintenance when a house is rented. In the worst case scenario if you can’t rent a home or lose your job, you will be able to sell the home and hopefully make a profit if you bought it below market value to begin with.
Conclusion
I believe the sooner you start investing the better, but make sure you have a backup plan if things don’t go as planned when you buy an owner occupied property that you plan to turn into a rental. Could you sell the home if needed after a year? Are you willing to live in the home longer than a year if things don’t go as planned? Cover your bases and get started investing! Once you have your loan in place and have a property in mind, here is what you can expect to happen during the closing process. mferguson
Investing in real estate can bring great returns, but it is not easy to get started. I have many articles on my blog about buying investment property with little money down, buying below market value or financing more than four properties. My article about making one million dollars in real estate touches on how to get started, but does not dive into the details. In this article I want to discuss exactly how to buy your first rental property when you don’t have a lot of cash to invest.
Educate yourself about investing in real estate first
The first step for any investor is to learn everything you can about investing. I have many resources for beginning investors in my article; great resources for beginning investors. I have many more articles that describe advanced techniques in my complete guide to investing in long-term rentals. Once you have figured out what type of property you want to buy, here is how you can buy it without putting down a huge down payment.
How to buy investment property with a small down payment
If I had no houses, little money saved and really wanted to invest; this is what I would do. With little money to put down on a property your options are limited unless you can buy a house as an owner occupant. If you can buy a home as an owner occupant you can put 3.5% down or less on a home! It takes some sacrifice and flexibility to use this method, but it is not always easy to get ahead in life.
Buying an investment property as an owner occupant
I am not advising you should pretend to be an owner occupant when you are an investor. There are serious penalties for pretending to be an owner occupant, especially on HUD homes (up to 2 years in prison and $250,000 fine). But you can buy the home as an owner occupant, live in the home a year (or whatever the owner occupant requirement is) and then rent the home. This process can be repeated over and over as long as you can take moving into new houses every year.
What type of loans allow for a smaller down payment?
There are many owner occupant loans that allow for a small down payment. Most investor loans will require at least 20% down or even 25% down. An owner occupant has many more options.
FHA loan
FHA loans are government insured loans that can be obtained with as little as 3.5% down. You can only have one FHA loan at a time unless you have extenuating circumstances like a job relocation. You do have to pay mortgage insurance on FHA loans, which I will discuss more later in this article. There are limits to the amount a FHA mortgage can be and varies by state and even city.
USDA loan
USDA is a loan that can be used in rural area and small towns. The loans most likely can’t be used in medium sized towns or large towns/metro areas. The loan is a fantastic loan for those that qualify and want to buy a home in the designated areas. USDA loans can be had with no money down, but do have mortgage insurance as well.
VA loans
VA loans are run through the United States Veterans Administration. You have to be a veteran to qualify for the loan, but they also can be had with no money down and no mortgage insurance! VA is a great option for those that qualify because the costs are so much less without mortgage insurance.
Down payment assistance programs
Many states have down payment assistance programs. In Colorado we have a program called CHFA. The program helps buyers get into owner occupied homes with very little money down. CHFA actually uses a FHA loan, but allows for less than a 3.5% down payment. Check with lenders on your state to see if you have any programs that help with down payment assistance.
Conventional mortgage
Even conventional mortgages have low down payment loans available for owner occupants. For owner occupants conventional loans have down payments as low as 5%. You will most certainly have to pay mortgage insurance with any conventional loan that has less than 20% down. Unlike some of the other loan options available you can have as many conventional mortgages in your name as you want as an owner occupant. That assumes you can find a bank who will give many loans to an investor like my portfolio lender.
FHA 203K Rehab loan
A FHA 203K rehab loan allows the borrower to finance the house they are buying and repairs they would like to complete after closing. This is a great loan for homes that need work, but the buyer has limited funds to repair a home. There are more costs associated with this loan upfront, because two appraisals are needed and lenders have higher fees for 203K loans. The same down payments and mortgage insurance will be needed as with a regular FHA loan.
Loan Costs a buyer needs to consider besides down payment
On almost any loan you will have more costs than just the down payment. The lender will charge an a origination fee, appraisal fee, prepaid interest, prepaid insurance and possibly prepaid mortgage insurance. Plus you may have more costs the title company charges like a closing fee, recording fees and possibly title insurance. In most cases the seller pays for title insurance, but with HUD and VA foreclosures the buyer has to pay for title insurance. These costs can add up to another 3.5% of the mortgage amount or sometimes more. When you talk to a lender they can give you an estimate of exactly how much these costs will be before you get your loan.
Reduce the amount of cash needed by asking the seller to pay closing costs
Even though the lenders and title company will charge you more fees than just the down payment, that does not mean you have to pay those upfront. You can ask the seller to pay closing costs for you. If you can get the seller to pay your closing costs for you, loans like VA and USDA may be obtained with no out-of-pocket cash. You may still have to put down an earnest money deposit, but that can be refunded at closing in some cases. When you ask the seller to pay closing costs it reduces the amount of money they are getting from the sale so you might actually be paying more for the home than if you didn’t ask for closing costs. But in my mind paying a little more for the house and financing those costs to save cash is better than paying more money out-of-pocket for a little cheaper home.
How much does mortgage insurance add to mortgage payments?
I talked about mortgage insurance briefly in the loan descriptions above. Mortgage insurance is an upfront fee paid at closing, a monthly premium paid on top of mortgage payments or both. Mortgage insurance is insurance for your lender, because the down payment is less than 20%. Loans with a lower down payment are typically more risky for a lender and that is why mortgage insurance is used. Each loan type has different mortgage insurance amounts and time frames. Below are links to more information on mortgage insurance for each type of loan.
FHA mortgage insurance
USDA mortgage insurance
Conventional loan mortgage insurance
With some mortgage insurance it can be removed after your home has enough equity. If your home raised in value with a conventional mortgage, it may possible to get the mortgage insurance removed.
A lower down payment increases the monthly payment significantly
Whenever you get a loan with less than 20% down, you are going to raise your monthly payment. Not only does your payment increase because the loan amount increases, but the mortgage insurance will add even more to your mortgage payment. Many times the difference between a 20% down loan and a 5% down loan can be hundreds of dollars per month. A main component of my strategy is cash flow and low money down loans do make it harder to cash flow on homes once you rent them out. It is very important you run the numbers on any house you buy that you plan to eventually rent out to make sure the home cash flows after all expenses including vacancies and maintenance. It is vitally important you buy these homes below market value in order to leave yourself enough room to cash flow and sell the home if needed. When you have little money available for down payments and repairs, it usually means you have little money for vacancies and maintenance when a house is rented. In the worst case scenario if you can’t rent a home or lose your job, you will be able to sell the home and hopefully make a profit if you bought it below market value to begin with.
Conclusion
I believe the sooner you start investing the better, but make sure you have a backup plan if things don’t go as planned when you buy an owner occupied property that you plan to turn into a rental. Could you sell the home if needed after a year? Are you willing to live in the home longer than a year if things don’t go as planned? Cover your bases and get started investing! Once you have your loan in place and have a property in mind, here is what you can expect to happen during the closing process. mferguson