My friend Bryant recently shared a TikTok that made the following claim:
“You can put 3.5% down to buy a home, live there for a year, then rent it out & repeat the process”
He was skeptical to say the least, but in fact, the claim (mostly) checks out – in fact, the strategy described is one of the fastest ways to build wealth when you’re starting without much capital, using a government-insured loan program from the Federal Housing Administration (FHA).
To that point, Chris Powers stopped into the replies and mentioned that this was the strategy he used when starting out in real estate.
For those not familiar, Chris is the founder & chairman of Fort Capital, an investment firm that buys industrial real estate properties. He runs a sizable operation; with Fort Capital’s more than 1.5B in assets under management (AUM), it’s hard to argue that he doesn’t know what he’s doing.
What’s more – Moses Kagan, another highly-regarded real estate pro, had this to say about the FHA (Federal Housing Administration) strategy we’re about to cover.
In this article, we’re going to go over how you can use an FHA loan with just a 3.5% down payment to start building real wealth with real estate.
What is an FHA loan?
FHA loans are mortgages that are insured by the US Government through the Federal Housing Administration to help promote home ownership among people who otherwise might not qualify.
FHA loans behave similarly to “conventional” mortgages, but with some additional tradeoffs. The biggest benefits are that they’ve got lower requirements for approval & offer a higher “LTV” (loan to value), which means you can buy a more valuable property with just a 3.5% down payment instead of the typical 20%.
They come with a few downsides as well, though. For instance, there’s a limit on how much you can spend on a property purchased with an FHA loan. The limit varies by county – in many areas it is around $420,000 for a single family home (as of 2022), with the limit in the most expensive real estate markets reaching as high as $1,000,000.
What kinds of property can you buy with an FHA loan?
One of the key things to understand when shopping for a real estate investment is that you aren’t limited to single family houses – in fact, you can go all the way up to a 4-unit apartment building with an FHA loan.
What’s more, the FHA purchase price limit is higher for 2-4 family properties than it is for single-family. This means that if you can afford the payments, you can purchase a 4-unit apartment building worth as much as $1.9 million for just a $67,000 down payment.
When you consider that your tenant’s rent will be paying your mortgage, it should be clear that if you’re looking for the best way to grow wealth is to go big.
Owning & renting out a 4-unit apartment building isn’t much harder than owning & renting out a single-family house, but the potential positive impact on your net worth is a lot bigger.
One more factor to consider is that you can only have one FHA loan at a time – so if you want to take advantage of the low down-payment, it often makes sense to go big.
What do I need to qualify for an FHA loan?
Typical mortgage standards are relaxed for FHA loans, but there are still some things banks will look for when issuing this debt. Notably, they look at your:
- Work History
- Credit Score
- Debt to Income Ratio
among other factors.
FHA Work History Requirements
FHA standards require lenders to verify 2 years of work history to issue a loan. There are some notable exceptions, but both the FHA and the lending bank want to know that you’ve had and will continue to have stable employment. This typically just involves the lender calling your employer to verify you worked there, but can sometimes involve a request for records to verify as the same.
If you changed jobs in the last two years, that’s not a dealbreaker – but the lender will need to call your previous employer to confirm as well. Even a career change into a different field isn’t usually a problem – they just want to ensure that your current position is stable and that you’re likely to remain employed.
Furthermore, it’s not the end of the world if you have a short, reasonable gap in your employment history. If it’s for more than a month, you’ll need a reasonable explanation.
One more thing – the two-year requirement can be waived partially or in full if you satisfy specific conditions. If you were one of the following in the last 2 years, it qualifies as a “permitted exception” and the lender isn’t disallowed from working with you.
- Full-time student
- Active-Duty Military
- Temporarily Medically disabled
- Staying home to care for children. (This one can be dicey)
FHA Credit Score Requirements
FHA loans require a credit check like any other mortgage. The bare minimum permissible credit score for an FHA loan is 500, but if your score is below 580, you’ll be required to put 10% down instead of 3.5%.
If you’re in the 500-580 range, you’re probably best off focusing on improving your score first. As always, better scores mean lower rates, so keep a close eye on yours and do what you can to keep it in good shape!
FHA Debt to Income Requirements
FHA loans have less-demanding limits on debt-to-income ratios as well. There’s a couple terms you need to know about here:
“Front end” debt to income: What % of your income would go your mortgage payments (including tax & insurance)
“Back end” debt to income: Your front end DTI plus any other debts you have to pay each month (credit card payments, car loans, student debt, etc.)
Where conventional loans typically look for a back end debt-to-income ratio of 36% or less, FHA loans can be made at 43% back end DTI or occasionally more in special circumstances.
FHA loans are a great tool for building meaningful, real, generational wealth – many real estate investors who started from $0 used them first – so can you!