We have all heard the old adage "It takes money to make money". From my own experience, this phrase can be infuriating when you don't have much to start with. If you have been analyzing properties using the Rental Property Spreadsheet, you may have found a property, or a market that looks appealing to you. But, you just don't have the money for a 20% down payment! The property could certainly be sold by the time you save up enough, and the market may have completely changed by then! Luckily, there are options to help you acquire rental property with a small amount of capital!
The first way we will mention is fairly obvious: borrow money from family, or friends for the down payment, and work out some sort of repayment option with them. Most people would rather borrow money from someone a close relative, than a bank, so that is always a starting point. We will say this: you must have some of your own money to invest. While buying a property with none of your money down sounds great, we don't recommend it. Not only will it make your investors feel uneasy, but you also may not feel attached to the property, or care about its success if you have not actually put your own hard earned money in. We feel that if you want to call yourself an investor, you need to have some of your own skin in the game.
Before you start putting money into real estate, there are a few bases you should have covered. If you have not already, you should have several funds that you are contributing to. Firstly, the emergency family fund is always a great idea (generally enough to cover 3-6 months worth of rent/expenses). You probably already have a 401k, or government savings plan through your employer, or maybe a personal investment account with a financial advisor. Beyond that, you want to start putting money away for your real estate investment starter fund. Take a look at your income and expenses, and try to peel off as much as you can afford to put into that real estate fund.
Now, on to the fun stuff. Traditionally, a down payment on a home is 20%. If you don't have enough saved for that chunk of cash, What are your options? Aside from borrowing money from friends, or family in order to get started investing in residential rental property, you have the U.S. government on your side. The Federal Housing Authority (FHA) is a program that allows homebuyers to get into property with very little money down. The FHA will insure loans made by FHA approved lenders. If you are willing to live in the house that you are buying for a while, this program can be a great benefit to investors all over the U.S. Below is a list of FHA general requirements:
- You must live in the home you are purchasing for at least 9 months to 1 Year
- FICO credit score of 580 or higher to be approved for 3.5% down payment. Otherwise, 10% down required.
- Must pay annual mortgage insurance (insures lenders against losses), as well as upfront premium (generally, 1.75% of purchase price, which can be financed.) Click here for MI calculator.
- There are limits to the amount that you can borrow. Click here for limits in your area.
- Mortgage debt-to-income ratio must be 31%, or less. This is the mortgage payment, property taxes, insurance, and HOA dues divided by your total monthly income.
- Total debt-to-income ratio must be 43%, or less. This includes mortgage payment, property taxes, insurance, HOA dues PLUS any other debt expenses (payments on your car, personal loan, student loan, etc.) divided by your total monthly income.
You may be thinking "I want an investment property, not a new place to live!". Well, if you can make it work, living in the house not only locks in a lower rate than if you were to buy it as an investment rental property, but it also allows you to fix the place up, work out any oddities with the property, and begin to develop relationships with your neighbors.
If you plan to take advantage of this program, and depending on the market in your area and the numbers you are looking at, we recommend having at least 10-15% of the purchase price of the property you are looking at in cash, as opposed to the 3.5% minimum that may be available to you.
Let's take a look at an example. We'll use $100,000 property. If your Real Estate Investment Savings account has $15,000 in it, you could either put the full 15% down ($15,000 at a 4% interest rate, making your monthly mortgage payment $406), or, you could put down just 10% ($10,000 @ 4%, monthly mortgage pmt of $430). While you are living in the house and fixing it up (if necessary) for the first year, you have an extra $5,000 for repairs on the property, or safety reserves (basically, just like the emergency account we talked about above, but for your property instead of your family). This extra $5,000 only costs you $24/month and can be very helpful to a buyer that has very little capital to begin with.
As a note, if you don't have the 10%-15% for a down payment, but you're sure that you've found a screaming deal, just be certain that you are putting enough down that your payments are not going to sink you should something go badly when you decide to rent the property out. Keep that monthly mortgage insurance premium on your mind as you are shopping around.
FHA-insured loans can be a great way to get you into a property when you are low on funds. Be sure to meet with an FHA-approved lender who will walk you through the process of getting pre-approved, and helping you to choose a property that they will lend on. Also, remember that you are buying for the purpose of renting the property out, do not get caught up in the idea that "you could never live there", because ultimately, YOU won't be living there, your tenants will!
On that note, it is very important to understand your numbers. If you have not already, check out the Rental Property Spreadsheet so that you know exactly what to expect as far as assumptions, expenses, cash flow, and return on investment.