Many of us like the idea of making extra money. Who doesn’t want a little more cash in their pocket each month?
Becoming a landlord is a nice way to earn some passive income, but not everyone can afford to buy a new place or purchase an apartment building.
With the help of FHA loans, it’s possible to build a real estate empire without a huge upfront investment. Here’s how.
House hacking with FHA loans
“One of the best tools you have is the FHA loan,” says Brandon Turner, a landlord and the cohost of the BiggerPockets podcast. He says the key to becoming a landlord is learning what kind of housing units to purchase with FHA home loans.
FHA loans are backed by the Federal Housing Administration, so lenders assume less risk when they approve you for a mortgage. This means that you can buy a home with more relaxed credit and down repayment requirements.
Turner got started with a loan similar to the FHA program. He bought a property containing two homes using a low down payment of 3 percent. He and his family moved into one of the homes and they rented out the other.
“My mortgage was $625 per month, and I was charging my tenant $650 each month. I was making $25 a month right off the bat,” Turner says. He calls this method of getting started as a landlord “house hacking.”
The concept behind house hacking is to buy a property with multiple units, live in one, and rent out the others to cover your costs — and maybe even make a profit. Over time, the money you save on housing costs can be used to purchase more properties.
Turner was able to use his first house hacking experience as the foundation for building a rental empire. Now he’s a landlord who owns multiple units and helps others do the same.
Buy a property with multiple units
Ready to start your own rental empire? The first step is to buy a property with more than one unit.
“For whatever reason, the FHA, and even the VA, considers any property with four units or less as a single purchase,” Turner says. “This means you can buy a duplex, triplex, or fourplex with an FHA loan or a VA loan.”
In order to qualify, you have to live at the property, using it as a primary residence. That’s where the multi-unit part of the plan comes into play: You live in one of the units and rent out the rest.
If you buy a duplex, you live in one unit and rent the other. With a triplex or fourplex, you have the opportunity to make even more income from tenants.
Depending on the rental market in your town and the units you have, it’s very possible that your tenants will cover your own housing costs — and maybe even more.
After one year, says Turner, it’s possible to move out of the unit and rent it to someone else. This is where things start to pick up.
After a year, there’s a good chance you’re seeing steady income from your rental properties. If you remain in the unit and your housing costs are covered by your tenants, you can put that extra money towards another mortgage payment, allowing you to buy another property to live in or rent out.
Know FHA loan requirements
Before you commit to house hacking, it’s important to understand what happens when you use FHA loans to buy properties.
There are limits to how much you can borrow. The FHA sets loan maximums based on home prices in the area. It’s done on a county-by-county basis, so talk to a mortgage professional about the limit in your neighborhood. Depending on the FHA loan limits and the cost of properties, you might be limited to a duplex for your first house hacking experience.
Next, you need to commit to living in the home for at least year. You must also move into the home within 60 days of closing.
Finally, you need to make your FHA loan payments on time and in full each month. Turner recommends saving up a buffer fund. That way, if your rental unit is empty for a few months, your finances aren’t strained.
“You still need to make sure you can afford your mortgage, even if you plan to rent out the other unit,” he says.
Why FHA loans are so good for house hacking
Turner points out that you can make this strategy work with just about any type of loan. However, FHA home loans are especially good because of the low down payment option.
With this type of loan, you can pay as little as 3.5 percent for a down payment. For many people, that’s much more affordable than trying to come up with 10 or 20 percent to put down.
On top of that, FHA loan requirements are more flexible when it comes to your credit. It’s possible to qualify for 3.5 percent down with a credit score as low as 580. Even though it helps to have good credit, you can still become a landlord with less than perfect credit.
Can you buy a second FHA home?
Once you are stable with your first property, you might want to purchase another property to rent out or move into. In this scenario, it’s tempting to use the FHA program again. However, that option may be limited.
You can obtain a second home, but it’s done on a case-by-case basis. You usually need to show need, such as relocating for a job, or prove that your expanding family can’t fit into your old home anymore.
FHA loan requirements are also such that you might not be able to count the income you receive from your rental property in your application. Unless you have 25 percent equity in your home, your income from renting out an FHA home might not be taken into consideration.
For many people, though, living in that first FHA property provides them the resources they need to take the next step. If your tenant is covering your own housing costs, that can help you build a large fund to use as a down payment on another property down the road.
Like Turner, you can use a program like FHA loans to get started as a landlord. It takes a couple years to really get going, but it’s one way start the process immediately — even if you don’t have a lot of money.
Want to learn more about FHA loans? Get details and see possible drawbacks of this loan type here.