Thanks to the federal government, there are many ways new homeowners can receive assistance to buy their first property. Some of these initiatives offer really enticing incentives like small down payments, low monthly payments, and low-interest rates. The FHA 203(k) is one of them and is particularly appealing thanks to its ability to be used for homes that need serious improvements or upgrades. Should I use an FHA 203(k) as an Introductory Investment?
But what about real estate investors, can we use it, too? Is it better to use an FHA 203(k) as an introductory investment into real estate flipping?
In summary: no*. But before you close this page, take a closer look at my answer. It’s not a straight-out “no,” it’s a “no” with an asterisk attached to it. You see, FHA loans are set aside specifically for homebuyers to secure financing for their primary residence. Thankfully, this is where that asterisk comes into play, as there’s a way to get your real estate portfolio started on the cheap with a little help from Uncle Sam.
Want to know how? Let’s dive in.
What is an FHA Loan?
FHA stands for the Federal Housing Administration and is a branch of HUD, the US Department of Housing and Urban Development. This is the branch of the federal government which oversees the residential property laws, regulates foreclosure procedures, and is in place to help US citizens navigate the world of home ownership. FHA loans started in 1934 as a way to help citizens purchase a home while recovering from the Great Depression.
Essentially the whole point of making FHA loans available is to help people become homeowners with government assistance. Particularly those who would not be eligible for loans from a traditional bank due to their income or other economic factors.
What’s great about these FHA loans is that they only require 3.5% of the loan as a down payment. Traditional lenders usually want to see 20%, so you can see why an FHA loan might be desirable for a new investor or homeowner.
Normally FHA loans are to be used for the purchase of the home and not the closing costs. There’s a trick to getting your closing costs added to this, though. To get closing costs included in your FHA loan you’ll need to get the seller to pay them for you.
Now, that might seem like a tall order to ask a seller, but you can add it to the final price so that it’s a net positive for them. So if a seller is asking for $100k for their home, you can offer $103k with the stipulation that the extra goes towards closing costs. This way, the seller gets the price they wanted and your closing costs are now folded into your loan.
While the FHA loan does make homeownership more accessible, that doesn’t mean you should treat it any differently than a traditional loan. To get FHA approval, you’ll need good credit, a stable and verifiable income, and proof that you’ll be able to make your mortgage payments on time and in full.
If one of these factors is tripping you up, I’d suggest working on improving them first before applying for your loan as the process can take a lot of time. Believe me when I say you don’t want to go down the route of applying for government assistance if you don’t have the financial history that makes it worth their time.
Should I use an FHA 203(k) as an Introductory Investment?
An FHA 203(k) loan is different from the standard FHA loan in that it’s to be used solely for repairs on the home.
There are two versions of the 203(k) loan which each have their own stipulations.
A Streamline 201(k) is to be used for minimal repairs and minor upgrades. It’s not to be used for structural repairs and is capped at $35,000.
A Standard 2013(k) loan is for major structural upgrades. The idea for this loan is to help low or moderate-income families take on a home that may need a lot of help. If the home gets repaired, it will raise the property value and help improve the neighborhood.
Since the 2013(k) is designated for structural repairs, there is no cap. The minimum you can ask to borrow is $5,000.
That all sounds great, right? Well, there are some downsides to it.
First off, FHA 203(k) loans are difficult to get as many lenders aren’t interested in offering them as a product. You’ll most likely need to go to a lender who specializes in 203(k) loans rather than a traditional bank.
In addition, the loan process can be tedious. You’ll need to go through the lender who then needs to go through HUD and the FHA to secure approval. There will be lots of paperwork and you’ll probably need to send multiples of your income statements, credit scores, and so on. This won’t be a quick process so don’t think you’ll be able to use a 203(k) on a property you jumped in on a whim.
An FHA Loophole for Investors
An FHA loan is not for investors, full stop. If you’re looking for a way to get a cheap loan on an investment property, you will be denied. Remember that this was created to help low and middle-income families buy a home, so the government does not look kindly on people who try to shirk that requirement.
However, there is a sort of loophole you can use to secure an FHA 203(k) if you want to go that route.
While FHA loans are made for homeowners and not investors, that does not mean they’re solely for single-family homes. In fact, you can apply for a 203(k) loan if you own a multi-family home that contains anywhere from 1 – 4 separate domiciles.
So what’s the catch? You as the homeowner will need to reside in one of those residences. It can be a duplex, triplex, or small apartment building that you want to fix up. As long as your primary residence is one of those spots, you’re eligible for an FHA 203(k). You can then sell or rent the remaining residences and add them to your investment portfolio.
As a little fun fact, while I didn’t apply for an FHA loan, my first property was this very situation. In my twenties, I bought a duplex and converted it into a triplex. I rented out the property and lived in the basement, then sold it off about 5 years later. While I didn’t get a 203(k) loan, it was a great investment property to get started with and I definitely advocate giving multi-family homes a shot.
So there you have it. While you cannot use the FHA 203(k) as a straight-up investment into your real estate ventures, there is a little wiggle room that can help you secure that first property if you’re interested in multi-family units. It’s how I started and would absolutely recommend giving that route a try.
Do you know of any tips for making it easier to secure a 203(k) loan? Leave a comment and let us know!