Mortgages & Creative Financing

An FHA-Financed Duplex is an Ideal First Investment Property: Here’s Why

Expertise: Personal Development, Real Estate Deal Analysis & Advice, Real Estate Investing Basics, Business Management
42 Articles Written

The hardest part of getting into real estate investing is where to start. I've been there, and it's stressful because it's a big decision. I made a lot of rookie mistakes just like most new investors do.

So what’s the best way to start if you aren’t rich, want to generate income right away and want to be able to buy more properties over the next few years? I propose buying a duplex using an FHA owner occupied loan. Let’s learn why.

What You Need to Know About Financing

Most people wanting to get into investing start by buying a house with an owner occupied loan (FHA, VA Conventional). Owner occupied loans are cheaper because they have lower interest rates and much lower down payments than investment loans. It’s also the most affordable way to go when you have little cash. Keep in mind, you have to occupy the home for at least a year with an owner occupied loan, or you’ll be committing fraud.

Related: Your First Investment: How to Use Future Rental Income to Qualify for a Duplex Loan

After a year of living in the home, you can legally move out and rent the property. There are no laws against doing this. However, unless you own 30% of the property at the time you rent it out, you will not be able to get another loan until you have two years of landlord experience with that home on your taxes. Going this route means you will have to wait 3 years to buy the second property. Most new investors don’t know this going in and find out too late.

There is a way to speed this process up, get rental income right away and avoid the biggest mistakes most new investors make.

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Buy a Duplex With an FHA Loan

First things first, duplexes are almost always cheaper and bring in more rental income than single family homes of the same size. If you plan on investing, it’s a good idea to start with a duplex anyway.

FHA is the only owner occupied loan you can get for a duplex that will allow a low down payment (3.5% as of March 2015), that doesn’t require landlord experience and that will count the future rental income from the other half of the duplex to help you qualify for a loan. Yes, you will be able to buy more than you can afford because you can rent the other side. How awesome is that?

Not only will you be able to buy more going this route, you will also gain the 2 years landlord experience needed to buy the next property. The reason you need two years experience renting that house is because they need to see how much you get in rent to be able to use that as income when you want to buy another house. Less than two years experience, and they won’t count your rent as income, and you’ll have to qualify for both homes at the same time to buy the second property.

When you do decide to move out after two years, all you need to do is get a lease on the half you are moving out of and turn that in to the lender. You will then be able to use 75% of the total rental income to qualify for the next loan.

Example: Your mortgage is $1,500 a month and you receive $1,000 a month from the rented side of the duplex while living in the other side. After 2 years you move out and get a signed lease on the side you were living in for another $1,000 a month, bringing your total rental income $2,000 a month. The lender will credit you 75% of that as income (25% is estimated to go to vacancies and repair costs). In the lender’s eyes you are now have a $1,500/month mortgage debt and a $1,500/month rental credit. You break even.

If there were a surplus, the extra would be added to your income and help you buy the next property. If it’s a deficit, they will take that amount away from your total income and it would hurt you when buying the next property.

That brings us to the 25% rule. You want to try to make 25% more than the mortgage every month so the house doesn’t count against you when you when you get the next loan.

Lenders also require you have at least 6 months’ mortgage payment saved up as a safety net before you buy the next place. That’s a good idea anyway.

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Related: How to Buy a Duplex: The Ultimate Step by Step Guide

Conclusion

If you buy a single family home, you won’t be able to count the rental income until you have lived there for a year (owner occupied requirement) and then rented the entire place for two more years to get the required experience as a landlord.

If you buy a duplex with an FHA loan, you can buy more houses, use rental income from the other side when you buy it and after two years of living there, you meet the owner occupied requirement and the two years’ experience. If the rental income after you move out is 25% more than the mortgage, you will be in a much better position for buying the next one.

“I did, then what I knew how to do. Now that I know better, I do better.” — Maya Angelou

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[Editor’s Note: We’re republishing this article to let our newer members know about this buying strategy. Let us know what you think with a comment!]

What do you think about this strategy for buying your first investment property? What type of financing did you use when you were starting out?

Leave your comments below!

Brett Lee is a licensed Real Estate Broker in Portland Oregon where he helps people achieve a better future so they can do the things that truly make them happy. Brett is also a buy-and-hold invest...
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    Patrick Bavaro from Fort Lauderdale, Florida
    Replied over 2 years ago
    Brett, Thank you for the post. Great information. Do you happen to know if the 30% owner stipulation rule or 2 years land lording experience is the same for the VA loan? I assume that it is being that it is a owner occupied loan. I am getting ready to purchase my first home, plan is for a a multi-family, over the next 3-4 months. Doing some further homework before then of course, and have a meeting with my realtor and VA mortgage broker this afternoon where I will be asking this question. Wanted to get another opinion from you. Thanks for your time! Patrick
    Kara Barker Realtor from Bristol, PA
    Replied over 2 years ago
    Great article! I did this for my first investment property recently, although I did conventional loan. So I am assuming I will be able to buy my next duplex without the 2 years rental income, is that correct Brett? I want to move out after one year and buy another…
    Joshua Massarini from Union Springs, New York
    Replied over 2 years ago
    Wow, great article. Quick question I got an FHA loan for a Triplex last November. Found out I was leaving a month later and got deployed to Afghanistan. I was under the impression that my one year of residency would be completed before I got back since I will not be back in the US till Jan 2019. Following which my plan was to purchase another home on a VA loan in Spring 2019. Is there still a 2 year rental income restriction on doing this? v/r
    Louis Coniglio Rental Property Investor
    Replied over 2 years ago
    Good one Brett. Thank you for sharing.
    Account Closed
    Replied over 2 years ago
    Great article Brett – my employer has a great 401k match program. What do you think of: contributing more to employer 401k match to get ‘free money’ – this will also result in annual tax deduction (so more tax refund money). Then withdrawing from 401k to contribute towards downpayment of the house along with using FHA loan. For people accumulating funds for downpayment, this could be a faster route.
    Alpha Journal Investor from Danbury, Connecticut
    Replied about 1 year ago
    I would recommend contributing the max to the 401k that your employer is matching. That's guaranteed money and decrease your taxes. You should always maximize your taxable accounts first then look into investments.
    Matthew Mitchell from Oklahoma City, Oklahoma
    Replied 6 months ago
    I'm tired of being told not seasoned enough no matter what I do, I'm tired of passing up great deals how to advertise for partners without getting in trouble. Or is there any way beside owner finance I can do it myself I'm not rich my credit is so so due medical bills from cancer two years ago. I will put in sweat equity. How I can I structure a deal based on the property and not me. Any one help I'm in okla city. If what I side interest you hurry contact me. How much you can give toward funding