FHA vs conventional loan

13 Replies

Hi BP famiglia! 

I am a first time home buyer and looking to purchase a multi family home - live in one and rent out the other. Is it better to apply for FHA loan and put only 5-10% down vs conventional 20% fixed loan from say chase bank? Is it worth doing FHA even if have to pay a higher PMI? I really can't afford to put 20% down in the area I am looking so I am trying to explore a more affordable option. I figure by owning a multi family I could lower my monthly payments by collecting rent on the other unit. I was also told certain properties wont qualify for FHA loans due to restrictions.

My goal is to own multiple properties creating monthly cash flow.  Is this too risky for my first investment? Am I going about it in the wrong way? 

I have learned so much through BP and thank everyone in advance for providing their help and guidance. I will certainly pay it forward when I am a successful REI ;)

If you can't afford to put 20% down, then FHA would be your best option.

Best of luck!

(206) 407-5452

@adrianchu what about PMI?

With FHA you'll be paying PMI for the life of the loan. You should get a good faith estimate for what the PMI would be if you put down 3%, 5%, or 10%.

But after a few years you might be able to pay down the loan enough to refinance out of FHA if you apply extra payments.

Originally posted by @Nick Lioi :

Hi BP famiglia! 

I am a first time home buyer and looking to purchase a multi family home - live in one and rent out the other. Is it better to apply for FHA loan and put only 5-10% down vs conventional 20% fixed loan from say chase bank? Is it worth doing FHA even if have to pay a higher PMI? I really can't afford to put 20% down in the area I am looking so I am trying to explore a more affordable option. I figure by owning a multi family I could lower my monthly payments by collecting rent on the other unit. I was also told certain properties wont qualify for FHA loans due to restrictions.

My goal is to own multiple properties creating monthly cash flow.  Is this too risky for my first investment? Am I going about it in the wrong way? 

I have learned so much through BP and thank everyone in advance for providing their help and guidance. I will certainly pay it forward when I am a successful REI ;)

 HI Nick,

You can also use a MCM conventional loan if you qualify as a first time buyer for as low as 5% down on 2-4 units while typical conventional financing requires 25% not 20%, as 20% down on 3-4 units is a fallacy (maybe on 2 units but not 3-4 atleast with conventional).

If you dont want to put down 5% then use FHA financing. There is MI for life but only if you think of it for life because you can always refinance or payoff the loan with other means after you create, increase, or modify the property/asset value from your own repairs/sweat equity.

Is it risky? Sure if you dont know what you're doing, mis calculated the utilities costs, repair, vacancy, and other costs as they can add up really fast.

The good thing is atleast you might have 3 other units to help you offset your monthly obligations. If you plan it right you may be able to make money and live for free. 

FHA has health and safety requirements so you may have certain repairs the property may have to have prior to being eligible and there are self sufficiency rules with FHA that require the monthly rental to exceed the total monthly mortgage obligation as well. So go conventional or MCM if you want to avoid those areas.

There are pros and con's to each.

Albert Bui, Lender in CA (#345453), WA (#345453), TX (#345453), and TN (#345453)
949-514-5106

@Albert Bui Note sure if you will see this comment on such an old post, but I just gave your MCM term a Google and found this, if it helps anyone else:

http://homeloanartist.com/mycommunity-mortgage/

It seems there's a loan max of $417k which is difficult in California.

Just curious if you know if that max has been raised since the two sites where I found that were dated 2014 and 2015.

Thanks!

starting in 2017 the 417k is going up to 424,100 so you got a 7,100 boost.

It may not do much in Orange County or Los Angeles county but it goes a long way in Bakersfield, banning, Stockton, Modesto, and other parts of CA.

Albert Bui, Lender in CA (#345453), WA (#345453), TX (#345453), and TN (#345453)
949-514-5106

You can also get conventional loans that are 5 % or 10 % down. I got a quote from a direct lender that offers these but the interest rate is higher. Here in CA was quoted 4.875 for that 5% down loan. I personally would rather pay more interest then pay PMI. You can deduct interest plus you can say it's a conventional offer when you write your offer on the house/multifamily. If there is high demand in the area that might be more competitive than FHA with less strict underwriting. With an FHA you will have the PMI for the life of the loan, so you HAVE to refinance. With a higher interest rate at least it's fixed so you don't HAVE to do anything but you could refi once you have more equity for a lower rate. IMHO the reason to use FHA is that it allows a higher debt to income ratio (42 vs 27) not because it is a low down payment. But I'm in CA where everything has a high price. Good luck!

PMI is going down in 2017 , homeowners will save $500 per year on average.

@Lee Ripma Where can I find more info on such conventional loans? I'm not familiar with the term "direct lender." Are these true 5 or 10% down scenarios or do they break it up across two loans - one at 80% and the other at 10 or 15%? Thus giving you a higher "blended rate" bc the small loan has a higher APR. Not that I can see any downfall to breaking it up across two loans, just curious...

Originally posted by @Christian Clark :

@Lee Ripma Where can I find more info on such conventional loans? I'm not familiar with the term "direct lender." Are these true 5 or 10% down scenarios or do they break it up across two loans - one at 80% and the other at 10 or 15%? Thus giving you a higher "blended rate" bc the small loan has a higher APR. Not that I can see any downfall to breaking it up across two loans, just curious...

What Lee mentions is partially true FHA does allow a higher DTI its 46.99% on the front end and 56.99% on the backend as of this writing (changes all the time) and this is best case (high fico/high cash reserves) while conventional is typically maxes out at 45% and with lots of cash reserves and great credit you can get up to 50%.

5% conventional does exist and its only available mostly on 1 unit SFR/Condo's/PUD's (planned unit developments/townhome/condo). There are some niche programs out there that allow 5% conventional on 2-4 unit in theory but I've never managed to be able to fund them since the mortgage insurance companies were not able to insure them (chicken or the egg dilemma, both are needed).

The reason Lee may have experienced a higher rate is because she may have elected for LPMI or lender paid mortgage insurance (MI) which means the monthly MI is absorbed or paid off for the life of that particular loan through the interest rate. This causes the rate to be higher and this is great for those who cannot write off MI (phases out completely at 110k AGI- adjusted gross income). The tax rules may change sometime in the future but its pretty much been this way the past 5-6 years that I've seen.

LPMI typically adds about .375% to the rate when you have 760 + fico and have atleast 5% down. This will vary greatly if the credit scores are much lower or the down payment changes.

The scenario she mentions is just a simple 95% or 90% LTV loan with a 5-10% down payment, one loan, however something you alluded to is a 80/10/10 or use of first and second loan. This is another strategy to avoid monthly MI completely but you trade that off with a higher price for your first loan (first loan pricing adjusts with a 2nd loan in place) and typically the 2nd loan has a higher rate. So at the end of the day one may work better than the other with a varying hosts of factors because 1st and 2nd may take longer to close and you have an aggressive seller who has 5 backup offers, in that case you go with your single loan quicker closing 95% LTV with 5% down, and get the deal done (example).

Albert Bui, Lender in CA (#345453), WA (#345453), TX (#345453), and TN (#345453)
949-514-5106

@Christian Clark @Albert Bui

Hi Christian,

It sounds like Alert Bui knows a whole lot more about this than I do! But I'll give you a bit of info here and he can chime in. There are two types of lenders if you're shopping for a standard loan, a mortgage broker who serves as a middleman to match you up with loan products offered by many lenders, and a direct lender that only originates their own loans. Direct lenders only sell their own products so the choices are limited. Both will ultimately sell your loan off to fannie may/freddie mac so have to follow those underwriting guidelines. Either type should be able to offer you these lower down payment conventional loans. I had a quote for 5% down and 10% down with higher rates but no PMI. An 80/10/10 loan may also be an option but that's not what I was talking about. The direct lender I got a quote from was mortgage depot. They were actually really bad about calling me back but a friend of mine loves them, so maybe sometimes they are great. I think I'm going to work with a mortgage broker for my purchase, because he has access to lots of different loans and has one that is going to work for me, he's on here @Luke Schrotberger . I happen to want a lower down payment loan for a property I'm going to use myself and use as a vacation rental and he has it since he has access to so many different loans. 

I hope that helps and best of luck to you!

My husband is active duty so we move ALOT (we are at our 5th location in less than 7 years of marriage so I meant ALOT). We have 8 rentals & counting. Honestly I don't worry about pmi. As long as my numbers work, pmi is great! 

My goal is to put as little down on the house as possible. Since when we leave the tenant will be paying it off. Therefore we go with VA, FHA , conventional 5% loans AS MUCH AS possible. Simply because this means we have more cash to put down towards a pure rental home. At the end of the day, I self manage. That is my "sweat equity" to having someone else pay down my house. Therefore I want as little of MY money in it, even if that means paying a little more for using someone elses money.

Good luck!

@Christian Clark , @Lee Ripma , @Elizabeth Colegrove

Thanks for bringing me into the conversation Lee.  As a real estate investor and mortgage broker, my personal approach is similar to Elizabeth's.  I'd rather keep as much cash in my pocket as possible so I look for properties that will cash flow with only 5% down.  

In terms of Mortgage Insurance, as @Albert mentioned the insurance will either be paid by the lender or by the buyer. Many people have heard the Mortgage Insurance is bad, however I see at as part of the cost of acquiring a property with max leverage. My personal preference is to have the lender pay the MI for the sake of simplicity.  

Christian, let me know if you have more questions and I'd be happy to answer any questions you have. 

Luke Schrotberger, Lender in CO (#NMLS 1126863) and CA (#NMLS 1126863)
619-540-8510

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