After over 30 years in real estate investing, I have to admit that getting that first property was absolutely the toughest.
Of course, it wasn’t just about being able to make the monthly payments. After all, while I had been saving up to buy my first property, I was still able to pay my rent. The toughest part, by far, was coming up with the actual down payment.
As many folks do nowadays, I graduated with student loan debt. I was also married with a child. And so, we moved in with family to save money while I studied to become an agent, as I wanted to actually get paid whenever I bought a property.
After two years of saving, we moved into an apartment. It was an affordable place, not the most I could afford, but it was the safest place to live while still saving money quickly. By having a second job (as a real estate agent), I was able to live off one check and bank the other, which is how I eventually saved up enough money.
That being said, the down payment was still tough to come up with. I often reference that many of us make most of our financial mistakes when we’re young and first starting out (between the ages of 25 and 35). I call it the “football game of life” that runs from ages 25 to 65, where those first 10 years tend to be the most crucial. Of course, since housing is usually everyone’s biggest expense, this can be an area where many of us go wrong.
Besides overspending on things like your car or housing right out of the gate, another mistake may be not utilizing leverage efficiently along the way.
Of course, buying a house with an FHA (Federal Housing Administration) loan can be the most expensive way to buy a home as far as MIP (Mortgage Insurance Premium) and monthly payments are concerned, but the good news is that most first-time home buyers are eligible for one FHA loan. Also, it usually requires the least amount of cash out-of-pocket (unless you’re a veteran and can qualify for a VA loan).
Let’s first look at why this is possible.
Since most first-time home buyers usually have less than 20% down payment to put towards a home as an owner occupant, FHA can require as little as 3.5% down. It is a government-backed mortgage, thus requiring the MIP that insures the loan since you would be putting so little money down. Keep in mind, this premium stays for the life of the loan unless, of course, you refinance.
The good news with FHA is that the qualifying ratios based on income and debt are a little more lenient than conventional financing, and you can also utilize a gift (or gift letter) from a relative to go towards your down payment.
My Down Payment
Unfortunately, I didn’t have anyone to give me a gift towards my down payment. My first property, a duplex in a blue-collar area, that I purchased FHA owner-occupied was still bought with very little money out of pocket. I was fortunate to be able to count a certain percentage of the rent from the upstairs rental unit towards my gross monthly income. And I was also able to build in a 2% seller assist that helped detract from some of the down payment monies that were needed. But even coming up with the difference after the assist seemed to take some time and effort.
Although at the time I did all of these things to keep my down payment low out of necessity, looking back, it was one of the smartest things I did.
Disadvantages of a Large Down Payment
Even if you’ve saved enough cash to make a large down payment, there are a few things to consider first.
For example, although a large down payment may decrease your monthly payment amount, you may want to weigh this against the mortgage interest deduction you receive with the larger monthly payment. What are the after-tax implications?
Another thing to consider when making a larger down payment is that capital is completely tied up in the property, and you don’t have access to it. If the property drops in value and you have to sell, that down payment may be completely lost.
An alternative is to save the extra cash as an emergency nest egg, or reserves, especially when you’re first starting out. Plus, doing so may help you save for the next property more quickly.
There’s an old saying that you should know your exit before making an investment, and I also believe you need to know what type of investor you are. For me, I knew that I was a buy and hold investor and my exit was to keep this first property as a long-term, buy and hold rental property. And to be quite honest, I still own this property today.
Of course, if you’re not entirely sure, a good rule of thumb is to make sure market rent is higher than your PITI (principal, interest, taxes, and insurance). That way, if you want or need to rent it out and keep it, you can.
For me, I never really wasted my down payments, as I’ve intentionally kept all of the properties I’ve ever lived in as rentals. Although it’s not for everyone, very few people seem to do this. Most people typically buy a house and then sell it before buying the next one.
For me, I bought all of them with the intention of keeping them as long-term rentals. I don’t know — maybe it was the real estate agent in me.
So, how did you (or will you) come up with the cash for your first down payment?
Let’s talk in the comments section below!