Am I Being Crazy About Low-Money Down Loans?

[Seth Nightengale]

Hello BP world!

Longtime lurker, first time poster here.

In May of '21, I bought a duplex with the intention of house-hacking. After a bad experience with the tenants I inherited, I opted to convert the unit to an Airbnb, and my experience has been awesome. On average, I net about double the income I would've received from a long-term lease while still retaining complete control of the property, experiencing the benefits of Aircover and being able to offer the space to friends and family who come to visit. Instead of having a tenant pay a portion of the mortgage, I get to live here for free and the property makes me money. My wife's full-time job is raising our children, but her side hustle is managing the day to day operations of the Airbnb, so we have a unique situation that would allow us replicate this model in the future :). I've also gained invaluable experience in DIY repair and improvement regarding everything from basic cosmetics like painting and changing light fixtures to completely redoing the old caste-iron plumbing on the property.

Despite the increased cashflow, my family has had some unexpected medical costs that set back my savings goals for the next investment. Initially, my plan was to buy one property a year. It's a little over two years since my first purchase and now I'm finally on track to purchase this winter and get the listing ready for busy season. However, I don't know how much money I want to use on my next deal.

Since my first purchase, my W2 income has increased by a lot. I should be preapproved for almost any duplex I would want to purchase in the greater Milwaukee area, but I'm nervous about the idea of only putting 3.5% down on a property worth hundreds of thousands of dollars. On paper, this is the best option. In my head, I know that as long as the numbers work it will be okay (for my full-time job I'm a deal analyst, so I'm very familiar with building models and providing recommendations that take into account risk and various probabilities, etc). 

With a low down payment, I worry about bigger picture impacts down the road, particularly when it comes to getting access to equity for the sake of scaling my portfolio. If I purchase a property with 3.5% down and put money into it to improve it for my own residence and for Airbnb, doesn't that greatly increase my time horizon for getting that capital back out of the property? I'm young and just getting started, and one of my lessons I learned from my first purchase was the value of having cash in my pocket where I can use it rather than sitting in a home. 

Am I being crazy? What do the pros think? Has anyone been in this position before? 

[Marcus Auerbach]

@Seth Nightengale one of the biggest mind shifts is to make financial decisions not based on your gut feeling, but based on cold, hard math. In this case, you might be worring about the wrong thing. When you consider your overall risk exposure (which BTW in real estate should always be as close to zero as possible) with a 1920's duplex it has a lot more to do with the condition of a 100 year old property, than with your downpayment. Condition transaltes into future capex and what you need to budget for the next 10 years (or otherwise could catch you by surprise) is the main concern, but also easily mitigated if you know what you are looking at.

Second, I am not a big fan of FHA 3.5% loans. Seller's don't like them, so it's hard to get a good deal under contract. And you have to pay PMI for life, which adds up. A low down conventional loan is much better suited and is a lot more attractive you a seller. We have a lender who does not require PMI on a owner occupied duplex, so that help with cash flow.