FHA or Conventional when you have both options?

Question

I'm planning on buying my first property in Chicago next year when i have enough money saved up. By that time I'll have enough money to put 20% down on a $200k property plus renovations. My plan is to buy and hold either a single or multi family house (30 year fix). In either cases, me and my gf will be living in the property which should get me qualified for an FHA loan. I want to find an under market value property that I can fix up a little and then refinance it a year or two later to get funds for my next property. My question is should i go FHA or Conventional?

I know depending on who I ask i can get either one. Below are some of the pros and cons I could come up with.  What are other things to consider? Which one makes more sense for my situation? (I have good credit)

FHA pros: low down payment, i'll be able to keep more of my savings, pay low or no mortgage when i rent other unit(s)

FHA cons: I'll have to pay PMIs, higher mortgage if I can't rent other unit(s)

Conventional pros: lower mortgage payments

Conventional cons: less money available for other deals, less money available if something goes wrong

Sebastien Beauboeuf · Answer

@Michael Facchini thanks! I never really thought about how the rates would be next year.  The only reason i wanted to wait until next year was to save enough for 20% down payment on 300k-400k property. I knew i had the FHA option but i guess i also wanted to have the option to put 20% down, if that was a better option. But i understand your point.

@Matthew Porcaro Thank you so much for your feedback!

@Mica Moore Yes i've heard that from different investors. That's one of the reasons i asked the question on the forum to get other investors' point of view and be able to make a better decision.

Michael Facchini · Answer

Yep, totally get it.  I have this conversation a fair amount with clients.  I of course want the best for them and don't want to rush them into anything, but have seen enough situations where a client waits a year or two to save up more money, thinking they needed to or it was the better way to go, only to find that property prices and rates increased, and now they're either in the same place or worse compared to doing less down earlier on.  If rates end up staying low, then great, you refinance.  But otherwise you don't let opportunity pass you by....again, under the assumption that the payment is comfortable and you are ready to buy.

Matthew Porcaro · Answer

Think of this in terms of cash on cash return.

If you put a 3.5% down payment, and you buy a small multifamily with an FHA or 203k loan, you're maximizing your CASH ON CASH return, since, you are putting down a relatively small amount, in exchange for someone else paying off your property.

Your tenants are ultimately paying down your principal, so if you can use the least amount of cash possible, there's no reason not to!

Eric Veronica · Answer

@Pierre-Sebastien Beauboeuf you may want to consider variation of a conventional loan called a homepossible. This program was initially designed to open up home ownership opportunities for home buyers in low-moderate income areas. Unintentionally it also gives new investors a great opportunity to purchase 2-4 unit properties with awesome terms.

Many areas of Chicago have no income limits and you can purchase 2-4 unit properties with 5% down. Interest rates are phenomenal. There are even some scenarios where we can structure the rate in a way where we can avoid monthly PMI altogether.  In January we closed the purchase of a $400,000 4-unit property in the Chicago area.  30 year fixed With 5% down. Interested rate was at 4.90% APR 4.98% with no PMI.

Tom Shallcross · Answer

@Pierre-Sebastien Beauboeuf - the answer is it's going to depend on your personal goals.  I like keeping more money in my pocket when possible, but if you are confident that you can purchase undervalue and have a way to increase the value, you should be able to refi out and only have either loan for a year or so.  Obviously you can't predict the the future so have a contingency plan.

One other thing to consider is FHA will have more hurdles for your appraisal as the home will have to meet HUD minimum safety requirements.  This can be problematic when looking to buy a home that needs work.  Along the same lines, your offer to the seller will probably be less attractive with FHA as the seller and his/her agent know it can potentially take longer and have more hurdles.  These items don't make FHA the wrong choice, but should be factored into your decision-making process.

Mica Moore · Answer

FHA is not likely to approve a fixer unless you get the FHA rehab loan.  Conventional is always better (aside for needing a larger down-payment) because a seller is likely to choose a Conv buyer over an FHA one (FHA is a hoop jumping game).

Michael Facchini · Answer

Congrats on the decision to buy your first place @Pierre-Sebastien Beauboeuf!  So, my thoughts on the matter are to consider an FHA 203k rehab loan if you're looking to put a fair amount of improvements/work into the place, especially if a multi-unit.  There are other renovation loan options you can consider too, but if focusing on a 2-4unit then 203k is a great way to go and only requires 3.5% down.  Perhaps this allows you to purchase sooner rather than later?  If you're under the assumption that rates will be higher next year, then maybe you start to ramp things up this year...and if the right place comes along, you don't wait on it....vs waiting until you have 20% down, which is not necessary.  If rates are attractive now and the right opportunity comes along, I'm under the mentality that it's best to jump on it and you can always refinance later if rates are low enough, it makes sense, etc.  Waiting to save up 20% can result in you losing time/opportunity, and even lead to worse financing options if the rate market bumps up by the time you've saved that 20%.  Any questions on things at any time, don't hesitate to reach out!

Sebastien Beauboeuf · Answer

@Harjeet Bhatti Ok thanks.

@Alvin Sylvain oh really? Good to know thanks.

@Tom Shallcross You made a lot of great points. I definitely didn't know yet about the HUD safety requirements. I also didn't think about how a seller and their agent might find my FHA offer less attractive. Thanks for your help!

@Eric Veronica I've never heard of the hompossible loan before. Thanks for the great tip. Would you be able to tell me what neighborhood you close that deal in Chicago? 400k for a 4-unit sounds really good.

Alvin Sylvain · Answer

Just FYI, I've been told that, as an investor, you'll need 25% down for conventional  these days.

And even going conventional, I believe you'll still be able to get the FHA 203K rehab loan.

Harjeet Bhatti · Answer

@Pierre-Sebastien Beauboeuf  FHA is good option when the borrower has lower credit  score and lower down payment. The borrower will have lower PMI and lower interest rate compare to conventional loan. FHA has 203k product which is good for rehab the property. The drawback you won't be able to  cancel the PMI if you have lower down payment.   FHA  has 3.50% down payment requirement and Conventional mortgages has  3% down payment unless you are buying 2-4 units. Make sure you get presentation from your lender so can compare both products.

FHA or Conventional when you have both options?

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