FHA Loan or Hard Money Lender for First Investment?

[Tommy Keay]

Hello All! First and foremost, thank you for your time interacting with this post!

Come 1st Quarter 2021, I plan to buy my first property. The purpose of this investment is to 1. Get a great deal (build instant equity) 2. Live in it as my primary residence.

Right now I see two options and I would love to hear everyone's opinion on which is better. Option 1 is getting a FHA loan and possibly a FHA 203k to rehab it since it will most likely be somewhat distressed, but still still satisfy FHA requirements. Later if I want to make it a rental, I could refinance it to a conventional loan to get rid of the PMI and produce more cash flow. Option 2 is going straight to a hard money lender and flip a house to live in it. This option would allow me to BRRRR the equity out of the house and place it into my first true rental investment faster.

Option 1 seems to be easier and a good way to slowly get started in the game. Is Option 2 realistic? Are there hard money lenders that lend to first time investors in the first place? Option 2 seems to be better if I want to dive right into it and increase the velocity of my investments. Would love to hear advice and feel free to tell me how you started.

P.S. My market is quite expensive but definitely good deals out there. Average house is $300K (good deals in type low B/high C neighborhoods are $180k) so it takes some time to save 20%. Good to keep that in mind.

[Perry Farella]

HI. As one who has seen many first time buyers do what you plan I can chime in here. Its often a good strategy to use an FHA 203k loan on a first time purchase if the numbers can work. Meaning if you can maybe find a 2 or 3 or 4 unit property and live in one apartment and lease the others. FHA still allows you to buy with 3.50% down and add in the rehab dollars to that same 30 year loan. The rates are historically low but depend to some extent on your personal credit history and score so I hope you have been using credit cards etc. and building good credit history. But there are some rules. One of them is on any FHA loan, if a 3 or 4 unit property, it has to meet the Self Sufficiency test. That means current rents or future projected rents, if units vacant, off an Appraisal report will be used for all units, even the one you would live in, counted at 75% of gross rent, then that number has to at least meet the full monthly payment including property taxes, FHA monthly mortgage insurance, and home owners insurance. Say a 3 unit has rents each of $1000 so that's $3000 total, including the unit you will occupy after rehab, then $3000 taken at 75% is $2250. So the total monthly house payment cannot be more than $2250. That's called Self Suffiency by FHA. These days with Covid and tenants maybe not all able to pay rent, some lenders are no longer even counting that future rent as income beyond your own job income to help qualify for the loan size needed. Not sure how long that will last but not all lenders are being so conservative, certainly not the one Im with.
I have many first time buyers doing this with 2 to 4 units because rents are high in most cities and interest rates are super low now. Any FHA loan requires the monthly mortgage insurance to be paid for all 30 years of the loan, at a factor of .0085 times loan size divided by 12 months to equal that monthly FHA mortgage insurance added to your payment, that's how they finance the program. So yes when you have 20% equity its wise to consider a refinance to a plain conventional 80% mortgage on say a 3 or 4 unit with no monthly mortgage insurance. Just not sure how long that might take. Another rule is you must sign up to live in the FHA mortgaged property for 12 months before moving out and leasing all units to tenants yet retaining the FHA loan.
Hard Money Lenders are a different animal. I did write in my Blog a comparison a couple years ago you can find. But often their rates are 12% or more and they may only want experienced rehabbers, especially now with Covid and tenants maybe not all paying rent which is a consideration for you too. What if you leverage yourself with a multi unit, FHA or Hard Money, but your tenants stop paying rent and in most states evictions are currently prohibited. Something to ponder. Hopefully by end of the year this will have all passed by and be resolving. Happy to answer questions any time.