The end of the FHA & Househack combo for newbies?

Question

Okay, maybe this was a bit of a dramatic title, but hear me out.

Until yesterday, my plan had been simple:

Step one: get my first ever property (a house hacked duplex) with an FHA loan.

Step two: move into property and stay in there for at least a year. This would allow me to take advantage of not only the low down payment and affordable interest rate of FHA, but also of the rental income to increase my savings rate.

Step three: buy a second property, maybe after a cash out refinance, and snowball from there.

Everything was ready to go. FHA was my best option, first-time buyers newbies with little cash on hand can’t be picky... right?
I’ve read it on forums, heard it on the podcasts, FHA is probably the best way to buy a duplex and get started.

I was ready to go, got pre approved by a lender, then one of the small downsides of FHA started to bother me: mortgage insurance. Unless I make a 20% down payment, I have to pay mortgage insurance for the entire life of the loan. Problem is, i don’t have the cash to do 20% and i really don’t like the idea of paying it for 30 years if I decide not to refinance. I know the amount goes down as you pay off the balance, but it just bothered me. My only other option to not pay mortgage insurance forever seemed to be a conventional loan with a much higher down payment and only pay until I reached 20% equity.

I was determined to find something better. So I did what we millennials do best and googled my way to an answer.

I found out Home Possible loans are available for duplexes for first time home buyers. JACKPOT I thought. I brought this to the attention of my lender who said he would look into it and work out the numbers. I explained to him that I wanted to take advantage of low down payment loans with decent rates, and he said that Home Possible would be even better than FHA in my case. He just had never seen someone use it for a duplex.

Then he dropped a bomb on me. And it blew my mind. It went something like this: 
If you’re looking to optimize over three years without refinancing, and you’re going to occupy the houses you buy, then this opens up a great path. You can start with Freddie’s Home Possible loan. After a year you’d be able to get the Fannie equivalent of this, the Home Ready loan. Then after another year, you could do FHA if you really need to.

My jaw dropped. These loans have lower down payments, and even though they have higher interest rates, insurance is cheaper AND goes away at 20%. WHAT?

This is when I ask for your help, BP veterans, lenders or anyone who know about this.

This sounds too good to be true, right? Maybe I just stumbled upon something that is old news to everyone, but this changes everything for me. 
Would FHA’s insurance really offset the higher interest of Home Possible and Home Ready?
Would this be the best combo for a newbie wanting to start with a duplex house hack?
I understand I am focusing solely on mortgage insurance here, but am I missing anything?

Anthony Gayden · Answer

That is still a very low down payment for a duplex.

As to your original question, I don't think I have ever heard of anyone using all of those loan programs in order to buy property with low down payments.

I personally started with an FHA loan and owner occupied a 4 plex with 3.5% down payment. I moved out a year later. The next home that I bought was a single family owner occupied that I bought with a conventional mortgage and 5% down and a 15 year mortgage, but I pre-paid the PMI. Two years later I bought another single family with 5% down conventional mortgage and turned my former residence into a rental.

I was able to buy three properties each with 5% or less down payment. I already told my wife that I plan on doing the same again in a few years.

Chris Mason · Answer

Hi @Robin Dassy,

It's not new news to me, but it is for others, so still a great post to help get the word out.

Agents in the Bay Area hate FHA, so they love this too. Home Possible @ 95% LTV is in my opinion the best way to get started. Only works with solid credit, the PMI carriers currently won't touch this if you're FICO isn't strong. And there are income limits by census tract, with the caveat that (for example) in 90% of Oakland the income limit is "No Income Limit." So just a quick check before you get excited about writing an offer on the property to ensure income limits aren't going to kill the deal... keep in mind that rental income counts towards that limit, so really you're limited to census tracts with no income limit (again, 90% of many major metropolitan cities).

Here's my little "Why 6 year old biggerpockets.com podcasts and blog articles telling you to start with FHA are, as of 2018, wrong." Really, any content about mortgages from any source that's more than 2 years old should be disregarded -- occasionally someone will bump an old thread with an old post that I myself made, and it might have been right at the time, but as of 2018 it is wrong.

It specifies two counties near me in the below, but most of SoCal will also be covered by those numbers. I don't track other states, check with your lender for that.

Quick note that there's no LTV advantage to going the HomeReady route on 2-4 unit props, just the (what amounts to) rate subsidy for 680-740 FICOs. Don't get the two programs backwards.

The second to last bullet on the above is why no one should ever get excited about FHA on a 3-4 unit property until it's 100% fully closed and you have your keys in-hand. Many lenders, including the largest lender in the nation, don't even offer FHA on 3-4 unit properties any more because the fallout is too high.

Robin Dassy · Answer

@Anthony Gayden Oh my goodness I was thinking it was on the other podcast. I do remember your episode! Man, it was amazing, you're truly a champion of strong will. I was baffled at how your successful career was spurred by something as simple (yet difficult to commit to) as self and lifestyle improvements. I was so pumped after the show haha. I hope you're still doing great!

Robin Dassy · Answer

Thanks to all of you for your encouraging replies!

@Chris Mason I have been making sure to work towards an excellent credit score over the time it took to save up enough for a down payment. I am really glad to have been so intentional about it, my lender has been able to come to me almost with the very best terms he could offer.

I do realize sources become obsolete, but your two years guideline makes a lot of sense in hindsight. I really wish more people knew about this alternative because it could potentially make the numbers on a deal look a whole lot better.

Thanks for the quick response man!

@Anthony Gayden I saw you were a podcast guest but could not remember that episode. I felt so bad until I realized it was missing... anyway.I do realize 5% is still a great deal, but I was just trying to optimize my strategy to have as many properties as possible in my portfolio with the least amount of cash possible sitting idle instead of working for me. I thought this would most likely my best bet for rapid growth.

My strategy is fairly similar to what you did, and I really believe a 3 or 4 plex would make things even better, but good deals on those are really tough to find in my area. Is there a reason you decided to go for a 15 year mortgage rather than 30 on your second property?@Stephanie Irto I know that the two are not that far apart. It's a little bit of a trade off. I just thought for a second that this option was BOTH a lower down payment and a better deal overall. It was too good to be true haha. The FHA lives on as a good alternative. I'm fortunate enough that my wife and I have been working on our finances and credit ever since we got engaged to the point where we can get almost the very best financing deals out there. I hope Home Possible becomes a bit more popular, it could truly help a bunch of people starting out if they're willing to put a bit more cash upfront.

Stephanie Medellin · Answer

@Robin Dassy  5% down on a duplex, triplex, or 4-plex is still a great option.  Take some time to save that extra 1.5% if needed - you'll be ready to buy before you know it!

Anthony Gayden · Answer

Thanks for the kind words. Life has been a whirlwind in the few months since the podcast. I am continuing to push hard towards my goals. I just hope that others hear my story and it helps to motivate them.

Anthony Gayden · Answer

@Robin Dassy

I went with a 15 year because I wanted debt pay down while the property was my primary residence. Even as a rental it still cash flows with the 15 year.

I recently got a HELOC on that house which will be used for my investing.

BTW, my podcast should still be up. I was on the Money Podcast show 21.

Robin Dassy · Answer

Got an update and down payments are 5% on Home Possible for duplexes... Oh well.

The end of the FHA & Househack combo for newbies?

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