FHA vs Conventional Financing as it pertains to CASHFLOW

[Nate Boda]

Ok so here's the scoop:

I am a beginning investor looking for my first buy and hold investment so as to get my feet wet. I am headed in the direction of a multi unit; a four-plex would be great since that is the maximum amount of units you can get a non-commercial loan with (go big or go home) but triplexes and duplexes would work too. I had originally planned on taking advantage of an FHA loan. The advantages of FHA are that you only have to put 3.5% down, and you enjoy a lower interest rate (I have been quoted out at around 4.25%) As far as the down payment goes, I would end up spending somewhere in the $5,000 to $10,000 range in my relatively expensive Philadelphia suburb area where decent multi-units run anywhere from 150k to 270k (and higher but $270,000 is probably the highest I feel comfortable going). So point being, it helps a guy like me who only has $10,000 to $15,000 in the bank to land his first property.

I am still saving every penny I can (around $1000 a month) and could maybe get some funding through friends and family to get me that 20% downpayment, but then again, cash is king, and FHA allows me to leverage to the max and keep my cash on cash percentage sky high. So as you can tell, I am conflicted with whether to pull the trigger on FHA, or wait for a little, get my money in order, and swing a conventional loan.

Here are the cons of FHA

The FHA program is designed as an incentive program for first time homeowners and so I would have to live in one of the units for an unspecified period of time; I've been told anywhere from 3 months to a year but your guess is as good as mine. This will eliminate my cashflow while living there, especially when you consider right now I am living at home with my parents for $500 a month including utilities and all of mommas food I can eat (I know, im a 28 year old nerd, but my girlfriend is gorgeous so that makes up for it... right?)

Next is the dreaded PMI (private mortgage insurance). This little sucker is mandatory for all FHA loans and is 1.35% of your mortgage annually. Just to give you an idea of how much this sucks, at a mortgage balance of $150,000 you would be paying $108 a month and at $270,000 you would be paying $293!! All so that your bank can still sleep at night if you bail on the payment.

So, all that being said, here's where I need your help. Both FHA and conventional loans have their good and bad and to be honest I am having a hard time knowing which is better for me. From a cash on cash standpoint, you can't beat FHA because your shelling out only 17.5% of what you would have to for conventional so its not hard to get to that 20% cash on cash benchmark (20% is what I've heard is reasonable however I am interested in hearing others opinions).

BUT it is much harder to cashflow at all with PMI taking a bite out of you every month and the higher mortgage payment from only putting down 3.5%.

From the research I've done it seems that you should cashflow at least $100 per unit per month after ALL expenses (utilities, insurance, taxes, 5% of rent for maintenance, 10% of rent for vacancy, and capex)

HOWEVER,

and here's the question that made me write this post, should you still use that $100 number if you are putting down so little with FHA? Is it ok to make less with the idea that your cash on cash is still high? I don't know. I hope someone whos first rodeo this isn't can give me some advice. All I know is that ive been running numbers past ALOT of properties in my area and the only way I can get them to cashflow $100 per unit is to go conventional and put down the 20% down payment.

Thanks so much for taking the time to read and respond

NATE