5% down vs. 20% down?

Question

I am shopping for a duplex in Salt Lake City, as a first time purchase and house hack. My game plan has been to put 5% down with an FHA loan. However, I am having trouble finding any properties where the numbers work, and questioning whether I should put 20% down in order to cover my expenses.

I am focusing on good areas of the city, as this is intended to be a long term buy and hold. I plan to rent to long term tenants. I run a small business that takes much of my time, so my time (and experience) is limited. My initial plan has been to put 5% down, and once the dust has settled on the purchase, and my costs are stabilized/more foreseeable, invest a good chunk of the remainder of my nest egg into index funds.

I may be able to make 20% down work on the most inexpensive options in the areas I am looking, however it will stretch the limits of my nest egg (to clarify, I would be leaving a personal safety buffer/slush fund, and not spending my last dollars on downpayment. But I would likely not have money left over for investing in index funds, or for much improvements to the property if they are needed).

I don't intend to change the areas I am shopping in order to achieve better ROI - I want to stay focused on good areas of the city. My metrics for a 'good deal' would be to cover cost of mortgage + reasonable expectation for expenses. I am not concerned with initial cashflow, as long as I am not purchasing a cash drain.

It may be that I simply need to hunt harder or get more creative to find a deal under market value. My concern with this is that it may keep me on the sidelines much longer.

On the flip side, the duplexes that are listed, in which the numbers don't seem to make sense, continue to go under contract - the numbers make sense for someone. Do I need to suck it up and pay 20% like investors are expected to, and breathe easy knowing I am not over-leveraging myself, and not wasting money on MIP?

I make enough money from my business to live on. I am not seeking cashflow. Rather, I am seeking to build equity and long-term wealth as well as eventual retirement support, as my current business would not allow for any income once I take my foot off the gas.

Any thoughts from the more seasoned folks out there? Thank you for any wisdom you might share!

Nick

Logan McKay Zylstra · Answer

Numbers don’t make a ton of sense right now. Numbers are better on 3 or 4 units if you can swing the downpayment for that.

Mike Dymski · Answer

"...where the numbers work..." is up to interpretation.  If you are covering a large percentage of your housing costs with the rent (including paying off the mortgage) (and have good opportunity for appreciation), that works for most house hackers.

Nathan Grabau · Answer

I recommend that clients have slightly negative cash flow at 5% down vs having slightly positive or break even cash flow at 20%. NoCo like SLC is a appreciation market, so we benefit from our battle being won with long term value growth vs cash flow. I am not sure if I would put the other 15% into an index fund, maybe a mix into a CD and index fund. Even though I am bullish on the stock market and have a actively managed stock portfolio next to my RE holdings, the reason I would keep the cash is as a front line of defense. A lot of people like to consider cash flow their front line of defense, but the truth is, cash actually is. If you have a property that cash flows 250 a month vs -100 a month, being in the cash flow positive situation does not help you if you have no cash when 2 furnaces, a main line, and hot water heater go out in the same week. If you have the cash, lets say it is 15% of 750k for a duplex, that 112.5k, allows you to handle almost anything that is thrown at you with that property.

Bryan Martin · Answer

I tend to agree with Nathan's line of thinking here.  Cashflow is great, but if you're buying in SLC, your goal is to have appreciation be your big winner.  Even at 20%, with interest rates as high as they are, I doubt there would be much cash flow.  Not the same advice that I would give everyone, but if you have other sources of income and don't need the cash flow from the rental property, than you should be fine.

Ryan Thomson · Answer

2. I know you aren't after a killer cashflow, but this point needs to be said as well. House hacking is tough to cashflow in year one (with current house price run-ups and interest rates) for a couple reasons:

a. You are living in one of the rentable unitsb. You are only putting 5% down so your loan amount is much larger and therefore your mortgage payment.

I would consider your net worth ROI. What I mean by this is considering how much your down payment returns to your net worth (appreciation, loan paydown, tax benefits, AND rent avoidance). Don't forget to include rent avoidance in your numbers! You have to live somewhere.

You may need to lower your return or cashflow expectations so you can get into a house hack that will allow you to avoid throwing rent money away every month. You know this, but don't forget all the other ways real estate makes you money. Paying down your mortgage and owning an asset that will appreciate over the long term.

Your ROI is much better with 5% down than 20%.

Ryan Thomson · Answer

Oh man! So many thoughts.

1. PMI

Don't try to avoid PMI it is one of the greatest things ever. It allows you to buy a property for 5% down.

PMI is so cheap. You could easily outperform PMI with investing that extra 15% in a US treasury bond.

Josh Young · Answer

@Nick Moran

One of the biggest advantages of owner occupied financing is the fact that you can put only 5% down on a conventional loan, save your cash, it gives you more options and flexibility/time to pivot when you have cash. I would look for a deal that would cash flow if you put 20% down, but then only put 5% down. In two years when you refinance to a lower rate and take off the PMI it will cash flow then, and you will have enough cash to buy your next property. Good luck!

Ruairi Keane · Answer

Hey Nick, I want to start by saying that I think there are always very good deals to be found, it just takes a lot of diligence and often patience to get the right one.

That said, it is tough to cash flow on the majority of properties hitting the market in Salt Lake right now because interest rates are so high and property prices haven't really changed in line with that. The downside to having less down as you are aware is that the monthly payment will be significantly higher, so I do think that putting down 15-20% if you can as opposed to 5% would certainly help make the numbers line up better; however, if you are looking to house hack then the expectation of having your mortgage fully covered without renting out both units would be a challenge either way.

I am very in line with you on wanting to focus on better locations even if it compromises the ROI to some degree. I think long term you will be much happier with the property you buy if it is in an area that you like, especially if you intend to live in it. I've had some in worse areas that I sold because I just didn't like the property itself even though the numbers made sense. The nicer areas will also likely see the most appreciation. I think there is definitely something out there for you that you will find, just stay diligent and keep looking every day.

I'd be happy to hop on a call with you or even text if you have any questions or just need help in general.

Jaron Walling · Answer

@Nick Moran How many offers are you making? Any experience with remodeling? Any work with contractors? You could aim for distressed properties, value add it, and get your equity that way. We have no crystal ball on future rates but buying nothing gets you no where. If house-hacking covers 89% of your living expenses you win.

All you need is a good base hit! Base hits add up.

Theresa Harris · Answer

That is the trade off with 5% vs 20%.  The 5% down payment lets you get in easier, but there are often extra fees (mortgage insurance) and then your payments will be higher.

You will also be living in half of it, so your living expenses may go down.  If you're happy with the numbers, that is what matters.

5% down vs. 20% down?

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