FHA vs. Conventional Loan: Which is better?

Question

Hello everyone,

My wife and I are just starting out on our real estate investment journey and on the Bigger Pockets podcast, it seems that they highly recommend using a FHA loan when starting out and purchasing a multifamily property.  However, when doing comparisons, it seems that a conventional loan could save you money in the long run.  Wanted to ask the community on what the pros and cons are of each and why it may be smarter to go with one strategy versus the other!

Thanks!

Shane

Tim Miller · Answer

A broad overview of the 2.

Conventional: Usually requires 20% down and the banks set their fees as low or high as they want. No mortgage insurance required for the most part. You can find 15% or even 10% down loans but you'll be required to get mortgage insurance. But you can get rid of it once you reach 20%+ in equity.

FHA: Requires 3.5% or 5% down and FHA sets most of the cost for getting the loan. You will have mortgage insurance for the life of the loan. This is the higher cost of FHA but you can refi later when you have 20% or more equity in the property to get rid of the mortgage insurance. FHA home inspections are more strict, what a bank may allow to pass, FHA may say, fix or no loan. In our area, FHA inspections cost a $100 or more than a regular inspection.

It all comes down to you goals, your plans and your current financial situation. Personally, just starting out I would suggest FHA. You will put out less money up front that you can save for unexpected repairs or other expenses.

Carlos Valencia · Answer

Hello Shane,

FHA is a great product to use to house hack as it allows you to invest with 3.5% down payment. When investing in multifamily property theres some things to consider when using FHA. When you use FHA for a 3-4 unit property you have to pass the self sufficiency test. The self-sufficiency test is to prove that 75% of the rental income you'll receive will cover the full monthly mortgage PITI (Principal, Interest, Taxes, Insurance payment. For example lets say your mortgage payment of PITI is 3k you have to make sure that the 75% rental income will cover that whole number of 3K. Meaning that if you have a fourplex and are able to get $1,200 in rents for all the units you will be at $4,800 X75% =3,600 In this example you would pass the self-sufficiency test with flying colors. As long as your rents are equal or more you will pass. Make sure to look out for that when your out there looking for a 3-4 unit property. If you buy a duplex this does not apply.

Conventional to but a multifamily you will need 15% -25% down to get into your first multifamily. No need for a self sufficiency-test.

It will really depend on how your market is to see what option will fit best for your scenario. Hope this provides a little more clarity to figure out what option is best for you.

@Albert Bui @Matthew Kwan

Shane Bishop · Answer

Thank you for the information!  That is very helpful and certainly something that we will keep our eye on if we start looking to purchase a 3-4 unit property.

Brady Ferguson · Answer

The biggest benefit of an FHA loan is the ability to purchase a property for as little as 3.5% down as long as it is owner occupied for at least 1 year. This is big for investors that are just starting out and do not have lots of available capital. The biggest disadvantage of an FHA loan is PMI which is required in most states when you put less than 20% down on a property.

If you are doing a house hack on small multi family, I would recommend still using an FHA loan to free up capital for other investments. That is assuming you do not have tons of capital to deploy. If you have plenty of capital, I would compare financing options to see what best fits your goals.

Michael Gussin · Answer

@Shane Bishop absolutely! If you’re in a situation where you don’t need both borrowers, that’s a very common approach to minimize capital being used while buying more real estate.

Hunter Reed · Answer

Not if the property appreciates overtime. You have to buy in the right location.

Michael Gussin · Answer

@Tim Miller summary above is completely on point.

@Shane Bishop often house hackers or first time buyers looking to build a real estate portfolio use FHA on their first purchase because of the option to put 3.5% on a multi family, as opposed to conventional where you would be required to put 15% down and even 25% down on a 3-4 family. Using  FHA allows you to preserve capital for your next purchase which is incredibly important before on investment properties you will need to put 20 - 25% down.

Where are you looking to purchase? If you are looking to invest in multiple properties for the long term, your finance strategies are of the utmost importance to keep your cash flow at a maximum.

Carlos Ptriawan · Answer

conventional is always better because it requires a much higher downpayment and no any sort of inspection.

Shane Bishop · Answer

In this instance, we only put the loan in my name.  Since my wife's name is not on that loan, would we be able to get a second FHA loan in her name for our next property, if we decided to do another house hack?

FHA vs. Conventional Loan: Which is better?

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