How to Go from FHA 3.5% to 20% Realistically

[Christian M. Conroy]

Hi all, 

My partner and I plan to buy with the broader DMV area with the intention of moving in around March, 2024 when out rental lease ends. We're giving ourselves a good lead time to do all the necessary research and numbers running, especially given the high price of the market we live in. And that's even accounting for the fact that we're willing to move anywhere around a ~1 hour drive into DC radius.

We are very interested in house hacking. I've read lots of the main books on the topic and now am just figuring out how to tailor the approach to our specific market. One of the key points discussed in a lot of these books is a strategy that involves buying a place with a 3.5% FHA interest loan, living in it for at least a year and for as long as needed to get up to 20% for a conventional loan, refinancing to a conventional loan, buying another place with an FHA loan, and then doing it all over again while also renting out that original unit fully.

I'm a bit unclear as to how that is a feasible strategy given the amortization schedules I am looking at. For example, let's say one buys a place for $400,000 at 3.5% down for a 30-year fixed term with an FHA loan. That means a loan of $386,000. Let's go back to the good ole days just for the example and use an interest rate of 3%.

I've calculated out the monthly principal and interest rate payments manually, but you could also see the full amortization schedule conveniently with a tool like calculator.net. 

In month one, you'd have a principal of $662.39 and interest of $965.00. In month two, that would be $963.34 and $664.05. In month three, that would be $961.68 and $664.05. And so on. Each month the principal pays down the loan balance and adds to equity. Starting from the 3.5% equity at the onset of the loan, it would take 89 months, or 7 years and 5 months to reach 20%. Not exactly a timeline that seems to be part of an early retirement plan. 

Adjusting the interest rate down to 1% changes it to 70 months, or 5 years and 10 months. 
Moving it to 0% only gets it to 61 months, or 5 years and a month. 

So when people are suggesting this as a useful house hack strategy, are they suggesting you pay more than your required monthly at some point to build equity faster? 

Or is this just a lesson that this strategy is only worth it in a very low interest rate environment in a low price market? 

Or am I just doing the math completely wrong here? 

Thanks in advance for any answer!

[Lawrence Potts]

Quote from @Christian M. Conroy:

@Lawrence Potts How would going the ADU route differ in terms of the finances? Wouldn't it be the same? Or are you saying go the ADU route in terms of finding forced appreciation for SFU by creating an ADU where zoning/permitting would allow one to do so?

Going the ADU route in regards to availability/inventory in your local market. Financing will differ. The only low down payment financing method on a multifamily is FHA (3.5%) (or VA if applicable) otherwise you’re looking at >15% conventional. Going the SFR w/ADU route you can go 3-5% conventional or some programs offer 0% down (first time home buyer programs, DPA’s etc.), and you can still reap the benefits of multifamily of rental income through the ADU. It’s another route you can go so you don’t miss out on base hits waiting for that “home run” hit. If that makes sense. Appreciation rates will differ depending on what has sold in close proximity to your property of similar kind.

I don’t think you need to delay cashflow and I also don’t think you need to put a big down payment. It should never be seen as “either this or that”, “one or the other”. Define cashflow: if your goal is to cashflow positively while living in one of the units, you’ll be looking forward (making assumptions about your market). That’s going to be very hard to find and everyone and their mother will have an offer in before you get your preapproval drafted. If you mean “cashflow after I move out”, that changes things. It may be very marginal, but it’s better than nothing. Depending on your underwriting, it may not be life changing money, but it’s better than not owning any assets. But sometimes your market forces you to pivot on your strategy. Maybe you need to pivot to equity? Maybe you need to focus on mid term rentals? That’s for you to determine.

To give you a more direct answer than this “pie in the sky” type of answer…what I would do in your situation based off the limited information we have….

I’d focus on getting my first home. Period. Multifamily, great. SFR with an ADU or ADU potential, good. SFR with a lot of bedrooms to rent out: it can work. House hack it to the extreme. Rent out everything you can. Mix it up between MTR, STR, LTR, etc. Learn as much as you can! Don’t be afraid to mess up, fail, learn, grow. Even if the property isn’t a huge cash cow, just get to first base. If you’re able to decrease your housing expense by +50%, that’s a HUGE WIN. Then pivot and adjust. I’d save as much as I can and move to the next home and repeat. I’d focus on equity. Sit on them for a few years, then 1031 to cashflow.

Just my take making assumptions on your situation and market. I’m guessing you have a lender you’re working with? If not, none of this matters until you talk to a good lender that invests in real estate and figure out what you can afford and then go from there.

Hope that helps!