Your First Investment: How to Use Future Rental Income to Qualify for a Duplex Loan

In This Article

If you’re like me, you’ve read hundreds of articles just like this one and quite a few books — and none of them explained how to invest without a lot of money. Let’s face it; the less money you have, the harder it will be to invest in real estate. You’ll just have to be more creative and work smarter. But what you learn along the way will make you unstoppable.

Your knowledge is like a penny that doubles every day. One day one you have a penny. At day ten you have $5. By the end of the first month, you are left with $5,300,000. It’s what you learn along the way that makes your success double. Did you know Warren Buffet made 99% of his wealth after his 50th birthday? He made his first investment at age 11. He started with little and learned a lot over the years — and that’s what paid off.

Owner Occupied Loans

Investing with other people’s money is expensive. Investment loans require 25% down and have high interest rates. Because of this, many first time investors are buying houses with owner occupied loans and renting them out later. Before we go any further, let’s get a better understanding of how this actually work so you don’t make mistakes or break the law.

Related: Your Tax Write-Offs Could Affect Your Ability to Get a Loan: Here’s How

If you buy a house with an owner occupied loan and want to rent it out later and buy another, you will have to:

• Live in the house for at least a year. If you move out and make it a rental any sooner, you will be committing fraud. After a year of living there, you are allowed to rent it out because you have met the owner occupied commitment.
• To be able to qualify for a second loan while renting out the first house you will need either:
  • Have 25-30% equity (own 25-30% of the current value of the home) in the first house to use the rental income to help qualify for a second loan. OR
  • Have at least 2 years of landlording experience and proof of income from your tax returns. This will allow you to use the rental income to help qualify for another loan. This also means you will have to live somewhere else for 2 years while you gain this experience. OR
  • Be able to qualify for the first loan and the second loan at the same time.

This is what most people don’t know when they think about buying an owner occupied house and renting it out later. It’s legal to do it, but there are a lot of restrictions that make it difficult.

The Solution

There is a way to beat a lot of these restrictions by using an FHA owner-occupied duplex loan. Keep in mind this is only for duplexes.

All of the above still apply, but:

• You only need a 3.5% down payment.
• You can start renting one side right away and bring in income.
• You will gain landlord experience while living there. You won’t need to move after a year and live somewhere else for another 2 years to get enough landlord experience to count your rental income.
• You can use the future rental income from one side of the duplex to help you qualify for the loan on the duplex.

An added benefit of duplexes over single-family houses is that they are cheaper and tend to bring in more income than a similar sized home. Let’s look at what the loan offers.

When using an owner occupied FHA loan for a duplex, you can use 75% of the estimated rental income from the other half of the duplex to help you qualify for the loan. This enables you to get a bigger loan than you can afford because your income has increased from being a future landlord. You don’t need landlord experience to qualify. However, it can be tough to find a lender willing to give you the loan if you only have the minimum 3.5% down, and some add more restrictions. Talk to a few lenders and find one who will give you the loan before you get too far. Keep in mind, it’s free to ask questions and get pre-approved for a loan.

Related: 8 In-Depth Questions You Should Be Prepared to Answer When Applying for a Loan

Example: If you were able to find a duplex with a $2,000 a month mortgage and you could rent one side for $1,200 a month, the lender would subtract 75% of that rental income (=$900) from the monthly mortgage payment and you would now only need to qualify for $1,100 a month.

The big drawback to FHA loans is that they have mortgage insurance for the life of the loan, which can cut profits. However, if you pay off 20-25% of the value of the property (or its value increases due to rehab and/or appreciation so that you own 20-25% of its current value), you can refinance later into a loan without mortgage insurance.

If the house is an investment, you will have to refinance into an investment loan with a higher than average interest rate, but it might be cheaper than paying mortgage insurance. Keep in mind, refinancing isn’t free and you never know what interest rates are going to do in the future so don’t get into a bad deal hoping it will get better later.

“Today, knowledge has power. It controls access to opportunity and advancement.” – Peter Drucker

Have you ever used this strategy to qualify for a duplex loan? What advice would you give to newbies looking to find financing starting out?

Leave a comment, and let’s talk!

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.