You want to be a real estate investor, but you don't even own your own home. How can you make it happen? Especially when you check out your assets and cash and can't find a 20% down payment anywhere in the pile, it looks impossible.
You've toyed with the idea of buying a personal home, but you're still renting. You can manage to scrape up a low FHA down payment for your own home, but you can't get that low down for an investment rental property. Wrong! Not only can you make that happen, you can live close to rent-free and later you can move to positive cash flow.
You can get a mortgage through the FHA with a super low down payment if you live in the home. So, how do you live in it and rent it out too? No, not a roommate. You can purchase a duplex home and rent out one side while you live in the other. Because it is your principle residence, you can get FHA lending. You not only now own your home, you're an investor too! The FHA will even let you count the future rental income to help you to qualify for the loan!
I'm not blowing smoke, and I'll use a real life example duplex for sale in Houston, Texas, as well as rental rates, all as currently listed at Zillow.com. Here are the home particulars:
• Listed selling price is $255,000. • Each side of the duplex is approximately 1996 square feet in size. • Built in 2007. • Rents of apartments and one side of duplexes in the local area justify a conservative rent income of $1,100 to 1,200/month. • Zillow's mortgage estimator shows the payment will be approx. $1,497/month.
Let's become the world's worst negotiator and pay full price for this home. However, we're going to take advantage of the FHA and our credit score is good, so we're going to be able to get a 3.5% down payment. With closing costs, we'll bring about $9,350 to the closing table. Let's run the numbers:
• You'll be paying approximately $1,687/month with taxes and insurance included. • You can reasonably expect to rent out the home for $1,150/month. • Your gross out-of-pocket to live there is now $537/month.
So, you own a home and you only fork out around $537 per month to live there. But, I'm not through yet. You get some tax breaks that reduce your monthly net cash out-of-pocket. These are estimates, but pretty close based on the example mortgage. First, you get to depreciate the rented portion of the home (not the land value). Let's say that the lot here is worth $40,000, so the structure for depreciation is worth $215,000. You can depreciate the rented portion (one-half) right now over 27.5 years, so:
• $215,000 / 2 = $107,500 Divide that by 27.5 for $3,909/year. • $3,909 / 12 = $326/month deduction off your income. • In a 25% overall tax bracket, $326 X .25 = 80/month cash not going out. • Our previous out-of-pocket of $537 - $80 = $457/month net out-of-pocket.
I'm not through yet though. You also get to deduct the mortgage interest on the half of the property that's rented (you're still getting to deduct your own mortgage interest on your personal residence side). The amortization schedule for this loan showed approximately $760 on average per month in mortgage interest the first year.
• $760 / 2 (half is rented) = $380/month X 25% (tax bracket) = $95/month • Current $457/month out-of-pocket - $95 = $362/month new out-of-pocket.
Next we can look at our tax bracket and deducting one-half of the property taxes and insurance, but you're getting the drift. You'll not get this down to zero or positive cash flow, but are you living in a nice home for around $300/month now?
Consult an accountant, as this is an on-the-fly example, but it's all realistic and on a real home in a real market. Then think about enjoying this for two years and then renting something else for you and renting out the other side of this property and moving to a positive cash flow position. The two-year requirement is how the FHA makes sure that you're building on a solid rental history that will allow you to use all of the income to qualify for another loan.
Also, if you have the discipline, taking the difference in what you were paying for rent that is now staying in your pocket and investing it somewhere is the way to go. If you were paying $1,100/month, you should see a cash infusion of the $800 +/- difference now. Use it to build a savings account balance to fund your next property purchase down payment.
NOW you'll see some positive cash flow and you're a rental property owner/investor ready to grow your business!