Real estate investors have a slew of options when it comes to financing their purchases. There are investment-specific mortgages, home equity loans, crowdfunding platforms, and even peer-to-peer lending options. But it’s often government-backed mortgages that provide the most affordable choice.
If you are prepared to live in the property for the first year, government-insured mortgages such as FHA and VA loans can offer investors a low-cost financing option, without super-stringent credit requirements to deal with. They also offer low down payments (sometimes none at all) and low interest rates to boot.
Still, they’re not without drawbacks. Are you considering a government-backed mortgage to finance your investment purchase? Let’s look at the pros and cons.
Advantages of using a government-backed loan as an investor
- They require little to no down payment: FHA loans require as little as 3.5% down (if you have at least a 580 credit score), while VA loans require no down payment at all. If you’re just starting out as an investor or just want to reserve those savings for renovations or repairs on the property, this can be a serious advantage.
- They don’t have strict credit requirements: You can have as low as a 500 credit score and still qualify for an FHA loan. And although the credit score requirements on a VA loan are slightly higher (it depends on the lender, but they’re usually around 600), they’re generally still lower than what you’d see for investment-specific mortgages or conventional loans.
- They offer low interest rates: Lenders are able to offer lower interest rates on FHA and VA loans than they can for other products, because there’s the government-insured safety net there to protect them. This can mean significant savings on interest over time -- especially when compared to those of investment property loans, which are known for their sky-high rates.
- You might be able to use your future rental income to qualify: Government-backed loan programs allow you to use future rental income to qualify for the loan. You just need to show documentation of previous landlord or rental experience, as well as prove that you have at least six months’ worth of cash reserves. If you meet these qualifications, a portion of the appraised monthly rents can be used toward your loan qualification.
- You can roll your closing costs into the loan balance: On VA loans, you have the option of 100% financing. This means you can essentially roll the closing costs into your loan balance, paying them off month to month over time. Keep in mind that this is not an option for FHA loans.
Disadvantages of using a government-backed loan as an investor
- They may require mortgage insurance: In the case of FHA loans, you’ll need to pay annual mortgage insurance upfront, unless you’re able to make a 20% down payment. This comes out to 1.75% of the loan amount at closing and an annual premium of between 0.80% and 1.05% depending on the loan amount (on a 30-year loan). Mortgage insurance is not required for VA loans, although there is a funding fee based on your loan total.
- You’ll have to live there: For FHA and VA loans, there’s an “owner-occupancy” rule. You have to live on the purchased property and maintain it as your primary residence for at least a full year. You also have to move in within 60 days of closing on the loan. It may sound like a steep price to pay, but since you are free to move out after 12 months, the timing might work out if you’ve got a big fix-and-flip or many renovations on your hands.
- You’re limited in terms of what properties you can buy: You can’t finance a huge apartment building with a government loan, so if that’s what you’ve got your eye on, you’ll want to look elsewhere for funding. Government-insured mortgages are available for one- to four-unit properties, however, making a duplex, triplex, or quadplex fair game. (Just remember: You’ll need to be living in one of the units.)
- You may have to meet special qualifications: FHA loans don’t have any special requirements, but to qualify for a VA loan, you’ll need to be an active military member or veteran of the U.S. armed services. In some cases, spouses of military members (or those who died in the line of duty) may also be eligible.
- There are loan balance limitations: Government mortgages aren’t meant for super-expensive purchases. On FHA loans, you’ll need to keep your loan balance at less than $484,350 for VA loans, and less than $314,827 for FHA loans. In higher-cost markets, the FHA threshold can go up to $726,525. The FHA changes these limits annually.
|Low interest rates||Can require mortgage insurance|
|Low down payment requirements||Requires you to live on the property|
|Less stringent credit score requirements||Limits the types of properties you can buy|
|Can use rental income to qualify||May require special qualifications|
|Can roll closing costs into the loan||Limits on loan balances are low|
The bottom line
As you can see, there’s a lot to weigh when considering a government-backed loan for your investment purchase. Although they certainly come with some serious benefits (especially in the upfront cost department), you’ll need to ask yourself if living on the property is worth it -- or even possible in your current situation. You should also look closely at your finances, credit, and the property you’re considering before making your decision.