Buying a Rental Property for Only 3.5% down How to Leverage Your Dear Children to Purchase Investment Properties for a Minimal down Payment

Normal Investment Property Requirements

Rental properties, if managed appropriately, are excellent investments and even one can significantly increase your income/assets in retirement.  But, as is the case with most good investments, there are significant “barriers to entry”, particularly the down payment.

A primary residence (the home you live in) usually requires a downpayment as little is 3-3.5%, but investment properties require 20% down (there are practically no exceptions).  So, for a $200,000 house, the down payment for an investment property would be $40,000 as opposed to only $7000 for a primary residence.  This makes purchasing rental properties- without them first being primary residences- out of reach for many homeowners, even if their income is sufficient to support the mortgage payment for 2 properties.

The Workaround

If you have grown children (even ones that don’t seem to provide much “return on investment”!) then it is likely you could “use” them to pick up a rental property for only 3.5% down, making such an investment far more achievable for some people.

Here’s how it works:

FHA mortgages (and now conventional mortgages) allow for “non-occupying co-borrowers”, as long as they are related.  That means you can be an owner/borrower of/on a property without actually living there, as long as a family member is living in the home as their primary residence.  Underwriters would consider the combined income, assets, debt payments, etc. of all borrowers when approving the loan, but it’s perfectly acceptable to have practically all of the income coming from you (the parents).  The occupying borrower would need to plan on living there for at least a year, but after that, it’s completely acceptable to treat the property as a rental.

Application of this Strategy

This is an exceptionally good strategy for parents with children attending college or children that are planning on renting anyway.  Here is an example of how this often works (I’m using actual expected mortgage payments and rental rates, based off the current Utah County market):

Example 1:  Mom & Dad buy a condo close to campus for $150,000 and put down 3.5% ($5250).  The mortgage payment (with taxes and insurance) and HOA fee come to $987/month.  Jimmy (the son) and his 2 roommates live there, with the 2 roommates paying $350/month in rent (they give Jimmy a break and only charge him $287).  The parents pay nothing (unless they were going to pay Jimmy’s rent anyway) while Jimmy finishes school.  Jimmy finishes school 3 years later and Mom & Dad then refinance the loan into a conventional loan without mortgage insurance (which they can now do, since the home has appreciated and they’ve paid down the mortgage), yielding a new payment of $900/month.  They could rent the property to 3 students for $1050/month and still net $100/month, even after reserving for maintenance.

That $100 may not seem like a lot, but keep in mind that the mortgage is being paid down and the property is appreciating.  By the time Mom & Dad are ready to retire, they would have a substantial amount of equity (close to $150,000, after 15 years).

Example 2:  Jimmy (from our previous example) gets married, has a few kids, and moves to a new city.  It will be a year or 2 before they can buy a house themselves and renting a $200,000 home (the size required for their family size) will cost about $1300/month.  Mom & Dad figure out that buying the same house (as non-occupying co-borrowers putting down just 3.5%) would yield a total mortgage payment of only $1192.  They decide to buy the house with Jimmy and his wife and let them pay $1200 in rent.  Jimmy and family get a break on rent and Mom & Dad just picked up a rental for only $7000 down!

A lot goes into purchasing rentals and managing them, but the returns are substantial, if done correctly (see our blogpost about rentals here).  If you’ve been considering acquiring a (or additional) rental(s) and have some grown kids to “cash in”, give us a call.  We’ll do a complete analysis so that you can see if it would work for you and your family.

Why You Shouldn’t Wait Until You Have a 20% Down Payment

It’s surprising how many mortgage and financial professionals are still advocating a 20% down payment. It’s bad advice and lazy thinking, as we’ll make clear.

The Old Argument:  Don’t buy a home unless you can put down 20%

It’s true that putting down 20% will shield you from mortgage insurance most of the time (some loans will still require mortgage insurance).  Also, the mortgage will be smaller (since you put more down), so the mortgage payment will be smaller.

But most people don’t have 20% to put down.  Not even close.  That is a $40,000 down payment for a $200,000 home (which is considered “small” in Utah and Salt Lake Counties).

The Better Argument:  Delaying homeownership until you have a 20% down payment is a waste of time and money

The crux of this argument is Net Worth, at least as it relates to housing.  The non-technical definition of net worth is how much cash you would have if you sold all of your assets and paid off all of the associated debts.  Let’s compare the net worth of two couples, one who put down 3.5% and bought a home now (we’ll call them the Flanders) and a couple that waited until they had a 20% down payment (we’ll call them the Wiggums).

First, a few assumptions:

• Both couples want/need a $200,000 home.

• The cost of renting is roughly equal to a mortgage payment for the same home (this is true, in today’s market).

• Homes in Utah appreciate 5% per year (a conservative average for the last 5 years).

• Both couples have $7500 saved now and can/will save another $6500 per year for the next 5 years.

The Flanders (3.5% down) –

• The Flanders have enough to put down 3.5% on a $200,000 home right now ($7500).  They buy the home and live in it for 5 years.

• After 5 years, the mortgage balance is down to about $175,000 and the home is worth about $255,000.  

• They sell the home, pay off the mortgage, and walk with $80,000.  

• They’ve also saved $6500/year for the last 5 years, giving them another $32,500.  The Flanders’ net worth is $112,500.

The Wiggums (20% down) –

• The Wiggums can’t put down 20% now (and won’t be convinced otherwise), so they save for 5 years, renting the entire time.  

• After 5 years, they buy a home, putting down $40,000.  For comparison’s sake, they sell the home the next month.

• Their mortgage balance is $160,000 and the home is worth about $200,000 (they just bought it), so they walk with $40,000.  

• The $6500/year they saved went towards the down payment, so the Wiggums net worth is just $40,000.

Each couple spent the same amount for housing, savings, etc., but the Flanders have almost $80,000 more than the Wiggums.  Plus, since the Wiggums waited 5 years to buy a home, rates would likely be higher and the home that cost $200,000 at first now costs $255,000 (because of 5% annual appreciation)!

There are exceptions that could affect this analysis (sudden market crash, super cheap rent compared to mortgage payments), but even accounting for those, it is almost always better to buy as soon as it is feasible.

There are few no-brainers in the financial world.  This is one of them.  It makes NO sense to forego homeownership until you have a 20% down payment!

For more information, feel free to look here.

A few tips toward adding value to your home (and a few things to avoid)

Whether you are selling, refinancing, or just renting, upgrading certain aspects of  your home can be a boon toward raising it’s value, while others are just a money-sink with no real return. Here at Evergreen Mortgage, we took a look at some of the best (and worst) places to sink time, money, and effort into to get the best bang for your buck.

Image by Nancy Hugo, CKD

1.Remodeling your kitchen.

It is a well-known fact that the kitchen is among the most important rooms in the home. You will definitely want this looking nice before getting that appraisal.

Replacing outdated appliances, and repairing or replacing the counters or floors, if needed, will go a long way toward making your home feel modern and up-to-date. Try spending money on stainless steel appliances for that truly modern look and feel.

Also, adding a fresh coat of paint never hurts either. Upgrading the kitchen can even raise the value of your home between 3%-7% on average.

Photo of a finished basement by Sean Madden. License Labelled for Reuse

2. Finish your basement or attic.

Not only will this add usable square footage to your home, but allows for a flexible living space, that can serve a variety of purposes: an extra room, an office, a second living room, a playroom for the kids, or the adults, the possibilities are endless.

The bottom line is having the extra usable space never hurts. Doing this can raise the value of the home between 4%-6% on average. 

Image by Todtanis

3. Freshen up the bathrooms.

Just like the kitchen, bathrooms should feel fresh and updated. Replacing your worn out linoleum floor, or possibly simply the faucets and fixtures, can go a long way toward improving the overall value of the home. You don’t have to go overboard, make the bathroom look nice. No one wants an old messy bathroom.

Some other things to consider:

1. Re-painting rooms that need it is an easy, cost effective way to add value to your home.

2. Update all of your energy-guzzling appliances to make your home energy efficient, replace single-pane windows with double-pane or triple-pane windows. For better heat retention and energy efficiency.

3. Maintain and fix any leaky faucets or drains, replace burnt out bulbs, and make sure the home is clean and presentable.

Doing these three things, is practically guaranteed to get some value, but let’s look at some of the things that won’t.

Image by Vic Brincat From Ontario Canada

1. Installing a pool.
While it is wonderful to be able to cool off during the summer time, adding a pool likely isn’t likely to raise the value of your home. That doesn't mean you shouldn't make the investment if you want a pool, just be aware that with maintenance costs it is more a liability than an asset. Whether you are simply refinancing, or trying to sell your home, a pool is an investment best left to those who really want one.

Image by Todtanis

2. Creating specialized spaces. While you may have always wanted to convert that bedroom into a personal sauna, it might not work out so well when it comes time to sell or refinance. Individuals looking at your home on Zillow or other websites will expect a certain number of rooms to be present. If the house no longer fits the description, they may look elsewhere.

Long story short, sometimes it is best to keep things simple.
 

Common misconceptions: Renting is cheaper than owning a home pt. 2

“I can’t buy a home, because I can’t afford the down payment”

Traditionally, to get into a mortgage, a buyer would need to put down 20% of the purchase price at the time of closing. This can be quite daunting (the down payment for $200,000 home would be $40,000) and for most, just isn’t a possibility.  In fact, 20% down payments are now an exception as opposed to the norm, especially for first-time homebuyers.

Here are several low-down payment options:

·         FHA loans – FHA loans only require 3.5% as a down payment.  Their rates are also lower than conventional mortgages and allow for less income/lower credit scores.  Most first-time homebuyers buy homes with FHA loans.

·         Conventional loans – You can still get a conventional loan without 20% down.  In fact, you can now get a conventional loan for as little as 3% down.

In addition, there are several no-down payment options:

·         VA loans – For those who are serving or have served in the military (not just veterans), VA loans are available and don’t require any down payment.  They also offer lower rates, no mortgage insurance, etc.

·         USDA loans – For borrowers willing to live in “rural” areas (in Utah, that’s north of Ogden and south of Spanish Fork), USDA also offers loans which don’t require any down payment. 

·         Grants, Gifts, and Seconds – Most loan types allow for down payments to be gifted from family, friends, and even employers.  There are also programs that allow borrowers to get grants for the down payment or borrow 3.5% as a low interest 2nd mortgage.

At Evergreen, we have significant experience helping clients without access to large down payments.  While owning a home takes budgeting and planning, don’t let the immediate absence of a down-payment deter you. 

Common Misconceptions: renting is cheaper than owning a home.

One idea that I often hear, especially from people my own age, is the statement “I couldn’t afford to own a home, whether due to the down-payment, or due to the amount of monthly payment.

For many, the prospect of owning that first home can be rather daunting. But is owning a home really more expensive than renting one? Let’s take a look at some comparisons.

Home Value                                 Mortgage per month                     Rent per month

$150,000 (condo)                       $1023                                               $1150

$250,000 (house)                       $1500                                              $1600

(Both mortgage values were calculated using 3.5% down at a 3.375% fixed interest rate)

We can see in a side by side comparison that renting isn’t necessarily cheaper than owning a home, in this case, both the condo and the house were slightly cheaper to own than to rent. While this isn’t always the case, there are plenty of benefits to actually owning a home, such as consistently growing equity and value.

If owning a home is something that you are interested in, contact a mortgage broker, as they can point out price ranges in the area, present options, and outline the steps needed to be taken to actually accomplish the goal of moving into a home.