DId You Know: First Time Home Buyers can Purchase a Duplex

Dining room with wood floor inside duplex

An FHA Financed Duplex is the Ideal First Investment Property

Investing in real estate is attractive for many reasons, mainly because it provides passive income which is not subject to self-employment taxes, it generally uses the bank’s money, and it can produce cash.

If you’re interested in rental real estate, but don’t think you’d ever have the chance to invest due to financial reasons, then we have some good news for you about FHA loans and duplexes. Stay tuned!

Rental real estate is typically seen as a defensive investment because when the economy struggles, people generally buy fewer homes and rent more often. Vacancy rates in the Minneapolis Twin Cities region barely blipped when the economy and stock market tanked in ‘08, ‘09,and ‘10.

Problems with Investment Properties

Financing Tensions

Most people that are gearing towards a real estate investment portfolio are going to start with using either an FHA, VA, or conventional loan.

For owner-occupiers, loans are more practical because they usually require lower down payments between 3.5% and 5% compared to the typical requirements for an investment property of 20% down.

That means if you’re looking at a $250,000 home, you’ll be able to start out with a down payment of $8,750 (3.5%) or $12,500 (5%) rather than the $50,000 needed for a 20% down payment.

Using an FHA loan for a duplex allows you low down payments to buy property.

The catch is that you need to occupy the home when you use an FHA loan. So what happens when you decide to step out of the home and rent it out?

You need to occupy the property for at least 1 year when purchasing with an FHA loan, otherwise you’ll be committing fraud. Don’t think that there are any ways around this either – you might be surprised how determined a bank can be in finding the truth if they suspect fraud.

There is good news, though. After occupying the home for a year, you’ll have the flexibility to legally move out and find tenants for the property. At that point, you’ll have many of the same options that you would have if you bought your duplex as an investment rather than with FHA.

If you move out, you’ll find that you’re in a pickle with financing.  The pickle is that unless you own 30% of the property at the time you rent it out, you’ll be unable to borrow again until you have two years of income from the rental property.

Getting stuck waiting to build up your two years of rental income before borrowing again is a rookie mistake many new real estate investors find themselves making.

The typical cycle of real estate investments looks like this: You buy a home with an FHA loan, live in it for a year, find tenants, then wait two more years before buying again.

Buying a duplex with an FHA loan can fast track this process.

It’s pretty common knowledge in the real estate investment world that duplexes are an excellent first investment because they are typically less expensive, produce great income, and have a little lower risk.

FHA Loans for a Duplex:

  • Low Down Payment (3.5 or 5%)
  • Doesn’t Require Landlord Experience
  • Future Rental Income Counts Toward the Other Half of the Duplex to Help You Qualify for Your Loan
  • You Can Buy More than You Could Otherwise Afford by Utilizing the Estimated Rental Income

2 Year Landlord Experience Requirement (To Borrow for Next Property)

The bank wants to see two years of income and landlord experience from your property because they want to see some cash flow before they will lend to you again.

Rookies make the mistake of following the original plan we laid out before: They buy the property, live in it for a year, and then wait for another 2 years to build up landlord experience.

Experienced investors, however, know that there’s a better way. They start with a duplex and owner-occupy it while simultaneously earning 2 years landlord experience…all while abiding by the FHA mandate!

Duplexes allow you to satisfy the 1 year owner occupied FHA requirement while simultaneously earning your two years of landlord experience – saving you an entire year of waiting before you can purchase your next property.

After two years, moving out requires you to get a lease on your half of the duplex. You have to turn this into the lender, which will allow you to be able to use 75% of the total rental income to qualify for the next loan. 25% of the income is deducted because the lender assumes it will go towards vacancy risks and repair costs.

The hope is that you’ve orchestrated a mortgage payment which will then be entirely offset by 75% of the rental real estate.

This is important in the lending process, but it’s also amazing on paper because the income is very tax-advantaged since you will use all expenses, administration costs, depreciation and cost segregations against the income.

The 25% rule: From a lending perspective, you want to bring in 25% more than the mortgage costs so that it won’t hinder your future borrowing.

6 Months of Mortgage Payments in Cash Reserves:

The lender will also need to you have cash reserves that total 6 months of your mortgage payments, which is really a great idea no matter what.


The Tensions and Bureaucracy You’ll Navigate:

  • Initial Down Payment Requirements
  • Required One Year Occupation Requirements from FHA
  • Goal of Building 2 Years of Landlord Experience
  • Attaining 25% Higher Rental Income than Mortgage Expense
  • Building Up 6 months of Mortgage Payments in Cash Reserves (So You Can Borrow for the Next Property and Protect Your Butt)

Benefits of the Duplex:

  • Allows You to Purchase Rental Property with FHA loan
  • Allows You to Borrow Using “Other People’s Money,” Qualifying with the Rental Income
  • Allows the 2 year Landlord Experience to Accumulate While Occupying
  • Allows the 1 year Occupation Requirement to Happen While Using Other People’s Money

The hardest thing about real estate investing is getting started.  There are a number of rookie mistakes with real estate investing that we want to help our buyers with. If you’re interested in investing in a duplex property, reach out to our team and we’ll help you get started!

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