Financing for House Hackers

In this second episode of the Ultimate House Hacking Guide, Joe helps us to understand the basics of financing, which loan types are available for house hackers and why house hacking can be so attractive from a financing perspective.

In this section, Joe helps us to understand the basics of financing, which loan types are available for house hackers and why house hacking can be so attractive from a financing perspective.

This module covers:

  • Owner-Occupied vs. Investment Property Loans
  • Types of Loans for Owner-Occupants
  • Paying Points to Buy Down Your Rate – Does it Make Sense?
  • Mortgage Insurance – Do I Have to Pay It?
  • Which Option is the Best?
  • How to Get Started

Four Learning Options!
Ultimate House Hacking Guide for Denver
  1. Order the book on Amazon or grab a copy from us
  2. Listen to episode “#205: UHHG – #2 Financing for House Hackers” on the Denver Real Estate Investing Podcast
  3. Watch the YouTube video (at the bottom.)
  4. Read this blog post, which is from the book.
Start at the Ultimate House Hacking Guide for Denver Overview for a list of all the modules.

As we’ve mentioned in the previous chapter, house hacks are purchased as a primary residence and done with an owner-occupant loan. There are great benefits to the owner-occupied loans, and these benefits are some of the main reasons why house hacking is such a popular investing strategy. Joe will go over the differences and advantages of these owner-occupied loans compared to traditional investment loans.

Owner-Occupied vs. Investment Property Loans

The main differences between owner-occupied and investment property loans are:

  • Down payment
  • Interest rate
  • How long you must occupy the property
  • Can I Combine Buying Down Points and Upfront Mortgage Insurance?

For owner-occupied loans, you could put as little as 0%, 3.5%, or 5% down, depending on which loan type you have.

For an investment property loan, you will be required to put 15%, 20%, or 25% down, depending on which loan type you have.

Interest rates for owner-occupied financing are always going to be the lowest rates available. These are the rates you see advertised on TV, the radio and online.

Investment property interest rates will always be a little higher than owner-occupied rates. They typically range between 0.75%-1.5% or higher, depending on the down payment, property type and other various factors.

In summary, you will always have the most favorable rates and least money out of your pocket when you are living in the property, meaning you have used owner-occupied financing. What’s the reason for this? Historical data shows that during any major downturn, the rate of foreclosures on owner-occupied homes is far less than those of investment properties. During difficult economic times, people are much more likely to fall behind on an investment property, whereas they will do anything possible to stay current on the mortgage for their home that they live in every day and shelter their family with.

This emotional connection to the property allows banks to take more of a risk on you and offer you a better interest rate, along with lower down payment options and, thus, higher purchasing power.

Another difference between owner-occupied and investment property financing is how long you have to live in the property. Why is there a length of occupancy requirement? The answer is because the lender is giving you a loan with a preferential interest rate and preferential terms based on the risk profile that you will be living in the property. How long is this requirement? For owner-occupied properties, it is required that you occupy the home for at least one year. With any requirement, there will always be some “what-if” questions that come up from people about their specific scenarios. “Well, what if I’m going to buy a house, have my mailing address there, but live with my girlfriend/boyfriend?” Word to the wise, don’t mess with fire. You need to live in the property. This is your primary residence, it’s where you sleep at night. Don’t mess around with legal documents.

Here is a snippet from the loan documents that you’ll be signing for an owner-occupant loan:

**6. Occupancy – Borrower shall occupy, establish and use the Property as Borrower’s principal residence within 60 days after the execution of this Security Instrument and shall continue to occupy the Property as Borrower’s principal residence for at least one year after the date of occupancy, unless Lender otherwise agrees in writing, which consent shall not be unreasonably withheld, or unless extenuating circumstances exist which are beyond Borrower’s control.

Example of extenuating circumstance: Being relocated for work.

NOT an extenuating circumstance: “I found a really great deal on another property!”

The consequences of violating the occupancy requirements will most likely not affect your current loan, but they will affect your next loan. When your lender goes to approve you for the new loan, they run your name through a database and you will pop up as a red flag because the system will know that it has been less than twelve months since the last loan. Again, don’t mess with fire. Buy a house, live there for a year, then you can repeat the process.

Types of Loans for Owner-Occupants

  • FHA
    • Minimum 3.5% down
      • Single-Family Residence (SFR), Condo, Townhouse, 2-4 Unit properties
      • Can only have one FHA loan at a time.

Jeff bought his fourplex using FHA, then one year later purchased his next property using a conventional loan as he was not allowed to have more than one FHA loan at a time. Jeff was also really smart using this FHA loan on the fourplex because it allowed him to only pay 3.5% down payment on a higher priced property rather than using the FHA benefits for a single-family home that only has a minimum 5% down payment requirement for a new conventional loan, thus stretching his down payment funds to the largest and best cash-flow property first.

  • Conventional
    • Minimum 5% down
      • SFR, Condo, Townhouse
    • Minimum 15% down
      • Duplex
    • Minimum 25% down
      • 3-4 Unit properties
  • VA
    • Minimum 0% down
      • SFR, Condo, Townhouse, 2-4 Unit properties
      • Only about 5% of transactions fall under VA loans because only about 5% of the population can qualify for VA loans.
      • Need to have served in the military and qualify for VA benefits. If you are eligible, it’s a great option.
  • USDA
    • Minimum 0% down
      • SFR, Townhouse
      • Only rural areas (Denver Metro does not qualify) – underdeveloped, low to moderate income areas
      • Think Elizabeth, Strasburg, Stranton
  • Down Payment Assistance
    • Minimum $1,000 down
      • SFR, Condo, Townhouse
      • No multi-family as there are certain income restrictions
      • Could increase closing costs and interest rate
      • Not ideal for house hackers due to possibility of a 2nd lien that needs to be paid off when you move out of property

Let’s say you get a down payment assistance loan with $10,000 assistance. After 12 months, when you want to move out and buy your next property, you’ll need to pay back the $10,000. If you’ve saved $20,000 for your next down payment, then you’ll only have $10,000 left after paying off the lien.

  • Renovation Loans
    • FHA 203K – Allows up to $35,000 to renovate the property
    • Conventional HomeStyle Renovation – finance up to 50% of property value to renovate the property
      • Tough to make work in the current Denver Metro seller’s market. It’s easier when it is a buyer’s market.
      • Requires you to have all contractor bids in before closing and final loan approval, which can take 15-60 days in Denver; many sellers don’t want to wait that long.
      • It’s better during a buyer’s market.

Paying Points to Buy Down Your Rate – Does it Make Sense?

If you can understand the financial aspects that go into buying a house, you can use that knowledge to your advantage and make sure you’re getting the most return for your money. Another reason why Jeff is so successful is because he has a solid financial background and understands where to look for opportunities to make his money work for him. We will use an example but please note that these numbers are just that, an example to show the concept of how buying down your interest rate can help make an impact, not necessarily that it’s a guaranteed outcome.

Disclaimer: Please note that mortgage rates in this example are just that, examples. Actual mortgage rates will fluctuate on a daily basis, depend on your credit score, depend on how much money you are putting down, etc. Contact Joe to get the most recent rates. A discount point is what you can pay out-of-pocket to lower your interest rate.

Does Not Pay to Buy Down RatePays to Buy Down Rate
Price: $400,000Price: $400,000
Down Payment: 5%Down Payment: 5%
Interest Rate: 3.75%Interest Rate: 3.125%
Discount Points = 0%Discount Points = 1.5%
Cost of Discount Points = $0Cost of Discount Points = $5,700
P&I Payment: $1,760P&I Payment: $1,672
Saves $133 per month and takes 43 months to break-even.

Cost of Points = Loan Amount * Discount Point = (380,000 * 0.015) = $5,700.

This cost is paid as an additional closing cost up front to get a lower interest rate (3.75% to 3.125%). You get a lower rate for 30 years for a little more money today, which results in lower monthly payments.

You can then calculate the monthly savings and break-even point of that monthly savings. If your break-even point is less than the amount of time you plan to spend in the property, it’s probably a good deal!

If you pay $5,700 up front to save $133 monthly, then $5700/$133 = 42.857 months. If you plan on keeping the property for 43 months or 3.5 years, then it’s probably worth it.

If we have $5,700 extra, why not just add that to our down payment and pay down the principal? Ultimately, the $5,700 used to buy down the interest rate will save you more money from a monthly cash-flow perspective. In our example above, you would save about $25-$30 per month to pay down the principal but save $133 per month to buy down the interest rate.

Also, note that there is no cap on how many points you can buy the interest rate down. While there is no cap, there is a point of diminishing returns to where it will no longer make sense to keep buying down the points. At some point, it will no longer make sense to pay hundreds or thousands of dollars to buy down the interest rate to save only $20 per month.

Basically, financing is tricky and the best thing to do is, once you have a property under contract, sit down with your lender so they can go through all these scenarios with you and you can get clarity on which options will be best for your situation.

Mortgage Insurance – Do I Have to
Pay It?

The short answer is yes. You must pay mortgage insurance on any loan when you put less than 20% down, unless it’s a VA loan. Anyone who tells you differently isn’t necessarily lying, but they may not be disclosing the mortgage insurance to you, so better read the fine print. It could mean you have higher closing costs or a higher interest rate. So, yes you have to pay, but there are three options on how to pay it.

  • Lender can pay it for you
  • You can pay for it monthly
  • You can pay it up front

Disclaimer: Please note that mortgage insurance costs in this example are just that, examples. Actual mortgage insurance costs will fluctuate on a daily basis, depend on your credit score, depend on how much money you are putting down, etc.

Options to Pay Mortgage Insurance

MonthlyUp Front
Price: $400,000Price: $400,000
Down Payment: 5%Down Payment: 5%
Monthly Insurance Payment: $144Up Front Cost: $4,978
Saves $114 per month and takes 44 months to break-even.

The break-even point = (upfront cost * monthly savings) = ($4,978 / $114) = 44 months. If you plan to keep the property for 3 years and 8 months, then it may be worth paying it up front.

Calculating mortgage rates is a complex process that uses 50+ variables to calculate including property zip code, price, property type, number of units, amount of your down payment, credit score, spouse’s credit score, income source, income level, type of loan, etc. The only way to know for sure what this will be is to call your lender and have them run the numbers for you after you’re under contract on a property.

Can I Combine Buying Down Points and Upfront Mortgage Insurance?

Yes, you can!

Disclaimer: Please note that mortgage rates and mortgage insurance costs in this example are just that, examples. Actual mortgage rates and mortgage insurance costs will fluctuate on a daily basis, depend on your credit score, depend on how much money you are putting down, etc.

No Points Buy Down and No Upfront Mortgage Insurance PrepaymentsCombine Points Buy Down and Upfront Mortgage Insurance Prepayments
Price: $400,000Price: $400,000
Down Payment: 5%Down Payment: 5%
Interest Rate: 3.75%Interest Rate: 3.125%
Discount Points = 0%Discount Points = 1.50%
Cost of Discount Points = $0Cost of Discount Points = $5,700
P&I Payment: $1,760Upfront Cost: $4,978
Monthly Insurance Payment: $144Additional Cost: $10,678
Total PMI: $1,874/monthTotal PMI: $1,627/month

The break-even point for combination of both buying down points and paying mortgage insurance up front will be 3 years and 7 months. If you have an extra $11,000 and plan to own the property for that long, it could be a good option for you. Another option to consider is that the $11,000 does not necessarily have to come from your pocket. There are ways to negotiate these costs into your contract by raising the purchase price or getting some seller concessions. For Jeff’s third house hack, we raised the purchase price while under contract by $5,000 and asked the seller for a $5,000 seller credit. He used the credit to prepay mortgage insurance.

There are a lot of levers that can be pulled to change your monthly payment. For these purposes, it’s less about understanding the exact numbers and more about grasping the concepts. Once you have wrapped your head around that, you can build your team of experienced agents and lenders, like us, to help you build your rental portfolio. We know what you can and can’t do, and how to help you maximize your opportunities.

Which Option is the Best?

Spending a little more money upfront, can change your monthly payment for the next 30 years.

Owner-Occ 5% DownOwner-Occ 5% with Point buydown & Upfront Mtg InsInvestment Property
Rate: 3.75%Rate: 3.125%Rate: 4.25%
Investment: $25,040Investment: $35,718Investment: $108,000
Payment: $1,874Payment: $1,627Payment: $1,869
   
Rent: $2,200Rent: $2,200Rent: $2,200
Cash-Flow: $-147Cash-Flow: $121Cash-Flow: $273
Total return: 118%Total return: 94%Total return: 30%

Survey says… Option #2 is the best. You are getting a little less from your total return on investment, but overall, it’s still a great number at 94%. You have positive cash-flow and lower monthly payments. You need to look at each transaction individually to determine which scenario is best for you and your long-term goals.

How to Get Started

1. Get pre-approved

  • Pre-qualification is based on verbal information and credit report.
  • Pre-approval is based on written information like collecting your actual taxes, W2s, paycheck stubs and your credit report.
  • Offers are much stronger with pre-approval letters and, in the Denver market, you won’t be a consideration if there is a multiple offer situation without a pre-approval letter.
  • The pre-approval letter says to the seller that the buyer has been fully qualified and is ready to go! All they need is a purchase contract, appraisal and title commitment.

2. Having your credit pulled will NOT ruin your life. Your life and credit will not go down the tubes if you have someone pull your credit. If you want to invest, lenders have to be able to see your credit. Lenders have to verify your payment history on previous loans, credit score, outstanding debts, outstanding student loans, etc. If the change of a couple points on your credit score from “pulling your credit score” is the difference in you being approved vs not being approved, you should NOT be investing right now.

  • As far as credit minimums are concerned, at the time of writing, 620 is the lowest credit score required to be approved for a new loan. To get the very best terms on a loan, a credit score of 740 and above is required.

3. If you want to have a serious conversation about where you stand and how to buy a property, then a lender will need a full application with all of your information, credit report, income, assets, goals, etc.

Overall, making these financial decisions will be the foundation of you starting your house hacking search. Don’t set yourself up to be disappointed by not knowing how much you are qualified for. It lets us know where we should look, how much you can afford, and is ultimately the reality check we all need to make sure we help you obtain your investing goals quickly and efficiently.

To get pre-approved, make sure to contact Joe Massey at Castle & Cooke Mortgage.

Call: 303-809-7769

Email: jmassey@castlecookemortgage.com

YouTube Video: Financing for House Hackers

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