Are you having trouble getting started as a real estate investor? Have you been going to REIA meeting after REIA meeting and just haven’t pulled the trigger? If so, the FHA 203(k) program might be your answer if you have been wasting time getting started and have more time, at least a year, preferably two years.
First, let’s examine why you haven’t pulled the trigger on buying your first investment property. Following are some common reasons newbies say they have trouble getting started:
“I don’t have a lot of money to invest”
“I don’t know how much repairs cost”
“I have a full-time job and I don’t have time to manage or monitor a rehab project which in turn may lengthen the time to completion and result in high holding costs”
“What if I can’t sell the house when repairs are complete”
“Even if I do a successful flip to start out, federal, state and FICA taxes will eat half of my profit!”
Do any of these barriers sound familiar? Do ALL of these barriers sound familiar?!
If so, then the FHA 203(k) program may be able to address some or all of these barriers…if you want, if you are committed and if you will actually live in the renovated house at least a year, preferably two years.
The general strategy that can be used by a hesitant investor with some resources (though not a lot), is to:
Buy a distressed property using an FHA-insured 203(k) loan at a significant discount to full retail price that will still have a lot equity after repairs
Renovate the property using funds that are mostly from the FHA-insured 203(k) loan, following HUD guidelines (including 203(k) consultant and 203(k) project manager)
Actually live in the property as your primary residence for at least one year, very preferably at least 2 years as described on the next line
Sell the property after at least two years residency and be exempt from federal tax from up to $250K in capital gains ($500K if married), assuming that the laws stay as they are in early 2017
What is the FHA 203(k) program? Here is an excerpt from the HUD (government) website description: “Section 203(k) offers a solution that helps both borrowers and lenders, insuring a single, long term, fixed or adjustable rate loan that covers both the acquisition and rehabilitation of a property. Section 203(k) insured loans save borrowers time and money.”
Further details about the FHA-insured 203(k) loan program can be found by clicking on the links shown at the government website at https://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/sfh/203k.
Some of the key basic terms of an FHA-insured 203(k) loan are that you can borrow up to 96.5% of the purchase price and repairs. While there are still a bunch of costs, such as for the 203(k) consultant and the 203(k) project manager, mortgage insurance and you also need some capital for the initial repairs before the lender pays for the initial repairs, the total amount of cash needed is much lower than for most construction loans you can otherwise get for purchasing and renovating a distressed property.
A very crucial term of getting a 203(k) loan is that you MUST live in the renovated home as your primary residence at least one year. If you do not live in the renovated home for at least a year and/or never intended to live in the home for at least a year, you would be violating the loan agreement and be subject to fraud.
That is why this program should be considered by investors who have been slow to get started and still expect t be slow enough going forward to actually live in the home for at least a year.
Then again, you might find that after you completed the renovation, it’s not that bad to buy and renovate a home and then put your real estate investing into high gear. Regardless of whether or not you use this renovation experience to jump-start your investing career, you will still need to live in this property for at least a year so you do not commit fraud. You really want to live there at least two years so you can get the tax break on the profit. The reality Is that you need a place to live anyway, so why not just stay and live there as your primary residence for two years and get the $250K exemption ($500K is married) tax break?
The reason you want to look for a distressed property to buy for the 203(k) program is that distressed houses are the ones that you are most likely to buy at a significant enough discount to leave enough equity to realize a nice tax-free gain at the end of the two year residency.
Since you will be living in the house as soon as it is habitable (habitability is usually determined by a local inspector) plus another two years, you don’t have to be pressured about when exactly the house will sell, like you would for a normal fix and flip.
In addition, since this will be your primary residence for at least two years, you will have a deep understanding of the repairs that were made and you have more incentive for monitoring progress during the renovation than for a normal arm’s length transaction. In other words, you will learn a huge amount about rehabbing. This learning curve is often a huge barrier and paralyzing fear for new investors.
As in all fix and flips, whether short term (NOT 203(k)!) or 1-2-year term (after living in it), the best way to increase the probability of success for making a lot of money is to buy low or buy very low. Buying low enough is crucial for this plan to work, just like it is for all buy-fix-sell opportunities for single family homes.
So, if you have been toying with the idea of becoming a real estate investor for a couple of years, going to REIA meetings and maybe even bought a guru package on rehabbing and flipping homes, but still haven’t bought one for any reason, think about this…if you would have bought and fixed a distressed house with a 203(k) loan and lived in it as your primary residence for the past two years, you would already now be in a position sell it and cash in on $30K, $50K, $100K (or whatever equity you generated) and be exempt from paying taxes on it (up to the IRS limits). If you have been hesitant until now to start actually investing in real estate, how much longer do you intend to wait?
Did you know that roughly half of REIA members never buy an investment property? Are you one of them? If so, are you going to remain an investor wannabe forever? In some ways, the FHA-insured 203(k) loan program might be just what you need if you are a slow starter who has a comfort zone of taking a year or two (preferably two) to get into high gear while renovating and living in your newly renovated home.
Think about how much tax-free money you would make after living for two years in a renovated home with a 203(k) loan then selling it. Would that tax-free money be great to build your real estate investment business? Would that tax-fee money realized after two years be great to pay down debt like student loans or credit card debt?
If the 203(k) loan program sounds like a fit for your life and investment goals, get all the details from HUD, make sure you comply with all the rules (there are many rules, but they’re worth the effort), then take action. You must take action.
Biography: Marc Halpern is a successful part-time investor who has achieved financial freedom in terms of passive income and net worth mostly through rentals and flips using “regular” money and self-directed 401(k) funds.
E-mail Marc Halpern directly if you want to improve your profits through coaching by a local expert in South Jersey/Philadelphia with track record.
Do not take any action or make any decisions based in whole or in part on the content of this article. ALWAYS consult with licensed professionals in YOUR state before making any investment.
Now watch the streaming video lectures of Marc Halpern’s Smarter Real Estate Investing Series:
Top 10 Essentials for Successful Flipping
How to Choose Houses for Rentals
Fund a Rental with A Flip: Analysis of an Impressive 2-Deal Case History
Landlording: How to Establish Acceptable Standards of Behavior with Tenants, Tenant-Buyers, Other People’s Children and Other Humanoid Life Forms
How to Effectively Choose Renovations for Flips and Rentals
Should I Flip? Rent? Wholesale? Lease-Option?
Advantages of Self-Directed 401k’s vs Self-Directed IRA’s
Leverage of OPM: The Good, The Bad and The Ugly in Real Estate Investing
Wholesaling from the Buyer’s Perspective
Decision Making, Happiness and Daily Lifestyle Aspects of Real Estate Investing
How to Recover from Bad Real Estate Deals
Overcome Barriers to Buying Your First or Next Investment Property