For homebuyers and real estate investors alike, coming up with a down payment presents the greatest barrier to buying.
But do you have to put a down payment on a house when you buy? Are there creative workarounds that homebuyers and real estate investors can take advantage of to minimize the down payment?
It turns out there are, especially for real estate investors. Of course, they have to come up with a far larger down payment than the average homeowner, too.
How Much of a Down Payment Do I Need?
Homeowners must typically put down between 5-20% of the purchase price when they buy a house. But the government does sponsor some loan programs with particularly low down payments; for example, FHA loans require only 3.5% down from borrowers with credit scores over 580. On the conforming side, Fannie Mae offers a 3% down mortgage program, as does Freddie Mac. Military veterans can even score 0% down mortgages from the VA!
Several factors impact the down payment required by your mortgage lender. Your credit history makes a huge impact, so if you have a few dings on it — or haven’t established much credit history — work to repair or build your credit fast. Lenders also look at the stability of your employment and income, because ultimately they price and structure loans based on the perceived risk that you will default.
Bear in mind that if you put down less than 20%, you’ll need to pay private mortgage insurance (PMI). It can add $1,000 or more to your annual mortgage costs, so it can put a serious dent in your budget.
Real estate investors, in contrast, must typically come up with a greater down payment. Expect to put down between 15-30%, with strong borrowers generally putting down 20-25% depending on their credit, their investing experience, and the lender.
That higher down payment requirement leads some investors to get creative, and look for loopholes to use homeowner financing to buy investment properties.
Loophole 1: Occupy the Property for One Year
To qualify for a homeowner mortgage, you need to live in the property for at least one year. After a year, you can move out and keep the property as a rental.
This strategy keeps your down payment and interest rate low, but it comes with several drawbacks. First, it sets a speed limit of one property per year. You can’t build your rental portfolio faster than that if you’re relying on owner-occupied financing.
Second, these mortgages all report on your credit. One or two mortgages reporting on your credit can boost your credit score, but five or ten? They can ruin your credit.
Third, most conventional mortgage lenders put a limit on how many mortgages you can have appearing on your credit. For many loan programs, that limit is four — after that, you’ll have a hard time getting a mortgage.
Finally, you have to buy the property under your personal name, rather than under an LLC or other legal entity to maintain your privacy as a landlord and avoid personal liability in the event of a lawsuit. If you want to borrow a loan for an LLC, plan to get a proper rental property mortgage from a portfolio lender.
This strategy is how the Hoeflers built their rental portfolio and reached financial independence. It worked especially well for them because they combined it with house hacking.
Loophole 2: House Hack a Multifamily
Another way real estate investors can use homeowner financing to minimize their down payment and interest rate is through house hacking a multifamily property.
While there are many ways to house hack to live for free, the classic model involves buying a small multifamily, moving into one unit, and renting out the others. Take Tim for example, who house hacked a duplex. His neighboring renters pay enough to cover not just his monthly mortgage payment but also much of his maintenance and repair costs.
And, like the Hoeflers, you can always move out after a year and buy another multifamily!
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Loophole 3: House Hack Through Your Children
One little-known rule with FHA loans allows parents to take out mortgages with their children, often called “kiddie condo loans.”
They work like this: you buy a property for your adult children, and they move in and pay you rent. They fulfill the occupancy requirement on your behalf, so you don’t have to move in to qualify for an owner-occupied FHA loan.
You can even use these kiddie condo loans to buy multifamily properties, up to four units. Your child moves into one unit (or even just one bedroom) for at least a year, and you’ve met your occupancy requirements.
Can I Borrow the Down Payment?
For owner-occupied mortgages, the answer is usually “no.” Exceptions sometimes include seller-held second mortgage financing.
Homebuyers can, however, accept a gift from friends or family to help cover the down payment. Lenders require a signed letter from the giver, stating that the money does constitute a gift with no strings attached and does not need to be repaid.
Another option for homebuyers includes down payment assistance programs. For example, the FHA offers down payment assistance programs particularly for first-time homebuyers.
Real estate investors, alternatively, can usually borrow the down payment. Because they come up with such a large down payment, many investment property lenders place more emphasis on the collateral — the property — than the borrower. That leaves investors with far more flexibility when getting a loan for a rental property.
In fact, investors can use this lenience to buy rental properties with no money down if they get creative. But that leaves them vulnerable to low or even negative cash flow; always run conservative numbers when using the rental income calculator!
Can I Put the Down Payment on a Credit Card?
Homebuyers cannot, as conventional mortgage lenders don’t allow it. But real estate investors usually can put the down payment on a credit card, or draw it from a rotating credit line like a HELOC.
Real estate investors can even open HELOCs against their rental properties, not just their primary residence, to tap into equity.
As for credit cards, real estate investors aren’t limited to their personal cards. They qualify as business owners, and can open $100,000 – $250,000 in unsecured business credit cards through concierge services like Fund & Grow. Nor do they get hit with cash advance fees, if they use the right tools to charge their cards directly to the title company when they buy!
That lets them take out a standard rental property mortgage through a portfolio lender (a lender that keeps the loan on their own books), and then cover the down payment with their business credit cards.
Again, be careful not to overleverage yourself. The more you borrow, the thinner your real estate cash flow.
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The BRRRR Method for 100% Financing
The acronym BRRRR stands for buy, renovate, rent, refinance, repeat. You buy a fixer-upper with a hard money loan, rehab it, and then refinance to a long-term rental property mortgage.
Using the BRRRR method, you still need to come up with a down payment for the initial purchase-rehab loan. But when you refinance to a 30-year rental property mortgage, you can pull your initial down payment back out. It works because the refinance is based on the after-repair value of the property, not the original purchase price. So if you created enough equity through your renovation, you can use that equity to cash out your original down payment.
At that point, you have none of your own cash tied up in the property. You’ve achieved 100% financing, and can turn around and reinvest the same cash into another rental property. And another. And another.
Nothing stops you from taking the same $40,000 and recycling it to build a rental property portfolio of 20, 30, or 40 properties.
So… Do You Have to Put a Down Payment on a House?
In most cases, yes you do. But not necessarily much of one, and you can get clever with ways to come up with a down payment that don’t involve saving cash.
If you’re a homebuyer with strong credit, you can take advantage of Fannie Mae or Freddie Mac’s 3% down mortgage programs. With weaker credit, you can still take out an FHA loan for 3.5% down.
Even real estate investors can use owner-occupied loans to score a rental property mortgage if they use one of the loopholes outlined above.
And investors who take out hard money loans for purchase-rehab, or long-term rental property mortgages from portfolio lenders, can typically borrow the down payment elsewhere. They draw on business credit lines and cards they secured through Fund & Grow, or negotiate a seller-held second mortgage, or buy a rental property with no money down by cross-collateralizing other properties with equity.
How much of a down payment you need depends on your creativity, your credit, your income stability, and your access to other funding sources. You can even put a down payment on a credit card — if you use the right rental property mortgage and open unsecured business credit cards.
But as you explore how much of a down payment you need, and ways to minimize it, bear in mind that for all the allure of no-money-down tactics, they often leave you dangerously overleveraged. With too little of your own cash in a deal, and too much mortgage debt, most properties fail to produce cash flow.
Buy a rental property that costs you money every month, rather than earning it, and you’ve bought a liability, not an asset.
What tactics are you considering, as you explore whether you have to put a down payment on a house, and how much down payment you need? How are you planning on coming up with the down payment for your next property?
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About the Author
G. Brian Davis is a landlord, real estate investor, and co-founder of SparkRental. His mission: to help 5,000 people reach financial independence by replacing their 9-5 jobs with rental income. If you want to be one of them, join Brian, Deni, and guest Scott Hoefler for a free masterclass on how Scott ditched his day job in under five years.