Ever wished you could borrow an FHA loan for a rental property without, you know, actually having to move into it?
For most real estate investors, coming up with the down payment for a rental property is the greatest barrier to buying. Most of us don’t just have $30,000 or $50,000 or $100,000 lying around collecting dust.
Typical rental property loans require at least 20% down in cash. And the down payment aside, the interest rates are higher than for owner-occupied mortgages.
But if you have adult children, you can capitalize on FHA’s “kiddie condo” program to get FHA, owner-occupied financing for a rental property.
“Kiddie Condo” Loan Overview
Now is a good time to mention that there’s no official FHA loan program called “Kiddie Condo.” That’s a term that mortgage brokers came up with as a marketing label.
Like many marketing labels, it has a nice ring to it, so we’re using it here.
Here’s the basic premise: FHA allows parents to co-sign their children’s mortgages as joint owners. (They also allow parents to co-sign without being on the deed, but that won’t serve your purposes here.) In any event, parents can collaborate on real estate investments with their adult children, and use FHA financing to fund the project as long as their children live in the property for at least a year.
For example, when my friend Tracy was in medical school, her parents bought a townhouse for her to live in. In turn, Tracy paid them rent, and years later when she finished her residency and moved away from Baltimore, her parents had a rental property in excellent shape with strong equity.
Tracy’s parents financed it with a rental property loan, but they could have borrowed an FHA mortgage if they had included Tracy on the deed with them.
House Hacking Through Your Children
In this way, parents can effectively house hack through their children. I’ve known parents who bought a property with their child, the child moved into one bedroom, and then they rented out the other bedrooms and/or units.
The child gets to live there for lower rent (or even for free), while the housemates pay enough rent to cover expenses. In exchange, the child handles property management: finding housemates, signing leases, collecting rent, handling repairs. Which means they get real estate investing and property management experience in the bargain!
Meanwhile, the parents get an investment property, financed with cheap owner-occupied financing. And they don’t even have to pay a property manager.
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Advantages of FHA “Kiddie Condo” House Hacking
I touched some of the advantages above, but let’s go into a little more depth, before then walking through a few risks.
3.5% Down Payment
Borrowers with a credit score over 580 are eligible for an FHA loan with a mere 3.5% down. Even by homeowner loan standards, that’s low. For a down payment on a rental property, it’s unbelievable.
Borrowers with rough credit in the 500-579 range can still qualify for an FHA loan, with 10% down. To be frank, most borrowers with credit that low have no hope of borrowing any other type of mortgage, even portfolio rental property loans. (See the video at the bottom of the page for additional ideas for investing in real estate with bad credit.)
For a $200,000 rental property, most borrowers are looking at a $7,000 down payment for an FHA loan, compared to a (minimum!) $40,000 down payment through other types of rental property loans.
Low-Interest Rates & Fees
At the time of this writing, a reasonably strong borrower can expect to pay in the 4-4.5% range in interest rates for an FHA loan. A borrower with good credit can avoid paying any points (a point is a one-time lender fee charged at settlement, equal to 1% of the loan amount).
For portfolio rental property loans, borrowers are more likely to pay in the 6-8% range, plus 2-3 points.
The lifetime interest charged on a 30-year loan for $200,000 at 4% interest is $143,738.80. The same loan at 7% interest would cost $279,016.00 over the life of the loan – nearly twice as much in interest.
Up to 4 Units
FHA loans allow properties with up to four units. So, you and your adult child can go in on a duplex, triplex, or fourplex, they can move into one unit, and you can rent out the other(s) to generate rental cash flow.
You can even use the theoretical income from these other units to help you qualify for the loan!
You Don’t Have to Live There
One of the drawbacks of house hacking a multifamily property is that you have to move into it yourself, personally, for at least one year after buying.
Which poses several constraints. First, what if you don’t want to live in a multifamily property? Or what if you love your current home, and don’t want to move anywhere?
Second, if you’re interested in building a rental portfolio, it restricts you to a maximum acquisition rate of one new rental property per year. And even then, conventional and FHA lenders will stop lending to you if you have more than two or three mortgages on your credit report.
By house hacking kiddie-condo-style, you don’t have to move. Your child fulfills the owner-occupancy requirement for you, and even then, they’re only required to live there for one year.
Downsides to FHA Loans
FHA loans come with some persuasive advantages, but it’s not all rainbows and butterflies. Here are some downsides worth considering before twisting your child’s arm into going in on a kiddie condo investment with you.
Most mortgages allow owners to apply to have the mortgage insurance removed from the monthly payment, once the loan balance drops below 80% of the property’s value.
Not so with FHA loans. Relatively recent changes to FHA loan specs require mortgage insurance to be paid for the entire life of the loan, which is often hundreds of extra dollars tacked onto your monthly payment.
Month after month, year after year, until you sell or refinance.
Reports on Your Credit
On the one hand, it’s a great way for your child to build a strong credit history early in their adulthood.
At the same time, it may throw off your credit, even if you pay on time every month. Having higher debt balances can hurt your credit in the short term.
And, of course, it restricts your ability to borrow conventional mortgages on other rental properties.
As mentioned above, you can typically only have a few mortgages reporting on your credit before conventional and FHA lenders will stop lending to you.
It’s also not scalable because it hinges on your child’s cooperation. And while a kiddie condo collaboration is a great way to go in on a deal with your kids in their 20s, don’t expect them to jump for joy when they’re 40 and you propose a kiddie condo house hacking deal to them.
Requires Responsible, Reliable Kiddos
Not only does it require your kids’ cooperation, but their responsible caretaking of the property.
They have to:
- Make the payment on time every month
- Collect rent on time from housemates and/or neighboring tenants
- Care for and protect the property from physical damage
- Enforce the lease agreement and potentially evict housemates or neighbors
Some 20-somethings aren’t up to those expectations. Know your children well before you propose a house hacking project with them.
Tangled Personal & Financial Interests
What happens if your kid stops paying the rent or mortgage? If they trash the property?
You can’t evict someone if their name is on the deed.
This is a problem with any collaborative real estate investment between friends or family. If one party fails to live up to the agreement, the other party is up the proverbial creek.
And not only does it strain your finances, but it also strains your personal relationship. Even if your child lives up to their end of the agreement, things can still get hairy if their best friend is a housemate and tenant, and they stop paying the rent or trash the property.
Another challenge with going in on a rental property with someone else is that you need a mutually agreed-upon exit strategy. But when you’re buying as a long-term investment, there’s no obvious exit.
It happens all the time: one person decides they want to sell, and the other party is happy to keep collecting rents. Which is fine if the one party can afford to buy the existing party out, but what happens if they can’t afford to do so?
These challenges aren’t necessarily deal-breakers, but they’re worth discussing before going in on a house hacking deal.
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Teach Your Kids About Money & Investing (No One Else Will!)
They don’t teach personal finance, budgeting, investing, or real estate in public schools. Which is probably why only 3% of Americans can answer five out of six questions accurately on a personal finance quiz.
If you want to arm your children with the financial and investing know-how they need to build long-term wealth, collaborating on a real estate investment with them is an excellent way to do it.
In fact, you should ideally start younger, with some of these tips to raise your kids to be good entrepreneurs rather than good employees. Employees are good at following orders; the entrepreneurial-minded are good at thinking strategically and taking charge of their own financial future.
Teach your kids how to find good deals on real estate, how to secure a loan, how to calculate rental cash flow. When you’re evaluating deals, sit down with them and use our rental income calculator together, to show them how to calculate ROI!
Then come property management skills like collecting rent, showing vacant units, filing evictions. Even better, if you’re handy and local, you can show them hands-on DIY property upgrades and home repairs.
Kids learn math, science, grammar in school. They learn how to build wealth from you.
Opportunity to Invest Long-Distance
As a final advantage to house hacking through your children, it opens the door to invest in real estate long-distance with local boots on the ground: your child.
If your kid attends college or grad school long-distance, they can offer some insights into the area. They can help you research up-and-coming areas, scope out promising neighborhoods, and serve as your eyes and ears.
Just be careful not to rely too heavily on their judgment: you’re the experienced investor, not them. And just because they like a ritzy neighborhood and want to live there, it doesn’t mean you can find a good return in that neighborhood.
Once you find a good deal, your child can oversee any (minor) repairs, and of course, take on increasing property management roles over time.
House hacking through your children, potentially with an FHA loan, can be a cheap, easy way to finance investment property. It’s also a great opportunity to teach your kids about real estate investing.
Agree on each party’s responsibilities, and on an exit strategy, so you’re not locked into a real estate partnership indefinitely.
Most of all, make sure your child is responsible enough to partner with on a project worth hundreds of thousands of dollars. Not all 20-somethings make good business partners, so use good judgment about whether the broader concept is a good idea, before considering details like financing.