Normal Investment Property Requirements
Rental properties, if managed appropriately, are excellent investments and even one can significantly increase your income/assets in retirement. But, as is the case with most good investments, there are significant “barriers to entry”, particularly the down payment.
A primary residence (the home you live in) usually requires a downpayment as little is 3-3.5%, but investment properties require 20% down (there are practically no exceptions). So, for a $200,000 house, the down payment for an investment property would be $40,000 as opposed to only $7000 for a primary residence. This makes purchasing rental properties- without them first being primary residences- out of reach for many homeowners, even if their income is sufficient to support the mortgage payment for 2 properties.
The Workaround
If you have grown children (even ones that don’t seem to provide much “return on investment”!) then it is likely you could “use” them to pick up a rental property for only 3.5% down, making such an investment far more achievable for some people.
Here’s how it works:
FHA mortgages (and now conventional mortgages) allow for “non-occupying co-borrowers”, as long as they are related. That means you can be an owner/borrower of/on a property without actually living there, as long as a family member is living in the home as their primary residence. Underwriters would consider the combined income, assets, debt payments, etc. of all borrowers when approving the loan, but it’s perfectly acceptable to have practically all of the income coming from you (the parents). The occupying borrower would need to plan on living there for at least a year, but after that, it’s completely acceptable to treat the property as a rental.
Application of this Strategy
This is an exceptionally good strategy for parents with children attending college or children that are planning on renting anyway. Here is an example of how this often works (I’m using actual expected mortgage payments and rental rates, based off the current Utah County market):
Example 1: Mom & Dad buy a condo close to campus for $150,000 and put down 3.5% ($5250). The mortgage payment (with taxes and insurance) and HOA fee come to $987/month. Jimmy (the son) and his 2 roommates live there, with the 2 roommates paying $350/month in rent (they give Jimmy a break and only charge him $287). The parents pay nothing (unless they were going to pay Jimmy’s rent anyway) while Jimmy finishes school. Jimmy finishes school 3 years later and Mom & Dad then refinance the loan into a conventional loan without mortgage insurance (which they can now do, since the home has appreciated and they’ve paid down the mortgage), yielding a new payment of $900/month. They could rent the property to 3 students for $1050/month and still net $100/month, even after reserving for maintenance.
That $100 may not seem like a lot, but keep in mind that the mortgage is being paid down and the property is appreciating. By the time Mom & Dad are ready to retire, they would have a substantial amount of equity (close to $150,000, after 15 years).
Example 2: Jimmy (from our previous example) gets married, has a few kids, and moves to a new city. It will be a year or 2 before they can buy a house themselves and renting a $200,000 home (the size required for their family size) will cost about $1300/month. Mom & Dad figure out that buying the same house (as non-occupying co-borrowers putting down just 3.5%) would yield a total mortgage payment of only $1192. They decide to buy the house with Jimmy and his wife and let them pay $1200 in rent. Jimmy and family get a break on rent and Mom & Dad just picked up a rental for only $7000 down!
A lot goes into purchasing rentals and managing them, but the returns are substantial, if done correctly (see our blogpost about rentals here). If you’ve been considering acquiring a (or additional) rental(s) and have some grown kids to “cash in”, give us a call. We’ll do a complete analysis so that you can see if it would work for you and your family.
