In November 2023, Fannie Mae implemented a game-changing reduced down payment requirement of just 5% for two-to-four-unit properties for conventional loans.
This presents a golden opportunity for house hackers looking to purchase or refi a two-to-four-unit property. However, few sources have broken down what this means for investors. Here, I’ll look at this new product, compare it to alternatives, and discuss what this means for real estate investors.
First, we will walk through eligibility, then compare this loan to its FHA alternative and summarize the impact for investors looking to purchase or refinance.
Eligibility
Fannie Mae laid out these new down payment requirements in their desktop originator release notes. It is important to highlight that this change only applies to someone’s “principal residence.” Lenders are strict about owner-occupied requirements, and this product is only for those living in the property they are purchasing.
Thankfully, two-to-four-unit properties can be incredibly easy to house hack, as the units are already separated—meaning you don’t have to share the same living room as your roommates. Additionally, they offer a very easy transition to rent them as an investment property if you move out (after the required time period).
Conventional loans have been an option for a long time, but the down payment requirements were higher. For example, a first-time homebuyer who would have qualified for 3% down on a single-family conventional loan used to be required to bring 15% down to closing for a duplex (or 25% for three to four units), which forced many buyers to opt for the 3.5% down option with FHA.
FHA loans require a minimum down payment of 3.5%. While this has made these loans attractive, the new 5% down payment requirement for conventional now provides investors with additional flexibility. At just 5% down, investors now have the option to choose between FHA and conventional financing for multifamily investment.
To take this analysis one step further, I tested the 5% conventional loan option by reaching out to one of our investor-friendly featured lenders on BiggerPockets to compare my FHA loan to a conventional loan.
I’ll uncover some details you will want to know if you are serious about using this product. If you want to skip to the results, scroll to the comparison summary below.
Comparison to FHA
FHA loans have long been a popular choice for owner-occupied two-to-four-unit properties due to their lower down payment requirements. However, the reduction to a 5% down payment by Fannie Mae offers a competitive alternative with unique benefits. There are multiple things to consider when comparing.
The Federal Housing Administration’s primary goal is to ensure that Americans have access to safe, affordable housing. So it is no surprise that when it comes to affordability, FHA loans have the upper hand, with relatively low down payments and interest rates. After all, that is part of the purpose of the FHA. But depending on your situation, a conventional loan could be less expensive and offer a more compelling solution.
But there is so much more to consider than just APR, fees, and closing costs. You must also consider:
- The closing process
- The refinance process
- Mortgage insurance
Here’s a comparison of multifamily loans:
The Closing Process
Because one of the goals of the FHA is to ensure safe housing, they have more stringent requirements on the condition of the property. The classic example of this is when the seller is under contract and told they need to touch up paint prior to a loan being funded. Although most agents and sellers do not mind getting out a paintbrush to close a deal, this is one example of how FHA loans differ from conventional loans and why sellers sometimes prefer conventional loans.
Mortgage Insurance
Mortgage insurance is an additional payment paid by the borrower to insure the lender against a situation in which the borrower stops paying their mortgage. One of the biggest differences between FHA and conventional loans is how mortgage insurance works. Both FHA and conventional loan products require mortgage insurance if the down payment is under 20%, but the mechanism to charge this insurance is different.
A conventional loan also needs insurance if the down payment is under 20%, but this must be purchased from a private company—this is called private mortgage insurance (PMI). With conventional loans, you can have this insurance removed after reaching 20% of equity in the property, which allows you to lower your costs in the long term.
The federal government insures an FHA loan through a mortgage insurance premium (MIP) to make housing more affordable. This mortgage insurance can be removed only in specific situations. You can find all the details here on HUD.gov.
A workaround for removing mortgage insurance payments (MIP) in some situations is to refinance into a conventional loan. However, you don’t necessarily know what rates will be in the future, and there is no guarantee that your current rate will be available when you reach 20% equity, so using a conventional loan locks in your ability to remove PMI once you reach 20% in the future.
FHA also has an upfront mortgage insurance premium. Conventional loans do not have this upfront cost, which is an advantage in the short term.
Refinancing
The conventional 5% down option could be an option for those who are refinancing out of an FHA loan and want the ability to take off the mortgage insurance in the future. There are three reasons to refinance: lower your monthly payment, extract equity, or switch loan products. Refinancing into a conventional loan at 5% down could give you flexibility in the future if the rate and terms are attractive to you.
Your lender will be able to tell you what loan product will accomplish your goals. Keep in mind that FHA loans have a streamlined option that makes refinances easier in the future, which is a nice feature when you do not want to go through the whole underwriting process again.
Comparison Summary
After learning about this new loan product, I decided to put it to the test for myself by running a comparison between conventional and FHA. For help, I used Find A Lender at BiggerPockets. I performed a search in my state and selected “HouseHack” and found Mike Stone with Megastar Financial in the results.
Full disclosure: I have also worked with Mike in the past, and he is awesome. He helped me with my first FHA loan, so he was the perfect lender to help me with my comparison analysis.
I provided my information to Mike and asked him to compare conventional and FHA on both a refinance that I am considering and a purchase.
First, I need to point out that your scenario could look entirely different. This is in no way meant to compare between FHA and conventional for any other investor. I am simply sharing what the difference was for me. For your situation, consult with a licensed loan officer.
Here are the results comparing a 5% down option for both conventional and FHA.
The results surprised me. Not only did the FHA option offer a lower monthly payment, but it also required $3,000 less to close.
However, my lender, Mike, shared several important pros and cons to consider beyond just the pricing.
Conventional advantages
- Mortgage insurance is more straightforward to remove
- The closing process tends to be easier
- Less strict requirements in general
- No self-sufficiency requirement for three to four units
- Allows borrowers to qualify based on rental income
- More likely to close faster (although this depends on other factors)
- Ability to have more than one conventional loan at a time
FHA advantages
- Government-subsidized mortgage insurance
- Less strict credit score requirements
- FHA streamline refinance
- You can always refinance in the future
For me, FHA was still the clear winner, but I am considering conventional on my next property for the reasons I’ve discussed here. Ultimately, comparing loan products on a two-to-four-unit house hack is best done with a savvy, investor-friendly lender who can run through multiple scenarios and coach you through the best option for you.
Final Thoughts
What we know is that by offering a competitive alternative to FHA financing, Fannie Mae has helped to reduce barriers to entry for house hackers. This new option can provide increased leverage and flexibility. As the real estate market continues to evolve, savvy investors can now choose the option that best suits their investment goals, ensuring they are well-positioned to capitalize on the income potential of multifamily properties.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
