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Getting into Real Estate and navigating the waters of purchasing your first home can be quite confusing. The goal of this article is to explain how to understand the differences between an FHA and conventional loan in terms that everyone can understand. In the last blog post, I discussed the concept of obtaining enough cash flow to cover your monthly overhead expenses. This is the point at which you can quit your job and become an asset manager.
Let’s talk about what the most common types of cash flow producing assets are:
- Real estate
- Owning equity in a business
- Dividend distributions derived from stock portfolios
- Interest from bond returns.
Residential Real Estate
I will discuss each of these topics at length in future blog posts and will start with real estate first (specifically residential real estate).
Real estate is divided into two main categories, commercial and residential. Typically, the first property an individual will purchase is a primary residence.
Three main categories of loans:
- Conventional loan
In this article, I will be discussing the difference between FHA and conventional loans.
An FHA (Federal Housing Administration) loan is a mortgage that meets certain federal guidelines and is backed (insured) by the government. The loan is usually purchased by a government entity such as Fannie Mae or Freddie Mac.
First, an individual usually needs to obtain a loan from an MLO (Mortgage Lending Officer). Moreover, the lender needs to be an approved FHA provider. For example, an individual goes to their bank (like Wells Fargo or their local credit union) and obtains a loan.
An FHA loan can only be used to purchase a primary residence and requires a minimal 3.5% down payment.
A conventional loan requires a higher down payment and has slightly stricter requirements.
You might ask, “Why would I apply for a conventional loan when I can put less money down on an FHA loan?”.
One reason is that sellers prefer conventional loan buyers. This is because FHA loans require that the home meet certain minimum standards. A few examples are: the house must have a stove, the water heater must have earthquake proof straps, the buyer must be purchasing the home as their primary residence, etc.
Another reason why sellers prefer conventional loans over FHA loans is that they believe that the buyer has stronger financials.
All loans require an appraisal, and the lender will only lend up to the amount that the home appraises for.
In an inclining market, where demand is high and there is an inventory shortage, a house may not appraise.
If this should happen then one of three things will have to happen.
- The buyer and seller will either have to re-negotiate the purchase price
- The home will fall out of escrow (no agreement is made)
- The buyer will have to pay the gap (come up with the difference between the appraised value and the contract price).
Interested in Learning More about Real Estate? Read on…because knowledge is power!
If you are interested in purchasing a fixer-upper home and want to finance the cost to remodel, then check out my article on FHA 203k loans. This is an FHA backed loan that allows you to finance up to 10% more than the appraised value. What is great about this loan is that you get to customize the property, that you plan on living in, to your liking!
If you are reading this article, maybe it is because you are considering purchasing a home. Typically, people who just invest in a home become “house poor“, i.e. you just spent a ton of money on a home and will have to be mindful of your budget. Obviously, the point is to purchase a home that is within your budget, but you will have to come up with a down payment (which usually represents a good sum of cash). Talking to an MLO will allow you to get a good idea of what you can afford.
The biggest thing you can do to save money on your heating/cooling bill (which represents 30% of your utility bill), is to insulate your home. Download this Free Home Energy Audit Guide to see what measures you can take to save money and the environment. Our electricity comes from burning coal and fossil fuels. Insulating your home is good for your budget, the environment, and lung health. You can’t go wrong!
The goal of Eco Economic’s Increase Your Financial IQ Course is to explain how to understand and win the financial game in terms that everyone can understand.
For now, if you have any questions about the material that I have written about or want to know more about a specific topic, post a comment below!
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