Can I Use an FHA Loan for a Rental Property? A Detailed Guide

Buying a rental property can be an excellent way to generate passive income and build long-term wealth through real estate investing. However, financing investment properties often requires a large down payment and excellent credit. This can put rental properties out of reach for many potential real estate investors.

This is where FHA loans come in. FHA loans are government-backed mortgages insured by the Federal Housing Administration (FHA). They offer low down payments, flexible credit requirements, and reduced closing costs compared to conventional mortgages.

But can you actually use an FHA loan to finance a rental property investment? The short answer is maybe, but with significant restrictions

In this comprehensive guide, I’ll explain everything you need to know about using FHA financing for rental properties. Here’s what we’ll cover:

• What are FHA loans and how do they work?
• FHA occupancy requirements for owner-occupancy
• Exceptions that allow FHA loans for rental properties
• Strategies for qualifying rental properties with FHA loans
• Pros and cons of using FHA financing for investment properties

Let’s dive in!

What Are FHA Loans?

The Federal Housing Administration (FHA) insures mortgages originated by FHA-approved lenders. FHA loans offer several key benefits compared to conventional mortgages:

• Low down payments – FHA allows down payments as low as 3.5% of the purchase price. This makes it easier for buyers with limited funds to purchase a home.

• Lenient credit requirements – You can qualify for an FHA loan with a credit score as low as 500-579 with 10% down. Credit scores of 580+ require just 3.5% down.

• Lower closing costs – FHA limits origination fees and other closing costs, keeping them lower than conventional loans.

• No income limits – FHA doesn’t have income limits or caps for its mortgage programs. Any income level can qualify as long as you meet debt-to-income ratios.

These benefits make FHA loans ideal for first-time homebuyers and anyone without ideal finances for a mortgage. They help people who may not otherwise qualify get approved for home financing.

Now let’s look at the key requirements and restrictions for FHA loans.

FHA Occupancy Requirements

The most critical factor determining FHA eligibility for rental properties is the owner-occupancy requirement.

FHA requires you to move into the property and occupy it as your primary residence within 60 days of closing. You must live in the home as your principal residence for at least 1 year after move-in.

This means you cannot purchase a property as a pure rental investment or vacation home with FHA financing. The property must be owner-occupied as your primary home.

FHA created this requirement to promote affordable homeownership, not real estate investing. The low down payment and flexible credit standards are designed for owner-occupants, not landlords and investors.

Violating the owner-occupancy rule can trigger mortgage default and potential foreclosure. So you must intend to live in the property when using FHA financing.

Exceptions for FHA Loans on Rental Properties

While rare, there are some exceptions where FHA mortgages can be used to finance a rental property:

1. Live in one unit of a multi-unit property

FHA allows financing for 2-4 unit properties as long as you live in one unit as your primary residence. For instance, you could purchase a duplex or fourplex, live in one unit, and rent the other unit(s) out.

As long as you occupy one unit, FHA views the entire property as owner-occupied. This exception gives real estate investors a way to use FHA loans for rental properties.

2. Convert your primary residence into a rental

If you need to relocate for a job, get married, or any other major life event, FHA may allow you to rent out your existing primary residence purchased with an FHA loan.

You’ll need to submit documentation providing a valid reason for moving out. And you must have occupied the home as your primary residence for at least 12 months before renting it out.

This exception allows converting a primary home into a rental investment if your circumstances change after purchasing the property.

3. Rent rooms in your primary residence

If you fall ill or become disabled and can’t work, FHA may permit you to rent out rooms in your primary residence to generate income.

You must submit doctor’s notes or other paperwork documenting your hardship. The rent collected can replace lost income to help pay your mortgage and expenses.

4. Refinance into a non-FHA loan

Once you have significant equity built up, you may be able to refinance your FHA mortgage into a conventional or other non-FHA loan.

Refinancing can remove the FHA owner-occupancy requirements and allow you to rent out the property. You’ll need at least 20% equity to qualify for most conventional mortgages.

These are the main exceptions that can provide a path to financing rental properties with FHA loans. But the exceptions place limits on property types and have strict qualification rules.

Next, let’s look at strategies for structuring your rental property purchase to work within FHA guidelines.

Strategies for Using FHA Financing on Rental Properties

If you want to tap into FHA loans for real estate investing, you’ll need to carefully structure your purchase around FHA occupancy rules. Here are some strategies to consider:

Purchase a Multi-Unit Property

The most straightforward approach is buying a 2-4 unit building and living in one of the units. FHA allows this with low 3.5% down payment options.

Make sure to consult zoning laws and homeowners association (HOA) rules to ensure multi-unit properties are permitted before purchasing.

House Hack a Single-Family Home

House hacking involves buying a larger single-family home and renting out rooms to help cover the mortgage. Boarding houses and room rentals are permitted with FHA as long as you live in the home.

Look for SFH properties with:

• At least 4 bedrooms, 2 bathrooms
• Finished basement or attic space for additional rental units
• Zoning allowing room/bed rentals

House hacking allows you to offset your housing costs while building equity.

Plan to Refinance Out of FHA Later

If your goal is to eventually own a fully rented investment property, plan to refinance into a conventional loan later.

Purchase a property you can afford on your own if needed. Make extra payments to build equity until you reach at least 20% to qualify for a refinance.

Pros of Using FHA Financing for Rental Properties

Utilizing FHA financing to acquire rental properties or house hack can offer these advantages:

• Low down payments – FHA requires just 3.5% down, making property purchase more affordable.

• Easier to qualify – Flexible FHA credit and debt requirements expand your financing options.

• Lower mortgage insurance – FHA mortgage insurance rates are lower than conventional loans.

• Assumable financing – FHA loans can transfer to new buyers if you sell, adding value.

• Preapproval options – You can get preapproved for streamlined underwriting and stronger purchase offers.

The low down payment options and flexible qualifying open up FHA financing to more real estate investors.

Cons of Using FHA Loans for Rental Properties

However, there are also some downsides to weigh:

• Strict occupancy rules – You must personally live in the property for at least 12 months, limiting options.

• Refinancing difficulties – FHA loans can be harder to refinance than conventional mortgages.

• Lower loan limits – FHA loans limits are capped, whereas conventional loans have higher limits.

• Upfront mortgage insurance – FHA requires 1.75% of the loan amount as upfront mortgage insurance.

• Ongoing mortgage insurance – FHA monthly mortgage insurance premiums are for the full loan term.

These drawbacks mean FHA loans are best suited for owner-occupants using financing strategies like house hacking, not pure investors. Conventional mortgages or portfolio lending from local banks can provide more flexibility for investors.

The Bottom Line

FHA financing can be a great option for affordable homeownership thanks to low down payment options and flexible underwriting. But the strict owner-occupancy requirements make utilizing FHA loans for pure rental properties difficult.

Purchasing a multi-unit property to house hack or planning to refinance to a conventional loan after building equity can allow investors to tap into FHA loans. But significant restrictions remain in place to limit use of government-backed financing for real estate investing.

Thinking of purchasing a rental property using FHA financing? Reach out today to discuss your options and determine whether FHA or a conventional mortgage is right for your investment plans!