Everything You Need to Know About Getting an FHA Loan for a Rental Property

An FHA loan can be a great option for financing the purchase of a rental property. With low down payment requirements flexible credit standards and affordable interest rates, FHA loans make investment property ownership achievable for many buyers. However, there are specific FHA guidelines and requirements when using these loans to purchase a rental. This article will provide an in-depth look at how FHA loans work for financing rental properties.

FHA Loan Overview

First, let’s start with a quick refresher on what an FHA loan is FHA stands for Federal Housing Administration – this government agency insures mortgages originated by FHA-approved lenders This insurance protects the lender from losses if the borrower defaults, allowing the lender to offer more flexible terms.

Some key advantages of FHA loans include:

• Low down payments – only 3.5% required for qualified borrowers
• Lower credit score requirements – as low as 580 FICO
• Lower debt-to-income ratios allowed
• Lower mortgage insurance premiums than other low down payment programs

These features make FHA loans accessible to more buyers, especially first-time homebuyers. But they can also be used to purchase rental properties by real estate investors.

Using an FHA Loan to Buy a Rental Property

The FHA does allow borrowers to use their loans to purchase rental properties, with a few specific guidelines:

• Owner-occupancy – To qualify for an FHA loan, you must plan to move into the property as your primary residence within 60 days of closing. However, you can rent out any additional units on the property.

• 1-4 unit properties – FHA loans can only be used to purchase single family homes or 2-4 unit properties. If you want to finance an apartment building or complex with more than 4 units, you’ll need a different type of loan.

• No short-term rentals – The FHA prohibits using the property for any rental periods less than 30 days, such as with Airbnb. You must find longer-term tenants.

Provided you follow these parameters, it is perfectly acceptable to utilize an FHA loan to buy a duplex, triplex, or quadplex, live in one unit, and rent out the remaining units to generate income. You can even buy a single family home and rent out rooms.

Qualifying for an FHA Loan for a Rental

When applying for an FHA loan to purchase a rental property, there are a few key factors lenders will evaluate:

• Your credit score and history – You’ll generally need a minimum 580 FICO score. The stronger your credit profile, the better your interest rate and overall loan terms will be.

• Income and employment – Lenders want to see stable income that is sufficient to cover both your personal expenses and rental property costs like the mortgage, taxes, and insurance. Having 2 years of consistent employment in the same field is ideal.

• Down payment funds – You’ll need to document where your 3.5% down payment is coming from, whether from your own savings, gift funds, grants, etc. All sources must be documented.

• Property appraisal – The property must appraise for at least what you’re paying for it. Otherwise, you’ll need to make up the difference out of pocket.

An additional factor is rental income from the property. Since some of the space will be tenant-occupied, lenders can consider a percentage of projected rents when approving you. Typically 75% of rents are counted. This rental income can help you qualify for a larger loan amount.

FHA Loan Limits for Rental Properties

FHA loans have maximum loan limits that vary by county and the number of units in a property:

• 1-unit properties – Up to $726,525 in low cost areas, higher in pricier markets
• 2-4 unit properties – Up to $931,600 regardless of location

In high cost areas like Los Angeles or New York, you may be able to get approved for over $900k+ on a single family rental property with an FHA loan. However, the four unit limit still applies no matter how expensive the market is.

Pros and Cons of FHA Loans for Rentals

Some key advantages to getting an FHA mortgage for an investment property include:

Pros

• Low 3.5% down payment requirement
• Easier to qualify than conventional loans
• Interest rates are competitive
• Smaller properties like duplexes are eligible

Cons

• Must be owner-occupied, can’t purchase from a distance
• Limited to 4 units maximum
• Ongoing mortgage insurance for life of loan
• Restrictions on short-term rentals

An FHA loan can be a good fit if you plan to live in one unit of a smaller rental property and want to get started with a low down payment. However, if you plan to buy a larger apartment complex or prefer to rent out the entire property, you’ll need to look at other financing options beyond FHA.

The FHA Loan Process for Rental Properties

If you decide an FHA loan is right for your rental property purchase, here is an overview of the process from start to finish:

1. Get pre-approved – Work with a lender to get pre-approved and learn your pricing and loan amount options. This also shows sellers you are a serious buyer.

2. Find a property – Whether working with a real estate agent or on your own, find an FHA-eligible property in your target area. Remember it must be a 1-4 unit residence that you plan to partially occupy.

3. Make an offer – Submit an offer and negotiate the purchase terms with the seller. Do not specify FHA financing in your offer – this could lead to discrimination. Disclose after reaching an agreement.

4. Inspection period – Conduct an appraisal and professional inspections during your contingency period. The property must meet FHA minimum property standards.

5. Loan processing and underwriting – Your lender will verify all documentation, income, assets, and eligibility requirements at this stage. Be prepared to provide paperwork quickly.

6. Closing – The closing process is similar to any standard real estate transaction. Review documents thoroughly and clear any final conditions.

7. Move in – You must personally occupy the property within 60 days as required by FHA guidelines. Then you can clean up, paint, and rent out the other unit(s).

It’s a little more involved than buying a primary home, but still a straightforward process overall. Working with an experienced real estate agent and lender familiar with FHA rental loans can help ensure everything goes smoothly.

Tips for Getting Approved

Here are some top tips for getting your FHA loan application for a rental property approved:

• Shop lenders – Compare multiple lender quotes to find the best rates and overall deal. Online lenders sometimes offer lower pricing.

• Boost your credit – Pay down balances and dispute any errors to maximize your score prior to applying. Every point helps.

• Lower your DTI – Reduce recurring debts and pay off installment loans if possible. The lower your ratios, the better.

• Have reserves – Lenders like to see 6-12 months of mortgage payments in reserves as a safety net. Cash is king.

• Get an appraisal early – Be sure the property value will come in at or above your purchase price before committing to buy.

• Document gift funds – Have paperwork from any family members gifting you money for the down payment or closing costs.

With proper preparation and an organized application, your chances of getting approved for an FHA rental property loan are very strong.

Alternatives to FHA Loans for Rental Properties

If an FHA loan doesn’t work for your situation, here are a few alternative financing options to consider:

• Conventional loans – May offer lower rates and allow 5-25% down payments on up to 10 unit properties. Credit score requirements start around 620.

• Portfolio loans – Offered by banks and community lenders to finance small rental properties. More flexible than conforming mortgages.

• Fix and flip loans – Designed for short-term financing to purchase and renovate a property before selling for a profit.

• Hard money loans – Asset-based loans from private lenders that can be used to rehab or bridge finance investment properties. Higher rates but quicker closings.

• Business lines of credit – Tap revolving credit lines offered by banks to real estate investors and businesses to close quickly on properties.

• Private/seller financing – Some sellers may be willing to act as the bank and hold a mortgage for you. Allows very little money down.

Depending on your credit, property type, and business model, one of these alternative mortgages could be a better fit than an FHA loan. An experienced investment property mortgage broker can help you explore all the options.

The Bottom Line

FHA loans can be a viable option for real estate investors to purchase a small rental property with only