With a few exceptions, the answer is no Part of the Series Federal Housing Administration (FHA) Loans Understanding FHA Loans
Low down payments and low credit score requirements make Federal Housing Administration (FHA) loans an attractive option for homebuyers who might not qualify for a traditional mortgage. While this may be good news for some homeowners, real estate investors looking to take advantage of the benefits of an FHA loan may need to look elsewhere. That’s because the conditions of these loans restrict those who qualify.
There are, however, ways in which some homeowners may be able to use an FHA loan for a property that also (or eventually) yields income.
Buying an investment property can be an excellent way to generate passive income and build long-term wealth. However financing investment properties can be more challenging than getting a mortgage for your primary residence. Many lenders have stricter requirements when it comes to loans for investment properties. So can you get an FHA loan for an investment property?
The short answer is no you cannot directly use an FHA loan to purchase an investment property in most cases. FHA loans are insured by the Federal Housing Administration (FHA) and come with occupancy requirements stating that you must use the home as your primary residence.
However, there are some exceptions that may allow you to use an FHA loan and rent out part of the property or to eventually rent out the home after living there for a period of time. While FHA loans are primarily designed for primary residences, savvy investors may be able to leverage FHA financing in certain situations.
In this article, we’ll explore:
- What FHA loans are and how they work
- FHA occupancy and eligibility requirements
- Exceptions that allow for rental income
- Strategies investors can use to qualify for FHA loans
- Alternatives like conventional loans and portfolio lending
What Are FHA Loans?
FHA loans are government-insured mortgages that allow borrowers to buy a home with lower down payments, looser credit score requirements, and smaller fees compared to conventional loans. Some key advantages of FHA loans include:
- Down payments as low as 3.5%
- Minimum credit score requirements of just 580
- Ability to use gift funds for the entire down payment
- Lower mortgage insurance premiums than conventional loans
These features make FHA loans ideal for first-time homebuyers and borrowers with less cash on hand or credit challenges. The FHA insures lenders against loss, so they are willing to offer mortgages to riskier borrowers.
FHA loans do come with some limitations, including on how much you can borrow. The current FHA loan limits for a single-family home are:
- $420,680 for most areas
- Up to $970,800 in high-cost areas like San Francisco and New York
FHA Occupancy and Eligibility Requirements
The main barrier to using FHA financing for investment properties is the occupancy requirement. The FHA states that you must intend to use the home as your primary residence for at least a year after closing on the mortgage.
Within 60 days of closing, you’ll need to move into the property and occupy it as your principal residence. You must live in the home for at least 12 months before renting it out.
FHA loans can only be used to purchase a primary residence, not a second home or vacation home. Investment properties and rentals are generally not eligible.
These occupancy rules aim to restrict investors who may want to benefit from the perks of FHA loans. The exceptions to FHA requirements do provide some openings for investors, which we’ll explore next.
Exceptions That Allow for Rental Income
The FHA recognizes that borrowers’ circumstances can change after purchasing their home. The FHA handbook does make provisions for certain situations that may allow you to earn rental income through an FHA-insured property:
Relocation for Employment
If you need to move for a new job and buy a second home, you may be able rent out your initial FHA-financed home after living there for 12 months.
Home Too Small
If your family grows and your current home becomes too small, you may also be allowed to rent out the original property after meeting the one-year occupancy requirement.
Renting Rooms
You can rent out rooms in your FHA home at any time, even from day one, as long as you continue living there as the primary resident.
Inability to Work
If you become unable to work due to illness, disability, or injury, the FHA may allow you to rent out your property to generate income in place of your wages.
These exceptions provide some openings for investors to earn rental income through FHA financing. You’ll need to review the specific policies with your lender.
Strategies Investors Can Use to Qualify for FHA Loans
Savvy real estate investors may look for ways to fit their purchase within the exceptions above and use FHA loans to their advantage. Here are two strategies:
1. House Hack
One approach is “house hacking” where you buy a 2-4 unit multi-family property using an FHA loan and live in one unit while renting the others. This conforms to FHA guidelines as long as you occupy one unit.
For example, you could purchase a duplex or triplex, live in one unit, and rent the other one or two units out. Many house hackers can cover their entire housing expense this way or even generate a profit.
2. Delayed Rental
Another method is to purchase a property using the minimum 3.5% down FHA loan and occupy it as your primary home initially. Make sure you can afford the mortgage payments during this period.
After one year, you may then be able to move out and rent the property based on certain FHA exceptions. This can provide a low barrier to entry for financing your first investment property.
Alternatives to FHA Loans for Investment Properties
If you don’t qualify for the FHA exceptions, there are other financing options to consider for investment properties:
Conventional Loans
You may be able to qualify for a conventional loan for investment properties, which have fewer occupancy restrictions. However, you’ll likely need a higher credit score and bigger down payment.
Portfolio Lending
Smaller banks and credit unions often offer portfolio loans to finance investment properties based on more flexible criteria rather than conforming to FHA or conventional standards.
Hard Money Loans
Hard money loans are short-term loans issued by private investors that can fund fix-and-flip properties. However, interest rates are much higher.
Partnerships
Joining together with other investors to purchase a property can help overcome any restrictions of FHA loans or other mortgages.
The Bottom Line
FHA loans can be a great way for first-time homebuyers to get into a home with less money down and looser qualifying standards. But the FHA requirements make it difficult to directly use these loans for purchasing investment properties in most cases.
If you meet the exceptions for renting out part of the home or renting it later after a one-year occupancy period, FHA financing may be an option. Conventional loans, portfolio lending from community banks, or partnerships are some alternatives to consider when buying investment real estate.
While tricky, there can be ways for enterprising real estate investors to leverage FHA loans in order to purchase investment properties if you understand the guidelines. Examining the exceptions and exploring creative strategies can potentially open the door to FHA financing.
What Are FHA Loans?
During the Great Depression, homeowners had a difficult time buying and maintaining payments on their properties. They were limited to loans worth 50% of a property’s market value, and mortgage terms were generally very short. Many loans ended with very large balloon payments, which most people couldn’t afford to make. This led to a massive amount of default and pushed up the foreclosure rate. In 1934, the U.S. Congress decided to form the FHA in an effort to promote affordable homeownership.
The FHA, which is part of the U.S. Department of Housing and Urban Development (HUD), is the largest mortgage insurer in the world and has more than $1.3 trillion in its portfolio. Loans insured by the FHA have lower down payment requirements and more liberal underwriting standards than most conventional mortgages.
As of 2022, for example, homeowners only need a credit score of 580 (or higher) to qualify. Approved applicants can finance as much as 96.5%, meaning they only need to put down 3.5%. Those with credit scores from 500 to 579 can still qualify, but they need to put down a little more—10%.
For the most part, FHA loans are restricted to buyers who intend to use the home that they purchase as a primary residence. This means that an FHA loan cannot be used to finance a second home, a rental home, a vacation home, or an investment property. However, there are a few exceptions and a few ways to get around this general rule.
The number of Americans who became first time homeowners in 2021 with the help of FHA-backed loans.
Refinancing an Existing FHA Loan
Suppose someone uses an FHA loan to finance the purchase of a primary residence. Let’s say the owner then moves out of the home for one of the reasons listed above, but continues to own it and rent it out for income. In other words, the house becomes an investment property. Suppose also that interest rates drop, and the owner wants to refinance through the FHA for a better deal.
Even though the homeowner no longer lives in the house, FHA rules allow them to refinance into another FHA loan. An FHA-to-FHA refinance is also known as an FHA streamline refinance. There are several requirements to qualify for refinancing including:
- A minimum of 210 days must have passed since you closed your original home loan.
- You must have made at least six on time monthly payments on your FHA-issued mortgage.
- Payments for all mortgages on the property for the past 6 months before receiving a FHA case number must have been paid within the month they were due
- You may not have more than one 30-day late payment within the last six months for all mortgages on the property.
- The refinance must lower your monthly principal and interest payments, which is often described as a net tangible benefit. The qualifications to meet a net tangible benefit depends on the type of mortgage you are refinancing to and from, such as a fixed rate to an adjustable rate mortgage or vice versa. Refinancing into a mortgage with a shorter term also qualifies as a net tangible benefit.
If a homeowner meets the criteria above, FHA streamline refinances are quite possibly the easiest loans to close. They require no employment or income verification, no credit score verification, and no home appraisal. The main thing that matters is that the homeowner has made their existing FHA loan payments on time.
Mortgage lending discrimination is illegal. If you think you’ve been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps that you can take. One is to file a report with the Consumer Financial Protection Bureau (CFPB) or HUD.
How To Buy An Investment Property with an FHA Loan
Can I use an FHA loan for investment?
Using FHA Loans for Investment: The key to using an FHA loan for investment is the commitment to treat one unit of a multi-unit property as your primary residence for at least a year. This means you must live in one of the units, turning the property into a primary residence before considering it for investment purposes.
Why are FHA loans not used for investment properties?
This rule is one of the main reasons that FHA loans aren’t typically used for traditional investment properties. Instead, they’re used more frequently for house hacking strategies where you live in one part of the property and rent out the rest. How do FHA loans affect the closing process when purchasing an investment property?
Can FHA loans fund real estate investments?
Given their constraints, FHA loans are not typically used to fund real estate investments. As noted though, there are exceptions to the FHA investment property guidelines. Some investors will use an FHA loan to buy a multiunit or multifamily property of up to four units.
Can I use an FHA loan to buy a rental property?
While FHA loans are not intended for buyers who wish to finance an investment property, there are several ways an investor may be able to use an FHA loan to purchase a rental property. 1. Primary residence for 12 months