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.
The Federal Housing Administration’s (FHA) mortgage insurance program helps make homeownership affordable for millions of Americans by requiring lower down payments and credit scores than conventional loans. But can you use an FHA loan to purchase a property that you intend to rent out and earn income from? Generally no – with some limited exceptions.
In this comprehensive guide, we’ll cover everything you need to know about using FHA financing for real estate investing, including:
- What are FHA loans and how do they work?
- FHA occupancy and eligibility requirements
- When FHA loans CAN be used for investment properties
- Tips for real estate investors using FHA loans
- Alternatives to FHA financing for investors
Let’s dive in!
What Are FHA Loans?
FHA loans are government-backed mortgages insured by the Federal Housing Administration. The FHA is part of the Department of Housing and Urban Development (HUD).
Some key features of FHA loans
- Require just 3.5% down payment for qualified borrowers
- More flexible debt-to-income ratio requirements
- Lower credit score requirements – as low as 500 FICO
- Popular with first-time home buyers
Because they are insured by the federal government, FHA loans offer a safer bet for lenders. This allows them to offer mortgages to borrowers who may not qualify for conventional loans.
Over 1.3 million FHA loans were endorsed in 2021 alone. They accounted for over 15% of the purchase mortgage market last year.
FHA Owner Occupancy Requirements
Here’s the catch if you want to use FHA financing to purchase a rental property or house flip – the FHA requires you to live in the property as your primary residence.
The property must be owner-occupied, and you must move in within 60 days of closing and live there for at least 1 year.
So if you’re looking to buy a straight-up investment property that you don’t intend on living in, an FHA loan is not the right choice.
However, there are some exceptions that may allow you to use FHA financing and still rent out all or part of the property. Let’s look at those next.
When FHA Loans CAN Be Used for Investment Properties
The FHA does make some allowances for using their mortgages to purchase properties that will generate rental income:
1. Multi-Unit Properties
You can use an FHA loan to purchase a property with up to 4 units. However, you must occupy one of the units as your primary residence.
For real estate investors, this presents an opportunity to live in one unit while renting out the others. Especially in hot rental markets, the rental income may cover your entire housing expense.
For example, you could purchase a 4-plex. Live in one unit, and rent out the other three.
2. Rent Out After Meeting Occupancy Requirement
If you meet the 1-year owner occupancy requirement, the FHA allows you to move out and rent out the entire property after.
Reasons this may happen:
- Relocation for a new job
- Home is now too small for your family
- Medical reasons that prevent you from occupying the home
In these cases, the rental income can replace your source of housing.
3. FHA Streamline Refinance
If you originally purchased your property with an FHA loan, you may be able to refinance into another FHA loan through a streamline refinance.
This allows you to refinance an existing FHA mortgage into a new one with lower rates/payments – without requiring an appraisal or income verification.
Streamline refinances can be an easy option if you want to refinance investment property still financed with an FHA loan. You must meet basic requirements like:
- Occupied home as primary residence for at least 1 year after original purchase
- Current on payments
- Refinance results in lower monthly payment
Tips for Real Estate Investors Using FHA Loans
If you can make one of the exceptions above work, here are some tips for real estate investors using FHA financing:
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Shop around – Work with multiple lenders to find the best rates/fees. Given the current market, be sure to lock in your rate as early as possible.
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Put down more if possible – While 3.5% is the minimum, putting down more upfront reduces risk and monthly payments. May yield better offers if you end up selling.
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Consider streamline refinancing – If rates drop in the future, streamline refinancing can lower payments on investment property.
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Screen tenants thoroughly – Vet tenants carefully to ensure reliable rental income to cover mortgage payments. Require sufficient security deposits.
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Factor in costs – Budget for maintenance, repairs, vacancy costs, property management fees, etc. to ensure adequate cash flow.
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Check local regulations – Research local landlord-tenant laws, zoning restrictions, and rental license/inspection requirements.
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Explore other financing – FHA may not always be the best option. Compare to conventional loans, USDA, VA, portfolio loans.
Alternatives to FHA Financing for Real Estate Investors
If you don’t want to occupy the property yourself, an FHA loan likely won’t work. Some other options real estate investors have include:
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Conventional loans – Require larger down payments and better credit but with fewer occupancy restrictions.
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Hard money loans – Asset-based financing from private lenders at higher rates/fees, but with more flexibility.
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Private/portfolio loans – Non-conforming mortgages from community banks and credit unions.
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Partners/syndication – Pool funds with other investors in an LLC to purchase larger properties.
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All cash – Pay all cash without financing if you have sufficient capital. Reduces risk.
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Home equity loan – Tap equity from current home to use as down payment on rental property.
As you can see, FHA loans can be used in certain circumstances to purchase real estate investment properties. But the owner occupancy requirement limits this option mostly to living in a multi-unit property or temporarily renting out your primary residence in certain situations after meeting requirements.
If you don’t plan on living in the home yourself, other financing options like conventional, hard money, or private loans may be better suited for purchasing straight-up investment properties. But with the right property and circumstances, FHA financing can be a tool for real estate investors to add to their rental portfolio.
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.
FHA Occupancy Requirement
Under FHA rules and guidelines, the property being financed must be occupied by the owner. This means that rental and seasonal properties do not apply. The FHA uses this rule to prevent investors from benefiting from the program.
The borrower must take possession of the home within 60 days after the mortgage closes, and they must live in the home for the majority of the year. The property must be used as a principal residence for at least one year. If there is more than one borrower listed on the mortgage, the FHA requires that at least one of them must satisfy the occupancy requirement.
The FHA doesn’t actually lend money for mortgages. Instead, loans are made by FHA-approved lenders, such as banks or other financial institutions.
FHA Loan for Investment Properties
FAQ
Can an investor get a FHA loan?
Can you assume an FHA loan as an investment property?
Can you convert an FHA loan to an investment property?
Can you get an FHA loan for a second home or investment property?
Are FHA loans a good investment?
Investing in real estate often involves navigating through various loan options, and for those looking for more flexible qualification requirements, Federal Housing Administration (FHA) loans are worth considering.
Can FHA loans be used for investment property?
FHA loans are not intended for investment property − rather, they’re generally used to finance a primary residence. That said, you’ll find some small exceptions to the rule that may provide real estate investors with opportunities to leverage FHA loans to acquire investment properties.
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 for a multi-unit investment property?
If you’re willing to commit to treating one unit of a multi-unit investment property as your primary residence for at least a year, an FHA loan may be a great option for you. In short, you can use an FHA loan for an investment property if you’re willing to live there.