FHA Loans for Rental Properties in 2023 – A Complete Guide

Purchasing a rental property is one of the best ways to build long-term wealth Rental income can provide passive cash flow for decades to come However, many investors struggle to come up with the down payment on an investment property. This is where FHA loans can help.

The Federal Housing Administration (FHA) offers special mortgage loans that only require 3.5% down. These government-backed loans are primarily designed for owner-occupied homes. But with the right strategy you may be able to use an FHA loan to finance a rental property.

In this comprehensive guide. we’ll cover everything you need to know about getting an FHA loan for a rental property including

• Overview of FHA loans
• FHA occupancy requirements
• Tips for using FHA financing
• Pros and cons
• Steps to getting approved

Let’s dive in!

What is an FHA Loan?

An FHA loan is a mortgage insured by the Federal Housing Administration. It offers two major benefits compared to conventional loans:

• Lower down payments – FHA allows down payments as low as 3.5% of the purchase price. Conventional loans typically require at least 10-20% down.

• More flexible credit requirements – FHA has more lenient credit standards, with minimum FICO scores around 580. Many conventional loans require scores of 620 or higher.

The trade-off is that FHA loans require upfront and annual mortgage insurance premiums, raising costs over the long run. But for investors short on cash, the lower down payment requirement can be game-changing.

FHA Owner-Occupancy Requirements

Here’s the catch when it comes to using FHA financing for a rental property – FHA requires you to live in the home as your primary residence. You cannot use an FHA loan to purchase a straight investment property that you do not personally occupy.

However, there are still ways for real estate investors to capitalize on FHA’s benefits:

House hacking – House hacking involves buying a 2-4 unit multi-family home, living in one unit, and renting the others. The rent covers your mortgage and then some, letting you live rent-free. Since it’s your primary residence, this fulfills FHA’s occupancy rule.

Future rental – Some homeowners choose to move out of the FHA-financed home after a year and convert it to a rental property. While technically against FHA rules, this does happen. Just know you’ll be liable for potential penalties.

As long as you occupy the home at first, FHA financing can be a powerful tool for rental property investing. But you must follow their requirements. Now let’s look at tips for using an FHA loan.

Tips for Using an FHA Loan for a Rental

If you want to tap into an FHA loan for a rental property, keep these tips in mind:

• Live in the property initially – Occupy the home as your primary residence for at least 12 months to fulfill FHA requirements.

• Consider house hacking – Look for a multi-family home and house hack by renting vacant units. Duplexes and triplexes work well. Make sure the home meets FHA standards.

• Get pre-approved – Work with a lender and get pre-approved for an FHA loan before making offers. This shows sellers you’re serious.

• Know the limits – FHA loan limits vary by county but max out around $970,800 for high cost areas as of 2023. Stay under those caps.

• Mind the fees – FHA loans charge upfront mortgage insurance premiums of 1.75% of the base loan amount. Factor this into your costs.

By keeping FHA’s rules and costs in mind, you can successfully use their financing to invest in rental properties. Now let’s look at the pros and cons.

Pros of an FHA Loan for a Rental

Lower Down Payments

With an FHA loan, you can get into a rental property with a down payment as low as 3.5% of the purchase price. This opens the door for investors who don’t have the 20-30% down required by conventional mortgages.

Easier to Qualify

FHA has more flexible credit standards than conventional loans. If your credit score is at least 580, you can likely qualify for an FHA loan. Many conventional mortgages require scores of 640 or higher.

Opportunity to House Hack

FHA loans let you purchase a multi-family property of up to 4 units. You can house hack by living in one unit and renting the others to tenants. The rental income will help offset your housing costs.

Cons of an FHA Loan for a Rental

Occupancy Requirements

As mentioned, you must live in the home as your primary residence for at least 12 months. This takes some multi-family investment properties out of the running for FHA financing.

Mortgage Insurance Costs

FHA loans require both upfront and annual mortgage insurance premiums. On a $200,000 loan amount, this premium could cost over $6,000 at closing and $2,000+ per year.

Tighter Approval Standards

While easier to qualify for than conventional loans, FHA still has stricter approval criteria than other government loan options like VA or USDA loans. Expect tighter debt-to-income requirements.

Steps to Getting Approved for an FHA Rental Loan

If you understand the pros and cons and think an FHA loan may be a fit, here are the steps to getting approved:

1. Improve your credit score – Shoot for at least a 580 FICO score. Pay down debts and correct errors on your credit reports.

2. Save up for closing costs – FHA expects you to pay closing costs, which can total 3-5% of the loan amount.

3. Get pre-approved – Work with a lender to get pre-approved. This shows sellers you can obtain financing. Shop national and local lenders.

4. Find a qualifying property – Search for a 1-4 unit home that meets FHA’s minimum property standards and requirements.

5. Make an offer and apply – Make an offer once finding a home. At this time, formally apply for the FHA loan.

6. Close on time – Work closely with your lender to ensure all conditions are met and documents are submitted on time for closing.

With preparation and diligence, the low down payment FHA loan can be within your reach as a real estate investor.

Find the Best FHA Lender for Investment Properties

Choosing the right lender is critical when seeking an FHA loan for a rental property. Not all lenders will approve investors using FHA financing.

We recommend considering both national lenders and local mortgage brokers. Here are some top options:

Lender – Navy Federal Credit Union

Why Choose Them – Credit union with extensive FHA experience and rental property lending options. Competitive rates and fees.

Lender – New American Funding

Why Choose Them – National lender with specialized FHA investor loan programs. Bridge loans available.

Lender – Local Mortgage Brokers

Why Choose Them – May have niche rental/FHA loan offerings. Knows local markets. Quick loan processing.

With an FHA-backed mortgage, you can purchase a rental property or house hack with less money down. Just be sure to follow their occupancy rules. Consult our guide and contact reputable lenders to kickstart the process today.