Can You Use an FHA Loan to Buy a Rental Property? A Deep Dive into the Rules

As a real estate investor looking to expand your portfolio, you may be wondering if you can use an FHA loan to purchase a rental property. FHA loans offer tempting benefits like low down payments and flexible credit requirements that seem perfect for investment purposes. However, FHA loans come with specific occupancy and usage requirements that limit their applicability for rentals. In this comprehensive guide, we’ll break down exactly how FHA loans work, their benefits and drawbacks, and under what circumstances they can be used for rental properties.

What is an FHA Loan?

An FHA loan is a mortgage insured by the Federal Housing Administration that offers more flexible qualification guidelines than conventional loans Key features include

• Low down payments – Only 3.5% down required for credit scores 580+
• Lenient credit requirements – Minimum 500 credit score
• Low closing costs – Limit of 3% of loan amount
• No income limits – Qualify based on debt-to-income ratio

Despite easier approval, FHA loans require mortgage insurance premiums. There’s an upfront 1.75% fee and ongoing monthly premiums from 0.45% to 1.05%.

FHA loans help first-time homebuyers and those with lower incomes access home financing But the tempting benefits have investors wondering if FHA loans can be used for buying rental properties too,

FHA Occupancy Requirements

The biggest barrier to using FHA loans for rentals are strict occupancy rules FHA requires owner-occupancy for 1 year after closing before a property can be rented out.

You have a few options to meet occupancy rules:

• Move in first – Live there 12 months, then move out and rent it
• House hack – Buy a 2-4 unit multifamily home, live in one unit and rent the others
• Build new – Custom build a home with a detached rental unit

After 12 months of owner-occupancy, there are no restrictions on renting out an FHA-financed property. You can move out and rent the entire home.

The takeaway is FHA loans can only be used to purchase a primary residence that you plan to live in. You cannot use them to buy pure rental properties or vacation homes you won’t occupy.

Using FHA Loans to House Hack

One popular real estate investment strategy with FHA loans is house hacking. This involves buying a small multifamily building and living in one unit while renting the others.

The owner-occupancy requirement is satisfied by living in a unit for one year. After which, the entire property can be rented out.

For example, you could purchase a duplex or triplex with 3.5% down using an FHA loan. Live in one unit while renting the other(s). After a year, you’re free to move out and rent all units.

House hacking allows investors to offset their housing costs while gaining rental income from day one. Down the road, the entire mortgage could be paid by rental cash flow.

Custom Building a Home with Rental Unit

FHA loans can also be used to custom build a home with a detached rental unit, like a guest house or accessory dwelling unit (ADU).

As long as the primary home is site built, not manufactured or mobile, construction-to-permanent FHA loans permit adding a secondary rental unit.

You’d live in the primary home for 12 months after completion. Then the rental unit could be leased out long-term. One closing and one FHA loan finances everything.

Combining owner-occupancy with built-in rental income potential is a creative way to use FHA financing. Just ensure your property is properly zoned for an ADU or guest quarters.

The Pros and Cons of Using FHA Loans

Pros

• Low 3.5% down payment
• Gift funds eligible for down payment
• Lower credit scores and debt-to-income ratios accepted
• One-time construction loan option
• Refinancing an existing rental property allowed

Cons

• Must live in property for 1 year before renting
• Monthly mortgage insurance premiums
• Limit on number of FHA loans per borrower
• Lower loan limits than conventional mortgages
• Flip/fix-and-flip properties ineligible

Alternatives for Financing Rental Properties

If you can’t float two housing payments to owner-occupy an FHA purchase for one year, alternative mortgages for rental property are:

Conventional loans – Require 15-20% down and 620+ credit score but with no occupancy rules.

Commercial loans – Costlier but designed specifically for investment properties.

Portfolio loans – Non-conforming mortgages offered by community banks. More flexible than agency requirements.

Partnerships – Team up with other investors to pool resources.

Hard money loans – Asset-based lending with higher rates and fees.

Each has pros and cons to weigh against your financial situation and business objectives.

The Bottom Line

FHA loans offer a tempting low down payment option for real estate investors, but their owner-occupancy rules limit their use for strictly rental properties.

If you can house hack a multifamily or build a home with a rental unit, FHA loans present unique financing possibilities. But you need to budget 12 months of parallel housing costs before earning rental income.

For pure rental properties, FHA loans pose challenges for investors that may make conventional or alternative financing a better fit. But refinancing an existing rental property with an FHA loan remains a viable cash-out strategy.

The key is understanding FHA occupancy requirements and getting compliant financing that aligns with your investment goals. With the right property plan, FHA loans can serve as a launch pad for building your rental portfolio over time.