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.
As a real estate investor, securing financing for your investment properties can be challenging. Many lenders are hesitant to provide mortgages for properties that won’t be owner-occupied. This is where FHA loans come in.
FHA loans are backed by the Federal Housing Administration and have more lenient borrowing guidelines than conventional mortgages. This makes them appealing options for investors who may not qualify for other types of financing. However, there are specific requirements and limitations to be aware of when using FHA loans for investment properties.
In this comprehensive guide we’ll cover everything you need to know as an investor seeking to use FHA financing including
What are FHA Loans?
FHA loans are government-insured mortgages that require lower down payments and credit scores compared to conventional loans. Borrowers typically only need a credit score of 580 and a down payment of just 3.5%.
These loans are provided by FHA-approved lenders like banks and credit unions The FHA doesn’t actually lend money directly but instead insures the loans against default This protects lenders and allows them to offer mortgages to buyers who may not qualify through conventional channels,
FHA Occupancy Requirements
One key requirement of FHA loans is that they must be used to purchase a primary residence. This means the property needs to be occupied by the owner.
FHA borrowers must move into the home within 60 days of closing and live in the property for at least 1 year. This is known as the occupancy requirement.
So at first glance, it may seem like FHA loans can’t be used for investment properties at all. However, there are some exceptions.
Financing a Multi-Unit Property
The FHA allows borrowers to purchase multi-unit properties of up to 4 units. At least one unit must be occupied by the owner as their primary residence.
This means you can live in one unit and rent out the remaining units to tenants, providing a built-in income stream For real estate investors, this is an excellent opportunity to tap into FHA financing
For example, you could purchase a 4-unit building with an FHA loan, live in one apartment, and rent out the other three. The rental income can help cover your mortgage payments and expenses.
Refinancing an Investment Property with an FHA Loan
If you already have an investment property financed with an FHA loan, you may be able to refinance it with another FHA loan. This is known as an FHA streamline refinance.
Here are some requirements to qualify for an FHA streamline refinance on an investment property:
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You must have made at least 6 months of on-time mortgage payments.
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Your loan must be at least 210 days old.
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The refinance must provide a “net tangible benefit” such as a lower monthly payment.
FHA streamline refis are relatively quick and easy to obtain, making them useful for investors who want to lower their rates or payments on a rental property.
Using FHA Loans for Multi-Family Properties
Beyond 4 units, the FHA also provides financing options for larger multi-family buildings. These include:
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FHA 221(d)(4) loans – For 5+ unit apartment buildings. Require only 3.5% down.
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FHA 223(f) loans – For buying or refinancing an existing apartment building with 5+ units.
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FHA 221(a)(7) loans – For buying or refinancing multi-family buildings that require rehab or repairs.
The occupancy requirements are also more flexible for FHA multi-family loans, making them a solid choice for real estate investors. The owner does not have to live on-site, allowing for 100% investment usage.
Renting Out Rooms in an FHA-Financed Property
If you have an FHA loan on your primary residence, you’re allowed to rent out rooms in the property. This can provide extra income even while meeting FHA occupancy rules.
You can rent out rooms immediately after purchasing the home. The rent money can then help cover the mortgage and other ownership costs.
Renting Out Your Property After 1 Year of Occupancy
Most FHA borrowers need to use the home as their primary residence for at least 1 year after purchase. However, there are some exceptions that allow you to move out and rent the property after meeting this requirement:
- Relocating for a job
- Home becomes too small for your family
- Medical reasons that prevent you from working, allowing rental income
So while FHA loans come with occupancy stipulations, there are still ways for investors to rent out the property on a delayed basis.
Using a Non-Occupying Co-Borrower
Some investors use an FHA loan with a non-occupying co-borrower, meaning someone signs on the mortgage but doesn’t actually live in the home.
This co-borrower provides additional income and credit qualifications to help the primary borrower meet FHA requirements. The primary borrower lives in the property to satisfy occupancy rules.
Meanwhile, the non-occupying co-signer retains partial ownership rights as an investment property. Make sure all parties understand the arrangement when pursuing this strategy.
Converting to a Conventional Loan
If you want to rent out an FHA-financed home but don’t meet delayed occupancy exceptions, one option is refinancing into a conventional loan.
Conventional loans don’t have the same occupancy rules, so you can rent out the property immediately after refinancing.
Just keep in mind you’ll need to meet stricter conventional loan requirements in terms of credit, income, and home appraisal.
Tapping Home Equity
With an FHA loan, you can access your available home equity after just 1 year of occupancy through an FHA cash-out refinance. This converts your mortgage into a higher balance loan and provides “cash-out” from the equity.
Investors can use the proceeds for any purpose, such as buying more investment properties. Just remember cash-out refis have higher rates and payments than other FHA refi options.
Wrapping Up Key Points
While designed for primary residences, FHA loans offer some flexibility for real estate investors:
- Purchase up to a 4-unit multi-family property and live in one unit while renting others
- Refinance investment properties with an FHA streamline refinance
- Rent out rooms in an owner-occupied FHA property immediately
- Move out and rent the property after 1 year of occupancy under certain conditions
- Use a non-occupying co-borrower for added income/credit qualifications
- Convert to a conventional loan to remove occupancy rules
- Access equity for reinvestment after 1 year via an FHA cash-out refinance
With the right approach, investors can tap into FHA financing to purchase or refinance investment properties. Just make sure you fully understand the program guidelines and occupancy requirements.
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.
Some Exceptions
The FHA has special provisions that may allow you to earn rental income from your home. If your job requires you to relocate and you need a second home—or if your home is too small for your expanding family—then you may be able to rent out your first home after you’ve satisfied the one-year occupancy requirement. If you are off work because you’re otherwise incapacitated, you may be able to rent out rooms in your home to boarders to make up for lost wages.
Of course, you can always pay off the mortgage early. The FHA doesn’t charge any prepayment penalties, so if you can eliminate the loan in its entirety, then you are free to do whatever you wish with the property.
FHA Loan for Investment Properties
FAQ
Is an FHA good for rental property?
Can you assume an FHA loan as an investment property?
Can an investor get a FHA loan?
Can I rent out my FHA home after 1 year?
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 FHA loans be used for investment properties?
The real estate market is full of investment opportunities, and one avenue that has gained popularity in recent years is using FHA loans for investment properties. FHA loans, which are backed by the Federal Housing Administration, have traditionally been used by first-time home buyers to purchase their primary residences.
What is FHA mortgage insurance?
The FHA’s role is to insure those lenders against losses on their loans. Because of FHA mortgage insurance, home buyers can do use FHA mortgages to do things which aren’t possible via other loan types, such as with conventional loans. For example, FHA loans allow for a down payment of just 3.5% and require a minimum credit score just 500.
Are FHA mortgages a good option for investors?
In this article: FHA mortgages are a great option for investors. FHA mortgages allow real estate investors to purchase multi-unit homes with just 3.5 percent down. If you’re going to buy a multi-unit home and live in it, using an FHA mortgage will minimize your upfront investment.