FHA Loans for Investors: A Complete Guide to Leveraging FHA Financing for Investment Properties

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 investment properties can be challenging. Many lenders are hesitant to offer loans to investors, especially those just starting out who lack an extensive track record. This is where FHA loans can provide a unique opportunity

FHA loans are backed by the Federal Housing Administration and have more lenient qualification standards than conventional mortgages. This allows investors, even those with less-than-perfect credit, to qualify for low down payment loans on investment properties in certain situations.

In this comprehensive guide, we’ll cover everything you need to know about utilizing FHA financing for your investment property purchases

Overview of FHA Loans

First, let’s start with a quick overview of what FHA loans are and how they work:

FHA loans are government-insured mortgages that require just a 3.5% down payment for qualified buyers. Conventional loans typically require 20% down.
They can be obtained through FHA-approved lenders like banks, credit unions, and online mortgage lenders. The FHA itself does not directly make loans.
FHA underwriting guidelines are more flexible than conventional loans. Minimum credit scores are just 580 for 3.5% down and 500 for 10% down.
Low monthly mortgage insurance is required on all FHA loans. Rates range from 0.45% – 1.05% depending on loan amount and down payment.
FHA loans can be used to purchase or refinance primary residences, second homes, and even some investment properties.

Now that we’ve covered the basics of FHA loans, let’s look at how they can be used for real estate investing.

FHA Owner-Occupancy and Investment Property Rules

The most important thing to understand about FHA loans is that they require owner-occupancy by the borrower. As an investor, you can only obtain FHA financing if you plan to live in the property.

Specifically, here are the FHA occupancy rules to be aware of:

Primary Residence: The property must be your primary residence where you live at least 9 months per year. Second homes and pure investment properties do not qualify.
Multi-Unit Properties: FHA does insure mortgages for 2-4 unit dwellings. You must live in one unit while renting the others.
1-Year Occupancy Minimum: Borrowers must live in the property as their primary home for at least 1 year after closing.

As you can see, FHA has strict owner-occupancy requirements for any property purchase. However, there are some exceptions that investors should be aware of.

Exceptions for FHA Investment Property Loans

While pure investment properties don’t qualify for FHA financing, there are some exceptions that allow for earning rental income in certain situations:

Relocation: If you move for a job, you may rent out your current FHA-financed primary after 1 year of occupancy.
Expanding Family: Your FHA home can be rented if it becomes too small for your growing family, also after living there 1 year.
Disabled Borrowers: Those unable to work can take in boarders immediately to earn rental income.

Another option is to refinance into a conventional loan after occupying the property for at least 1 year. This removes FHA restrictions so you can convert your former primary residence into a rental.

Strategies for Leveraging FHA Loans on Investment Properties

While limitations exist, savvy real estate investors can still leverage FHA financing to purchase investment properties in the right circumstances:

1. House Hack a Multi-Unit

As mentioned, the FHA does insure mortgages for 2-4 unit properties with just 3.5% down. By living in one unit and renting the others, you can “house hack” your way into an investment property with an FHA loan.

The rental income alone may cover your entire mortgage payment and turn you a profit each month. It’s a great way to get started investing in real estate.

2. Rent Out Rooms to Section 8 Tenants

For single family homes, take in Section 8 tenants immediately to collect rental income. Section 8 tenants receive government housing vouchers that guarantee on-time rent payments, providing peace of mind for investors.

3. Refinance to Conventional After 1 Year

Refinancing into a conventional loan after 1 year of occupancy removes FHA restrictions. You can then convert the property into a pure rental. Make sure to get an appraisal showing appreciating value before refinancing.

4. Pay Down Mortgage Aggressively to Build Equity

Since prepayment penalties are not allowed on FHA loans, you can make extra payments to pay off your mortgage early. After building 20%+ equity, refinancing to remove PMI opens up even more options.

The key is creatively working within the FHA requirements while living in the property to make it work as an investment. Having FHA financing available gives investors, especially those just starting out, access to financing that they may not otherwise qualify for.

Qualifying for an FHA Investment Property Loan

Now that you understand how FHA loans can be used on investment properties, let’s discuss the qualification guidelines. Here are the key requirements to keep in mind:

Credit Score

580+ for 3.5% Down Payment
500-579 for 10% Down Payment

FHA has flexible credit standards that give financing options even to borrowers with less than perfect credit. Scores as low as 500 can qualify.

Down Payment

3.5% Down Payment with 580+ Credit Score
10% Down Payment with 500-579 Credit Score

With as little as 3.5% down, FHA loans allow investors to get into a property with a minimal down payment.

Debt-to-Income Ratio

<43% Total Debt-to-Income Ratio

FHA loans allow for higher DTI ratios than conventional loans, making it easier for investors to qualify.

Cash Reserves

3-6 Months Reserves Required

Reserves include your savings and other liquid assets that can be tapped if needed. Just 3-6 months of reserves are required.

Mortgage Insurance

Upfront 1.75% + Monthly 0.45% – 1.05%

Upfront and monthly mortgage insurance is required on all FHA loans. Annual premiums range from 0.45% – 1.05% depending on various factors.

The bottom line is FHA has much more flexible underwriting standards than conventional loans. This gives real estate investors, even those with past credit issues, more options for securing financing.

Pros and Cons of FHA Loans for Investment Properties

Let’s summarize the key pros and cons to consider when using FHA financing on investment properties:

Pros

Low 3.5% Down Payment Required
More Flexible Qualification Standards
Ideal for Newer Investors and Those with Credit Challenges
No Prepayment Penalties

Cons

Owner-Occupancy Required for 1 Year Minimum
Monthly Mortgage Insurance Required
Refinancing Difficult Without Appreciation
20% Equity Required to Remove PMI

While limitations exist, FHA loans present a unique opportunity for investors to buy investment properties they may not otherwise qualify for. The key is understanding the requirements and having an exit strategy planned when using FHA financing.

Alternatives to FHA Investment Property Loans

If you don’t want to occupy the property for at least 1 year, FHA loans are not the best option. Here are some alternatives to consider instead for pure investment properties:

Conventional Rental Loans – Require 20-25% Down but no occupancy requirement.
Fix-and-Flip Loans – Designed for short-term loans to rehab and quickly sell properties.
Hard Money Loans – Asset-based financing from private lenders at higher rates.
Private Money Loans – Get financing from private individuals rather than institutions.
Commercial Loans – For 5+ unit residential and commercial properties.
Portfolio Loans – Some local banks may offer portfolio investment property loans.

The bottom line is there are many options beyond FHA for financing investment properties. FHA can be a good fit when you plan to house hack or live in the property temporarily.

Wrapping Up

Securing financing as a real estate investor can certainly be a hurdle to overcome. However, FHA loans can provide a unique opportunity to leverage low down payment government-backed financing to purchase investment properties.

The key is understanding the owner-occupancy requirements and having an exit strategy planned when using FHA loans. While not a solution for every investor, FHA financing can be an ideal option for those who meet the requirements and need to get into an investment property with less cash and credit than required for conventional mortgages.

fha loans for investors

Finance a Multiunit Property with an FHA Loan

One way to use an FHA loan to buy an income property is to purchase a multiunit dwelling. The FHA allows homeowners to buy a property with up to four units, provided that one is occupied by the owner. There is no upper limit to the size of the lot. In this way, an owner is able to live in one unit, making it an owner-occupied property and FHA-eligible. The owner can rent out the other unit(s) for income.

A savvy investor in a hot rental market sometimes earns enough income using this method to live in the home for free. As noted above, the FHA lends up to 96.5% of the appraised value, meaning the purchaser can put down as little as 3.5%.

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 Loan for Investment Properties

FAQ

Can an investor get a FHA loan?

You can also use FHA loans to buy an investment or rental property. There are two important restrictions to understand, however. The first is that the property can have no more than four rental units total. The second is that you need to occupy one of the units in the property as your primary residence.

Can investors assume FHA loans?

All FHA insured mortgages are assumable. However, FHA has placed certain restrictions on the assumability of FHA-insured mortgages originated since 1986. Depending on the date of loan origination, a creditworthiness review of the assumptor by the lender may be required.

Can you do Airbnb with an FHA loan?

FHA loan rules do not permit rentals of living units in the home purchased with an FHA mortgage if those rentals are for less than 30 days. The Airbnb business model is not acceptable under FHA loan rules, which means that if you purchase with an FHA mortgage, Airbnb operations are a violation of the FHA loan rules.

What is the minimum cash investment for FHA?

FHA loan policy about down payments for new purchase home loans is quite clear. One condition of FHA loan approval is that the borrower provide a minimum cash investment–a down payment–of at least 3.5%. That money is required to be verified by the lender as having come from an approved source.

What are the requirements for an FHA investor loan?

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.

Are there benefits to FHA investor loans?

Typically, FHA mortgages offer the lowest interest rates than conventional loans so if you have good credit, it could add up to even more savings. The downside of using an FHA mortgage to purchase an investment property is the residency requirement.

Are FHA investor loans available for investment properties?

Federally insured FHA mortgage loans also aren’t available for the purchase of an investment property. An exception is allowed if you’re using an FHA mortgage to refinance a home that was previously purchased as an investment property.