How to Use an FHA Loan for an Investment Property

Buying an investment property can be an excellent way to build long-term wealth. However, financing investment properties can be tricky, especially for new real estate investors. This is where FHA loans come in.

FHA loans are government-backed mortgages insured by the Federal Housing Administration (FHA). These loans offer more flexible underwriting guidelines than conventional mortgages, making them easier to qualify for.

The catch is that FHA loans require you to live in the home as your primary residence. So how can you use an FHA loan to buy an investment property?

There are a few loopholes that allow real estate investors to tap into FHA financing. In this comprehensive guide we’ll explain everything you need to know about using FHA loans for investment properties.

Overview of FHA Loans

First let’s do a quick rundown of FHA loans and how they work

• FHA loans require just a 3.5% down payment. This low down payment makes them popular with first-time homebuyers.

• They have looser credit score requirements than conventional mortgages. You may qualify with a credit score as low as 580.

• Debt-to-income ratios up to 57% are allowed with FHA loans. For context, conventional mortgages usually cap DTIs at 45%.

• FHA loans are assumable. This means that if you sell the home, the buyer can assume the remaining mortgage balance.

• Mortgage insurance is required for the life of FHA loans. This adds to the monthly costs but protects the lender.

Now let’s look at the occupancy requirements that deter investors from using FHA financing.

FHA Occupancy Rules

All FHA borrowers must intend to use the property as their primary residence. According to FHA guidelines, a primary residence is where you spend the majority of your time and intend to live for most of the year.

As the name suggests, investment properties are not primary residences. Investors purchase them to rent out and generate passive income, not to live in.

Because of the occupancy requirements, most real estate investors don’t even consider FHA loans. But there are some perfectly legal ways to work around these limitations, which we’ll get into next.

Exceptions That Allow FHA Loans on Investment Properties

The main strategy for using FHA financing on a rental property involves temporarily living in one unit of a multi-unit building. Here are the two scenarios where this is possible:

1. House Hacking

House hacking involves buying a 2-4 unit property, living in one unit, and renting out the others. For instance, you could purchase a 4plex through an FHA loan, occupy one unit, and collect rental income from the other three units.

The rental income can help offset your mortgage payment and expenses. If done right, you may even live rent-free. Just make sure the property meets FHA requirements:

• It must pass FHA appraisal standards

• You need to move into your unit within 60 days of closing

• You must live in the property as your primary residence for at least 12 months

After one year of occupancy, you can move out and rent out all the units as pure investment properties.

2. Relocation For Work

If you need to relocate for a job, FHA allows you to rent out your current primary residence. But there are a few stipulations:

• You must have lived in the home for at least 12 months prior to renting it out

• The new home you purchase with the FHA loan must be located in the same geographical area as your new job

• You can only own one FHA-insured property at a time

This exception gives you flexibility if your living situation suddenly changes. Just make sure you meet all the requirements to avoid issues.

Refinancing into a Conventional Loan

Here’s another creative solution for transitioning an FHA-financed home into a rental property:

First, purchase a home with an FHA loan and live in it for at least 12 months. After occupying the property for one year, you can apply to refinance into a conventional mortgage.

Conventional loans don’t have strict occupancy rules like FHA loans. Once you refinance, you can legally rent out the property without limitations.

This refinancing strategy allows you to keep the home but eliminate the headaches of FHA occupancy rules. Just make sure you meet the following criteria before refinancing:

• Have at least 20% equity in the property

• Get the home re-appraised to confirm sufficient equity

• Have a credit score of at least 660

• Show stable income without gaps

• Keep debt-to-income ratio below 45%

Refinancing into a conventional loan is a slower route than house hacking but comes with greater flexibility. And you get to take advantage of FHA financing for the purchase.

Using an FHA 203(k) Rehab Loan

FHA also offers 203(k) loans that let buyers finance repairs along with the purchase of older homes. Known as rehab loans, these can assist real estate investors in two ways:

1. Add a Second Unit: You may be able to use 203(k financing to add an additional unit or apartment to a single-family home. As long as the property remains under four units total, it meets FHA eligibility rules for an owner-occupied property. Just make sure to live in one unit for at least 12 months.

2. Fix Up a Multi-Unit Property: A 203(k) loan allows you to buy and remodel a 2-4 unit building that needs work. For instance, you could purchase a rundown 4plex with 203(k financing, renovate the units, live in one for a year, then rent them all out.

203(k) loans give you flexibility to customize the property and boost rents through renovations. They can help you maximize your investment potential.

The Pros and Cons of Using FHA Financing

Below we’ve summarized some of the key advantages and disadvantages of financing investment properties with FHA loans:

Pros

• Low down payments, starting at just 3.5%

• More lenient credit and income requirements

• Lower monthly mortgage payments than conventional loans

• Ability to purchase multi-unit properties through house hacking

Cons

• Must live on the property for at least 12 months

• Limit of one FHA loan at a time per borrower

• Monthly mortgage insurance premiums for life of loan

• Refinancing into conventional loan may be necessary for flexibility

• Properties must meet FHA minimum quality standards

As you can see, FHA loans offer some clear benefits thanks to low down payments and easier approvals. But the occupancy rules create complications when investing.

Carefully weigh the pros and cons before deciding if an FHA loan is right for your investment property purchase.

Finding the Right Lender

If you want to move forward with an FHA loan, finding the right lender is key. Look for these traits:

• Experience with FHA loans – Choose a lender that does a high loan volume and has in-depth FHA program knowledge.

• Investment property experience – Find a lender familiar with house hacking FHA loans and other real estate investor strategies.

• Responsive customer service – You’ll likely have lots of questions, so responsive loan officers are vital.

• Online reviews – Read reviews from past clients to gauge customer satisfaction.

• Competitive rates and fees – Shop around for the best pricing, as costs can vary significantly between lenders.

Also check that the lender is FHA approved and familiar with rules for your state. A knowledgeable lender can guide you through the process from application to closing.

The Bottom Line

FHA loans can be an excellent financing option for real estate investing if you know how to approach them. While occupancy rules limit using FHA for pure investment properties, workarounds like house hacking and refinancing open up possibilities.

If you’re willing to live in one unit for 12 months, FHA loans allow you to purchase multi-unit properties with as little as 3.5% down. Just partner with the right lender and learn the program guidelines. With the proper strategy, FHA financing can help maximize your rental property returns.