Can You Buy a Rental Property With an FHA Loan?

An FHA loan is a mortgage insured by the Federal Housing Administration, a part of the U.S. Department of Housing and Urban Development. These loans are designed to make homeownership more accessible, particularly for individuals who might have limited savings for a down payment or lower credit scores. While the government insures these loans, private, FHA-approved lenders are the ones that issue them. This insurance protects lenders against losses if a borrower defaults, allowing them to offer more favorable terms than some conventional mortgages.

FHA Loan Eligibility for Multi-Unit Properties

Using an FHA loan for a rental property involves specific conditions related to multi-unit dwellings. A standard FHA loan, known as an FHA 203(b) loan, can be used to finance the purchase of properties with up to four units. These properties include duplexes (two units), triplexes (three units), and quadplexes (four units).

The FHA considers properties with one to four units as single-family homes for the purpose of this loan program. While the primary intent of FHA loans is for owner-occupied residences, the framework allows for the acquisition of these multi-unit properties, provided the borrower lives in one of the units.

FHA loans for properties with five or more units fall under different FHA multifamily financing programs. These programs have distinct requirements and are aimed at real estate developers or larger investors.

Understanding the Owner-Occupancy Requirement

A primary condition for using an FHA loan, especially for a multi-unit property, is the owner-occupancy requirement. The borrower must intend to occupy one of the units as their primary residence. This occupancy must begin within 60 days of the loan closing and continue for at least 12 months from that date.

The purpose of this rule is to ensure the loan is primarily for homeownership rather than solely for investment purposes. Borrowers are required to sign a document declaring their intent to occupy the property. If a borrower fails to meet this requirement, they could face consequences.

There are limited exceptions to the owner-occupancy rule, such as unforeseen job relocation or an increase in family size that makes the current property inadequate. These exceptions are reviewed on a case-by-case basis and require specific conditions to be met. After fulfilling the initial 12-month occupancy period, an owner can rent out the occupied unit or use the property as they wish, though they are limited to one FHA mortgage at a time.

Financial Requirements and Rental Income

Qualifying for an FHA loan on a multi-unit property involves meeting specific financial criteria, including credit score, down payment, and debt-to-income (DTI) ratio. For a 3.5% down payment, borrowers need a credit score of 580 or higher. If a credit score is between 500 and 579, a 10% down payment is required.

For multi-unit properties, potential rental income from non-occupied units can help borrowers qualify for the loan. Lenders factor in a portion of the estimated gross rental income, often around 75%, to account for potential vacancies and maintenance expenses. This calculated rental income can then be added to the borrower’s gross income, which can improve their debt-to-income ratio.

The standard FHA debt-to-income ratio guideline is around 43%, meaning total monthly debt payments should not exceed 43% of gross monthly income. However, with strong compensating factors, such as higher credit scores or substantial cash reserves, lenders may allow a DTI ratio up to 50% or even 56.9%. The inclusion of rental income can significantly lower the effective DTI, making a larger loan amount more achievable for the borrower.

For properties with three or four units, an additional requirement known as the “self-sufficiency test” applies. This test mandates that the net rental income from the property, after accounting for a vacancy factor (often 25%), must be sufficient to cover the full monthly mortgage payment, including principal, interest, taxes, and insurance (PITI).

For 3-4 unit properties, FHA guidelines also require borrowers to have financial reserves equal to three months of the full mortgage payment (PITI) after closing costs and down payment are covered. This reserve requirement helps demonstrate the borrower’s ability to manage the property’s expenses. While duplexes do not undergo the self-sufficiency test, the consideration of rental income remains a valuable tool for qualification across all eligible multi-unit FHA loan types.