FHA Loans for Real Estate Investing
Low credit scores and low down payments make FHA mortgages a great choice for homeowners who may not be eligible for a conventional loan. Although this might be amazing news for some homeowners, property investors looking for the perks of an FHA mortgage will have to search elsewhere. The reason is that the conditions of these mortgages limit eligibility.
While FHA mortgages are typically used for primary residences, there are still ways that homeowners can use them for properties that generate income. If you're one of those homeowners wondering what your options are, keep reading.
Can I Use an FHA Loan to Purchase an Investment Property?
Generally, the answer to this question is "no." The main purpose of FHA mortgage loans is to help first-time homebuyers.
However...
There's a way to work around that stipulation and apply for an FHA loan on a property that will generate income, as long as you meet the eligibility requirements.
Where Do I Begin?
Your best bet is to start looking at multi-family homes; think duplexes, triplexes, and quadplexes. The only caveat here is that you’ll have to live in one of the residences within the multi-family unit (it must be your primary residence).
You’ll also have to be approved for an FHA loan. That means providing the appropriate documentation showing proof of income, a valid social security number, and an employment verification letter, among other requirements.
Requirements For FHA Loans
FHA loans are great, especially because of the low down payment required to purchase a home. Whereas a conventional mortgage might require 20% down, FHA loans typically require a minimum of 3.5% down, regardless of how many units are within the property you want to purchase.
You can also use gifts (i.e., cash) and down payment grants (money you do not have to pay back as long as you reside in the home for a specified period of time) to purchase a home. You will also have to meet the minimum credit score requirement of 580 to be eligible for an FHA loan.
How You Can Use FHA Loans for Investment Properties
Multi-Unit Property
A smart way to use an FHA loan is to buy a multi-unit home. FHA allows homeowners to invest in real estate with up to four units (as long as one unit is resided in by the owner). In addition, FHA does not set any upper limit on the size of the lot, allowing for greater flexibility in the property a buyer can choose. This means the owner can reside in one unit, proving it to be an owner-occupied residence and eligible for the Federal Housing Authority. Additionally, the owner can rent out the other units for passive extra income.
For example, a seasoned investor in a high-demand rental market can occasionally earn sufficient income through this tactic and reside in the property for free. As previously stated, the FHA lends as much as 96.5% of the appraised value, meaning the buyer can put down as little as 3.5%.
Rent Your Primary Home
The FHA offers unique provisions that might enable you to earn rental passive income from your primary property.
Does your job require you to move and you need another home? Or is your residence too small for a growing family?
Then it's possible to rent out the primary property after you have fulfilled the one-year residency demand.
And if you're not working, it’s possible to rent out rooms in your residence to boarders to make up for the lost wages. Surely, you can always pay off the loan early. FHA does not charge any advance payment penalty, so if you can get rid of the mortgage completely, then you're encouraged to accomplish whatever you want with the real estate.
FHA Loan Refinancing
Now, imagine someone using an FHA mortgage to finance the purchase of their primary property. If the homeowner later moves out of the home for any reason but still owns the property and rents it out for passive income, the home becomes an investment property. Additionally, suppose the interest rates drop and the homeowner wishes to refinance through the FHA for a better deal.
Like anything else regarding changes and adjustments to a loan, refinancing an FHA mortgage does have certain requirements, including:
- The borrower (you) has made a minimum of six payments on the FHA loan.
- A minimum of 210 days must have passed since the closing of the FHA loan you want to refinance.
Even if the owner is no longer residing in the home, FHA rules permit them to refinance into a new FHA mortgage. This type of refinancing is known as the FHA Streamline Refinance. And as with any other home financing program, there are specific eligibility rules to qualify for the refinancing, such as:
- The refund must decrease your monthly principal and interest payments, which is usually termed as a net tangible benefit. The criteria to fulfill a net benefit are based on the category of loan you're refinancing to and from, such as from a fixed-rate to an adjustable-rate mortgage or vice versa. Refinancing into a loan with a shorter term also fulfills the net tangible benefit.
- You shouldn't have more than one 30-day late payment in the past 6 months for any loans related to real estate.
If an owner meets the eligibility criteria mentioned above, the FHA Streamline Refinance can be one of the easiest mortgages to close. These refunds do not require income verification or employment record, home appraisal, or credit score verification. The key requirement is that the owner has made all of their current FHA mortgage payments on time.
Fixer-Upper Investment Property
If you're willing to live in a fixer-upper, you may want to consider applying for an FHA 203(k) loan. With an FHA 203(k), you will be able to make renovations and have the cost of materials and labor rolled into the FHA 203(k) loan you receive.
Note that there are two different kinds of FHA 203(k) loans (the Standard and the Streamline) — be sure to apply for the one that best suits your repair and renovation needs.
Learn more about the different types of FHA loans
Final Words
Generally, FHA mortgages can only be used to purchase a primary residence and cannot be used for funding a rental home, second property, investment residence, or vacation property. However, some exceptions do exist.
For instance, you can use an FHA mortgage to purchase a home with up to four units. But here's something important to keep in mind - you must live in one of the units as your primary residence.
You can then rent out the other units to generate passive income. And you can also refinance your initial home loan via an FHA Streamline Refinance.
FHA loans are a good way to begin building an investment portfolio and gain landlord experience if you opt to use your loan for purchasing a multi-family home. You should review your options with a mortgage broker before applying for and/or entering any loan agreement.
If you're still unsure, compare the differences between conventional mortgages and FHA loans.