FHA loans are well-known for low down payments and low credit score requirements, making them an ideal option for homebuyers that may not qualify for more traditional mortgage options. As a real estate investor, you may be wondering if you can also take advantage of these benefits when it comes to purchasing investment properties. While FHA loans do have occupancy requirements that most often prevent using an FHA loan for the purchase of investment properties, there are exceptions.
Here we take a closer look at FHA loans and how, as a real estate investor, you can take advantage of FHA loan benefits.
Key takeaways
- FHA loans have low down payments and credit requirements but are usually not used for investment properties due to occupancy rules. Exceptions exist, like for properties needing significant repair and multi-unit properties.
- Investment properties, like rentals or fixer-uppers, can bring cash flow, appreciation, and tax benefits. But they also carry risks like market fluctuations and property management responsibilities.
- To qualify for an FHA loan on an investment property, you must meet credit, down payment, debt-to-income, employment, and property guidelines. Creditworthiness can be improved by timely bill payments, reducing debt, and managing credit responsibly.
- Pros of using FHA loans for investment properties include lower down payments and flexible credit requirements. Cons are the occupancy rule, mortgage insurance premiums, and potential property restrictions.
- You can use an FHA loan creatively for investment purposes, like buying a multi-unit property and living in one unit while renting out the others. However, it’s crucial to meet all requirements to avoid mortgage fraud.
What is an FHA loan?
An FHA loan refers to a mortgage loan insured by the Federal Housing Administration (FHA), a government agency within the U.S. Department of Housing and Urban Development (HUD). The purpose of FHA loans is to encourage homeownership by providing more accessible financing options, particularly for borrowers with lower credit scores or a limited down payment.
Here are some key features of FHA loans:
- Mortgage Insurance: FHA loans require borrowers to pay mortgage insurance premiums (MIP). The upfront MIP is typically financed as part of the loan, and an annual MIP is added to the monthly mortgage payment. The insurance protects the lender in case the borrower defaults on the loan.
- Lower down payment: FHA loans offer a lower minimum down payment compared to conventional loans. Typically, the down payment requirement is 3.5% of the purchase price or appraised value of the property, whichever is lower.
- Easier credit requirements: FHA loans are more lenient when it comes to credit qualifications compared to conventional loans. Borrowers with lower credit scores may still be eligible for an FHA loan, although specific requirements and interest rates may vary.
- Loan limits: FHA loan limits are set by every county and vary depending on the housing market. These limits cap the maximum loan amount that can be insured by the FHA. The limits are adjusted annually to account for changes in the housing market.
- Property requirements: FHA loans have specific property requirements to ensure that the purchased property is safe and habitable. The appraisal process includes an inspection to assess the property’s condition and compliance with FHA guidelines.
- Mortgage Insurance for the life of the loan: In most cases, FHA loans require mortgage insurance for the entire life of the loan, regardless of the amount of equity the borrower has in the property or the loan-to-value ratio (LTV). This differs from conventional loans where mortgage insurance can be canceled once a certain level of equity is reached.
- Limited eligibility for investment properties: FHA loans are primarily designed for owner-occupied properties. Borrowers looking to purchase investment properties or second homes may not be eligible for an FHA loan.
To learn more about FHA loans, check out “FHA Loans: Eligibility, Requirements, Limits, & Rates”
Investment property considerations
Investment properties are real estate properties that are purchased with the intention of generating income or profiting from them. Unlike primary residences or second homes, which are primarily used for personal occupancy, investment properties are acquired as financial assets. Here are some common types of investment properties:- Rental Properties: These properties are purchased with the purpose of renting them out to tenants. The rental income generated from tenants’ monthly payments provides a steady cash flow for the property owner.
- Vacation Rentals: These properties are typically located in desirable tourist destinations and are rented out short-term, such as through platforms like Airbnb or VRBO. Owners can generate income by renting out the property to vacationers and tourists.
- Fix-and-Flip Properties: Investors purchase properties that require renovations or repairs at a discounted price, improve them, and then sell them at a higher price to make a profit. The goal is to increase the property’s value through renovations and capital appreciation.
- Commercial Properties: This category includes properties such as office buildings, retail spaces, industrial properties, and warehouses. Investors lease out these properties to businesses or organizations, earning rental income from commercial tenants.
- Multi-Family Properties: These properties consist of multiple units, such as apartment complexes or duplexes. Investors can generate income by renting out each unit separately to tenants.
Can you use an FHA loan for an investment property?
In general, FHA loans are not available for borrowers looking to purchase investment properties. To be eligible for an FHA loan, borrowers must meet these certain occupancy requirements:
- Primary Residence: The borrower must intend to occupy the property as their primary residence. This means that the home must be their main place of residence and they should plan to live in it for a significant portion of the year.
- Timeline: The borrower is required to move into the property within 60 days of closing the loan. This demonstrates their intention to use it as their primary residence.
- Certification: As part of the loan application process, the borrower needs to certify their intention to occupy the property as their primary residence. Signing the loan documents confirms their commitment to live in the home. It’s worth noting that the FHA conducts periodic occupancy inspections to ensure borrowers are adhering to the occupancy requirements. If it is discovered that the borrower is not living in the property as their primary residence, it can be considered mortgage fraud, which is a serious offense.
Some exceptions
While FHA loans are primarily intended for owner-occupied properties, there are a few exceptions to the eligibility rules that may allow for the use of an FHA loan for an investment property. These exceptions include:- Section 203(k) Rehabilitation Loan: The FHA’s Section 203(k) loan program allows borrowers to purchase a property that requires significant repairs or renovations and finance both the purchase price and renovation costs into a single loan. This can be used for investment properties as long as the borrower intends to occupy one of the units within the property as their primary residence.
- 2-4 Unit Properties: FHA loans can be used to finance multi-unit properties, such as duplexes, triplexes, and fourplexes. In this case, the borrower must occupy one of the units as their primary residence, while the remaining units can be rented out to tenants.
Qualifying for an FHA loan for an investment property
Qualifying for an FHA loan for an investment property involves not only meeting the occupancy requirements discussed above but also meeting certain criteria set by the Federal Housing Administration. Here are some key factors that are typically considered when determining eligibility:
- Credit Score: While FHA loans are known for accommodating borrowers with lower credit scores, a minimum credit score is still required. The specific credit score requirement may vary among lenders, but typically a score of 580 or higher is necessary to qualify for the minimum down payment.
- Down Payment: FHA loans offer more flexible down payment options compared to conventional loans. The minimum down payment requirement is typically 3.5% of the purchase price. However, borrowers with a credit score below 580 may be required to make a larger down payment, usually 10% of the purchase price.
- Debt-to-Income Ratio: The FHA also considers the borrower’s debt-to-income (DTI) ratio, which compares their monthly income to their monthly debts. Generally, the DTI ratio should be no higher than 43%, although lenders may have additional requirements.
Employment and Income Stability: Lenders will review the borrower’s employment history and income stability to ensure they have a steady source of income to make mortgage payments. Typically, a two-year employment history is preferred, but exceptions can be made for recent graduates or those with a shorter employment history. - Property Guidelines: The property being purchased must meet certain criteria established by the FHA. These guidelines ensure the property is safe, habitable, and meets minimum property standards.
Tips on how to improve creditworthiness
Improving your creditworthiness can increase your chances of qualifying for an FHA loan. Here are some tips to help you improve your credit:
- Check and Monitor Your Credit Report: Obtain a copy of your credit report from each of the three major credit bureaus (Equifax, Experian, and TransUnion) and review them for accuracy. Dispute any errors or discrepancies promptly. Regularly monitor your credit report to stay aware of your credit status.
- Pay Bills on Time: Payment history is a significant factor in your credit score. Make sure to pay all your bills, including credit cards, loans, and utilities, on time. Late payments can have a negative impact on your creditworthiness.
- Reduce Debt: High levels of debt can negatively affect your creditworthiness. Work on paying down your existing debts, especially credit card balances. Aim to keep your credit card utilization ratio (the amount of credit used compared to your credit limit) below 30%.
- Avoid Opening New Credit Accounts: Opening multiple new credit accounts within a short period can lower your credit score. Limit new credit applications and focus on managing your existing credit responsibly.
- Maintain Long-Term Credit Relationships: Lengthy and consistent credit history can be beneficial. Avoid closing old credit accounts, even if they are not in use. Keeping these accounts open and in good standing demonstrates stability and a longer credit history.
- Limit Credit Inquiries: Excessive credit inquiries within a short period can raise concerns for lenders. Minimize applying for new credit unless necessary, as each application can result in a hard inquiry on your credit report.
Pros and cons of using an FHA loan for investment properties
Using an FHA loan for investment properties has pros and cons to consider. One advantage is the lower down payment requirement, making it more accessible for borrowers with limited funds. Additionally, FHA loans often have more flexible credit requirements, accommodating borrowers with lower credit scores. However, a significant drawback is the occupancy requirement, as FHA loans are primarily intended for owner-occupied properties. The borrower must certify their intention to reside in the property. FHA loans also entail mortgage insurance premiums, which increase the overall cost. Loan limits and property restrictions may further limit options for higher-priced or non-compliant investment properties.
Tips for successfully using an FHA loan for investment properties
While FHA loans are designed to help make homeownership a possibility to those borrowers that might not meet traditional mortgage requirements. These loans are designed to help borrowers find and move into their primary residence and, in general, are not available for investment properties, with a few exceptions. These can include:
- Purchasing a multi-unit property allows you to use one unit as a primary residence while renting out the remaining units, often allowing you to live for free and, in many cases, turn a profit.
- Renting your primary residence – In cases where, after a year of occupancy, your work requires relocation or you are no longer able to work, you may be eligible to rent out your primary residence in order to generate income.
Leveraging an FHA loan for investment properties
While not designed for use in the purchase of investment properties, there are ways that you can leverage an FHA loan and the benefits available. Purchasing a multi-unit property with an FHA loan allows you to purchase a primary residence and investment property in one, often allowing you to live free while also, in many cases, turning a profit. When considering an FHA loan for an investment property, it is crucial that you understand and meet all the necessary requirements in order to avoid committing mortgage fraud and getting yourself in trouble.
We can help you navigate FHA loans
At Hero Home Programs, we understand how confusing the home-buying process can be. Our goal is to help our heroes achieve homeownership and help navigate them through the borrowing process, including FHA loans and investment properties. If you are considering an investment property with an FHA loan, it is important to make sure that you follow the requirements and criteria, and we are here to help. To learn more, contact us today.
