The Ultimate Guide to FHA Loans for Rental Properties

Last Updated: December 2023

FHA Loan for a Rental Property

FHA loans are a special loan product that is backed by the Federal Housing Administration. Unlike conventional mortgages, which can require a 20% or more as a down payment, FHA loans have a very low down payment requirement – currently just 3.5% and more lenient credit score requirements. FHA loans are generally designed for owner-occupied properties, but can be creatively used to purchase rental properties if the borrower is willing to reside in the property. An example of this is with multi-unit properties, where a borrower can live in one unit and rent out the remaining units.

What is an FHA Loan?

An FHA loan is a special type of real estate loan product that provides a mortgage insured by the Federal Housing Administration (FHA), designed to help borrowers with lower credit scores and smaller down payments. While primarily intended for owner-occupied properties, FHA loans can be used for rental properties if the borrower lives in one of the units in a multi-family property, such as a duplex or triplex.

Important FHA Loan Terms

Federal Housing Administration (FHA) – The Federal Housing Administration (FHA) is a United States government agency whose primary purpose is to facilitate homeownership and improve housing standards by providing mortgage insurance on loans made by approved lenders.

Private Mortgage Insurance (PMI) – Private Mortgage Insurance (PMI) is a type of insurance policy that protects mortgage lenders in the event a borrower defaults on their loan. PMI is typically required by lenders when a borrower makes a down payment less than 20% of the property’s purchase price.

Types of Properties That Qualify for an FHA Loan

With an FHA loan that is insured by the Federal Housing Administration, a borrower can purchase various types of properties, but there are specific requirements, limitations, and rental real estate finance terminology to understand beforehand. The main types of properties you can generally buy with an FHA loan include:

  • Single-Family Residences (SFR): This is the most common type of property purchased with an FHA loan. It refers to stand-alone houses designed for one family.
  • Multifamily Residences (2-4 units): You can buy properties with up to four units, like duplexes, triplexes, or fourplexes, as long as you occupy one of the units as your primary residence.
  • FHA-approved Condominiums: Not all condos qualify for FHA loans. The condo project must be on the FHA’s approved condominium project list, and specific criteria must be met.
  • Manufactured Homes and Mobile Homes: Prefab homes can be financed through FHA loans, but they must meet certain criteria, such as age, foundation, and location requirements.
  • Townhouses: Much like condos, if the townhouse development is FHA-approved, individual units can be purchased with an FHA loan.

Pros & Cons of an FHA Loan for a Rental Property

FHA Loan Pros

  • Lower down payment requirements: FHA loans allow for down payments as low as 3.5% of the property’s value, making it easier for investors with limited capital to enter the rental property market. This is particularly advantageous for first-time homebuyers or those with limited funds.
  • More lenient credit requirements: FHA loans have more relaxed credit score requirements compared to conventional loans, making them accessible to borrowers with lower credit scores. This can be beneficial for investors who may not qualify for a conventional loan.
  • Ability to finance multi-family properties: FHA loans can be used to purchase multi-family properties with up to four units, as long as the borrower lives in one of the units. This can provide a unique opportunity for investors to both live in and provide property management services for their rental property, while also generating rental income from the other units.

FHA Loan Cons

  • Owner-occupancy requirement: FHA loans for rental properties require the borrower to live in one of the units if the property is a multi-family dwelling. This limits the loan’s use for investors looking to solely invest in rental properties without occupying them such as a real estate syndication.
  • Mortgage insurance premiums: FHA loans require both an upfront mortgage insurance premium and an annual premium, which can increase the overall cost of the loan. These insurance costs may make an FHA loan less attractive than a conventional loan for some investors.
  • Property condition requirements: FHA loans have specific property condition requirements that must be met for a property to be eligible for financing. These standards may necessitate property repairs or improvements before the loan can be approved, potentially increasing the upfront costs for the investor.

FHA Loan Requirements for Rental Properties

FHA loans are primarily designed for financing primary residences. However, it is possible to use an FHA loan for a rental property under certain circumstances. To qualify for an FHA loan for a rental property, borrowers typically need to meet the following requirements:

1. Owner-Occupied

To use an FHA loan for a rental property, the borrower must intend to occupy one of the units in a multi-unit property (up to four units) as their primary residence. The remaining units can be rented out. Single-family rental properties that the borrower does not plan to occupy are not eligible for FHA financing, but a real estate house hacking strategy could theoretically work.

2. Good Credit Score

While FHA loans are known for their more lenient credit score requirements compared to conventional rental property loans, borrowers still need to meet a minimum credit score. Typically, a credit score of at least 580 is required for a 3.5% down payment, while a score between 500 and 579 may qualify for a 10% down payment. Lenders may have their own additional credit score requirements.

3. Acceptable Debt-to-Income Ratio (DTI)

Lenders will evaluate the borrower’s debt-to-income ratio to ensure they can manage the mortgage payments along with their other debts. FHA guidelines generally require a DTI of 43% or lower, although exceptions may be made for borrowers with compensating factors, such as significant cash reserves or a history of making larger housing payments.

4. Property Appraisal and Minimum Standards

The property must undergo a special type of appraisal (FHA Appraisal), which evaluates both the market value and the property’s condition to ensure it meets the FHA’s minimum property standards (MPS). MPS include guidelines related to safety, sanitation, and structural integrity. The property must meet these standards to be eligible for FHA financing.

Rental Property FHA Loan FAQ

Can I Use an FHA Loan to Buy a Rental Property?

Yes, you can use an FHA loan to buy a multifamily property (up to 4 units) with the intent of renting out the units that are not occupied by you. However, one of the main stipulations of the FHA loan is that the borrower must live in one of the units as their primary residence for at least one year. You can’t use an FHA loan for a property intended solely as a non-owner occupied rental.

Do I Need a Larger Down Payment for Multifamily Properties with an FHA Loan?

The FHA requires a standard 3.5% down payment for borrowers with credit scores of 580 and above, irrespective of whether it’s a single-family or multifamily property. However, if your credit score is between 500 and 579, you’ll typically need a 10% down payment. Always check with your lender for the most current requirements.

What are the Property Requirements for Rental Properties with FHA Loans?

The FHA has specific requirements to ensure the property’s health, safety, and structural integrity. An FHA-approved appraiser must inspect the property. For rental properties, this means all units, even if they are not occupied by the owner, must meet these standards. This can include requirements related to electrical systems, roof condition, and potential hazards like lead-based paint.

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