An FHA loan allows potential home buyers to put less money down than a traditional mortgage and caters to borrowers with lower credit. This makes an FHA loan an attractive option for home buyers who may not be able to qualify for a traditional mortgage. While this is good news for some, real estate investors may be able to qualify and take advantage of the benefits of FHA loans.  However, there are some ways in which you may be able to use an FHA property, to eventually provide income.

 

What is an FHA loan?

The Federal Housing Administration, which is a part of the Department of Housing and Urban Development (HUD), is the largest insurer of mortgages in the world with over 1.3 trillion in its portfolio. Loans that are insured by the FHA typically have lower down payment requirements and more flexible underwriting standards than most conventional mortgages.

Applicants generally need a credit score above 580 to qualify, and approved applicants can finance as much as 96.5% of the home’s value. This means you can put as little as 3.5% down to qualify. If your credit score is between 500 and 579, you may still be able to get approved, but would need to put down a larger down payment (10%+).

In general, FHA loans are restricted to borrowers looking to use the home as their primary residence. This means an FHA loan cannot be used to finance a second home, vacation home, rental home or investment property. There are, however, a few exceptions and a few ways to get around this general rule.

 

Occupancy Requirement

Per FHA guidelines, the property being financed must be occupied by the owner. This means that seasonal and rental properties do not apply. This rule is put in place so investors can’t benefit from the program.

The borrower must take possession of the home within 60 days of closing and must live at home for most of the year. The property must be used as your primary address for at least one year. If there are multiple borrowers listed on the mortgage, the FHA requires that at least one of them satisfy the occupancy requirements.

 

Multiunit Properties

One way to use an FHA loan to buy a property that generates income is to purchase a multi-unit property. The FHA allows you to purchase a unit with up to 4 units, assuming one is occupied by the owner. This way, an owner can live in one unit and rent the other unit out for income.

A savvy investor can use this method to live in the home either for free or at a heavily discounted price, offset by the income generated. As mentioned before, FHA lends up to 96.5% of the appraised value, meaning you can put down as little as 3.5%.

 

Special Cases

There are some special provisions that may allow you to earn rental income from your home. If your job requires you to relocate and you need a second home, or if your home is too small to expand your family, then you may be able to either rent out rooms of the property or rent out the first property after the year occupancy requirement is satisfied.

Of course, you can always pay the loan off early as the FHA doesn’t charge any prepayment penalties. Once the loan is paid off, you can do whatever you’d like with the property.

 

Refinancing an FHA Loan

You could potentially finance the purchase of a primary residence using an FHA loan, then move out for one of the reasons above, but continue to own it and rent it out for income. That property then becomes an investment property.

Even though you’d no longer live in the property, FHA rules still allow you to refinance into another FHA loan. This type of refinance is also known as an FHA streamline refinance. There are several requirements to qualify for refinancing which include:

 

• At least 210 days must have passed since you closed on your original home loan.
• You must have made a minimum of six-monthly payments on your FHA mortgage.
• All mortgage payments on the property for the last 6 months within the month they were due.
• The refinance must be lower than your current monthly principal and interest or a shorter term.

 

If you meet the requirements above, FHA streamline refinances are generally the easiest to close. They don’t require typical employment or income verification, credit score verification and no home appraisal. The main thing that is taken into consideration is that you have made your FHA payments on time.

 

Key Take Away

FHA loans must be used to purchase a primary residence and cannot be used to finance a second home, rental home, investment property or vacation home. There are some exceptions however, that allow you to generate income from a property financed with an FHA loan provided you are using it as your primary residence.