FHA loans are for borrowers purchasing a property to live in full-time, but there’s a way around it. If you buy a multi-unit property and live in one of the units, you can use FHA financing. The FHA offers flexible guidelines that make it easy to qualify for the loan. If you plan to buy a 3 to 4-unit property, though, you’ll need to pass the FHA Self-Sufficiency Test.
What is the FHA Self-Sufficiency Test?
The FHA wants to know that a multi-unit property is self-sufficient. In other words, the total rent that you receive for the units must be equal to or greater than the mortgage payment. This means the total mortgage payment, which includes principal, interest, real estate taxes, and insurance. If the mortgage is more than the rent you could bring in, the property is not self-sufficient.
Figuring Out the Net Rental Income
Because you don’t own the property yet, you have to rely on market figures to determine the net rental income. First, you must consult with an appraiser who can tell you the market rent for the area for a unit like you would rent out.
Next, the lender needs to find out the vacancy rate for the area. If the vacancy rate is 15%, you would deduct 15% from the market rent for the area. This gives you the net rental income and is what lenders will compare to your total monthly mortgage payment if you were to get the FHA loan.
If the net rent is greater than the mortgage payment, the property is not self-sufficient and would not be eligible for FHA financing.
Other Qualifications for the FHA Loan
Using FHA financing for a three to four-unit property requires you to meet the following guidelines:
- Minimum 580 credit score – Some lenders may require a higher credit score, it varies by lender
- 5% down payment – This gives you a little ‘skin in the game’ and lowers your risk of default, although 3.5% is much lower than most other loan programs require
- 31% housing ratio – The principal, interest, taxes, and insurance cannot exceed 31% of your gross monthly income
- 41% total debt ratio – Your new mortgage payment plus other existing debts (car loans, student loans, credit card payments) cannot exceed 41% of your gross monthly income
- Stable income and employment – Most lenders prefer it if you were at the same job for the last two years with increasing income throughout that time
Buying a multi-unit property with an FHA loan is one of the best ways to start investing in real estate. With a small upfront investment, you can dabble in renting out units and making a profit (if the mortgage is less than the rent). Since the FHA does not underwrite or fund the loans, each FHA lender can add their own requirements onto what the FHA wants to lower the risk of default. Shop around with different lenders to find the loan that is right for you.