Investment Opportunities with FHA Loans

FHA loans make it relatively easy to receive financing to purchase a property, especially if you lack sufficient funds for a down payment. While they are intended for funding primary residences, FHA loans can also be used for investment properties in a handful of ways.

Learn more about FHA loans, how they work with investment properties, loan requirements, terms, and costs, the pros and cons of using FHA loans for investment properties, and alternative financing options to consider.

Unlock your real estate dreams with TheLender. Ditch traditional paperwork hassles and leverage our unique bank-statement program. Trusted by thousands and recognized nationally, we simplify your financing journey. BOOK A FREE CONSULTATION NOW.

What an FHA loan is

An FHA to is a type of home mortgage financing backed by the Federal Housing Administration and offered by participating lenders. This loan is designed to aid low- and moderate-earning purchasers, especially first-time buyers who find it challenging to save for a down payment and suffer from weaker credit scores. That’s because an FHA loan can be had for as little as 3.5% down or a credit score as low as 500 if you qualify.

“The FHA insures this loan against default, which means that the participating lender is protected if you fail to make payments. This allows lenders to offer FHA loans with lower down payment requirements and more lenient credit score requirements than conventional loans,” explains Baruch Silvermann, CEO of The Smart Investor.

How FHA loans for investment properties work

Technically, FHA home loans cannot be used to purchase an investment property. This financing is designed for owner-occupied homes. But if you play by the rules, you can use these funds legally to purchase a property that can be used to generate rental income now or in the future.

Here are five ways that FHA loans can be used for investment properties:

1. Live within the home as your primary residence for one year, move out, and keep it as a rental.
2. Buy a multifamily property and house hack. “With this option, you can purchase a multifamily property with up to four units and move into one of the units while renting out the others,” says G. Brian Davis, founder of SparkRental. “Ideally, the rents you earn from the neighboring units will cover your entire mortgage payment plus extra to cover vacancies and repairs.” However, Sam Sharp, executive vice president of National Sales for Guaranteed Rate, cautions that 75% of the total rents for the building must be equal to or greater than your mortgage.
3. Remain in your single-family home and rent out unused living spaces to others. Just note that the rentals cannot be short-term; they must be for 30 days or longer.
4. Refinance to a non-FHA loan. “You can use an FHA loan to purchase a property that you live in. But you can get out of the home after only 212 days instead of a full year if you refinance the loan as soon as possible. That way, you can get it on the market for renters that much sooner,” Leonard Ang, CEO of iPropertyManagement, notes. “It is possible to refinance an FHA loan into a non-FHA loan or into another FHA loan, provided you meet the requirements for the new loan; however, if you're refinancing to make it a rental property, you'll want to go with the non-FHA option. The rule regarding the timing of the refinance states that at least 212 days must have passed since your first payment on the FHA loan before you can refinance.”
5. Pay off your FHA mortgage early. Once you fulfill your loan requirements and pay off your balance in full, you are entitled to use the property as a rental/investment property as you see fit.

Investment property FHA loan rules and requirements

FHA loans can be used to finance particular types of properties. Eligible properties include single-family homes with up to four units, multifamily properties with up to four units, duplexes or triplexes, condominiums, and townhomes.

“However, to qualify for an FHA loan, you must occupy one of these units as your primary residence for at least one year,” Silvermann cautions. Additionally, you must take possession of the residence within 60 days following mortgage closing.

Investment property types that are not eligible for FHA loans include second homes and vacation homes that are not intended to be your primary residence. Also, the property must be habitable with no serious damage.

To qualify for an FHA loan, you’ll need a credit score of at least 500, which requires you to put at least 10% down, or a credit score of 580, which makes you eligible for a 3.5% down payment.

“Secondly, your debt-to-income ratio should not exceed 50%. Your DTI ratio compares your monthly debt payments to your gross monthly income, indicating your ability to handle additional mortgage payments,” Silvermann continues.

Investment property FHA loan terms and costs

FHA loans are available in 15- or 30-year terms with fixed interest rates. Often, the fixed rates for an FHA loan are lower than for conventional loans.

However, what you pay for your FHA mortgage loan may be higher than expected, even if your fixed rate is lower than would be charged for other types of loans. That’s because you will typically make a lower down payment than you would be required to do with other types of loans, which means you’ll need to borrow more funds. Plus, you must pay annual mortgage insurance, which can often range from 0.15% to 0.75% of your loan amount.

“You will pay annual mortgage insurance for the life of the loan, unless you put at least 10% down, in which case the mortgage insurance requirement drops off after 11 years,” says Sharp. “The FHA also charges an upfront mortgage insurance premium, which is nonrefundable, which equates to 1.75% of your loan amount. The good news is that this fee can be rolled into your loan amount to help lower your out-of-pocket expenses at closing time.”

Lastly, be aware that you will pay closing costs on an FHA loan, which often equates to 2% to 6% of the cost of the purchased property.

Pros and cons of using FHA loans for an investment property

On the upside, an FHA loan can be a viable and worthy option if you want to start earning rental income – provided you fulfill the one-year occupancy requirement or pay off your FHA loan early. You won’t need to save as much for the down payment when you choose an FHA loan, you don’t need stellar credit to qualify, and you can rely on a relatively low fixed interest rate. Your ability to earn rental income should help cover your FHA mortgage costs.

“An FHA loan can be a great way to purchase an investment property. This will allow you to get the most for your money when building your portfolio,” says Sharp. “You don’t need to be a first-time home buyer, and there are no specific requirements based on property location or income limits.”

On the downside, the one-year occupancy requirement can be a deal-killer for many prospective investors. And paying mortgage insurance annually and upfront can add up quickly, eating into your bottom line.

Alternatives to FHA loans to purchase an investment property

An FHA loan isn’t your only option here. Instead, explore a conventional loan, which can offer greater flexibility with no owner-occupancy requirements, but which may require a higher credit score and larger down payment – in many cases 20% as a minimum.

Or, if you are an active military member, veteran, or surviving spouse, you may qualify for a VA home loan, which can be had for zero down and no mortgage insurance; VA loan rules regarding owner-occupancy are similar.

The bottom line

If you dream of being a landlord but have less-than-ideal credit and are finding it challenging to save for a down payment, an FHA home loan is worth exploring. This can be an especially enticing route to earning rental income as a beginner.

But do your necessary due diligence first. Compare loan types, Just loan offers, lenders, requirements, terms, and costs carefully.