By Rebecca Lake for SmartAsset
If you’re looking to take the plunge into real estate investment, you’re probably wondering what your financing options are. Loan requirements tend to be a little more stringent when it comes to investment properties, since they’re considered a bigger risk by lenders. If you’re having trouble qualifying for a loan, you don’t have to give up on your dreams of becoming a landlord. You may be able to use an FHA loan to secure an investment property.
What is an FHA Loan?
The U.S. Department of Housing and Urban Development oversees the FHA loan program, which provides federal insurance for loans issued by eligible lenders. Your eligibility for an FHA loan is based on your credit, employment history and income. If you’re approved for an FHA loan, you can buy a property with one to four units with as little as 3.5 percent down.
There are several different types of FHA loans you can apply for. A 203(b) loan is designed for first-time home buyers. The 203(k) loan program lets you make repairs or improvements to a property you already own. There are additional FHA loan programs available for seniors and individuals who are looking to buy manufactured or mobile homes. Buyers are subject to federal mortgage limits, which are based on where the property is located.
Principal Residency Requirement
When you take out an FHA loan, it’s based on the understanding that the home will be your primary residence. This means you have to live in the home for the majority of the calendar year. FHA guidelines require you to establish occupancy within 60 days of buying the home. You also have to sign the mortgage note before the property is considered to be owner-occupied. If you’re married, only one of you has to actually occupy the home to qualify.
According to HUD Handbook 4155.1, the FHA won’t insure more than one principal residence mortgage for the same borrower. Federally insured loans also aren’t available for the purchase of an investment property. An exception is allowed if you’re using an FHA loan to refinance a home that was previously purchased as an investment property.
Buying an Investment Property With an FHA Loan
While the federal guidelines state that you can’t use an FHA loan for the sole purpose of buying an investment property, you can still qualify if you’re planning to live in the home full-time. For example, you can buy a four-unit building with an FHA loan as long as you live in one unit while renting out the other three. It may even be possible to use the projected rental income to help you qualify for the loan.
With a two-unit home, the income requirements are typically the same for a single family property. If you’re looking at a home with three or four units, you may have to show that the property can generate enough income to equal the monthly mortgage payment, along with insurance and taxes. While the FHA program is designed to let you borrow with a small down payment, you may have to kick in a little more if you’re buying a multiple-unit home.
Pros and Cons
Buying an investment property with an FHA loan is a great way to get into real estate investing without having to put up a lot of money up front. If you’re able to keep renters on a steady basis, the rental income alone may be enough to cover all of your housing costs. Typically, FHA loans offer more favorable interest rates than conventional loans so if you have good credit, it could add up to even more savings.
The downside of using an FHA loan to purchase an investment property is the residency requirement. Before you apply for an FHA loan, you need to be sure that the property is located in area that you’ll be comfortable living in for the long term. If you take out an FHA loan but you don’t meet the residency requirements, you could end up being prosecuted for fraud. Even if you don’t get in legal trouble, the FHA could decide to accelerate your loan which means you’ll have to pay off the principal remaining balance in full.
Real estate investing can be lucrative but there are plenty of pitfalls you should be aware of. As with any property, you want to ask yourself, ‘How much house can I afford‘ before you buy. Also, if you’re planning on taking out an FHA loan to buy your first place, you need to know exactly what the rules are to make sure your investment dream doesn’t flop.
Photo Credit: auzziebrown1