by Amresh Singh
17 min read
FHA loans are a lucrative loan option for primary home buyers, but can you use an FHA loan for investment property too? In this article, we will unfold this mystery for you. From discussing the benefits and limitations of FHA loans to finding alternative loan options for overcoming FHA loan limitations, we have it all covered. Now that you know what lies ahead, let’s start without delays.
Understanding FHA Loan
FHA loans are government-backed mortgages issued by FHA-approved lenders and insured by the Federal Housing Administration. FHA loans have more flexible requirements than a conventional loans. As a result, they are prevalent amongst the primary home buyers due to their easy-to-meet requirements of down payment and low-interest rates.
Different Types of FHA Loans
The Federal Housing Administration (FHA) offers several types of loans to help individuals and families purchase or refinance homes. Following are some common types of FHA loans:
- FHA Purchase Loans: These loans are designed for first-time homebuyers and require a down payment of as little as 3.5% of the purchase price. FHA purchase loans are available as fixed-rate or adjustable-rate mortgages.
- FHA Streamline Refinances: These loans are designed to help homeowners refinance their existing FHA mortgage into a new FHA loan with a lower interest rate and shorter loan term. Streamline refinance loans do not require an appraisal or income verification.
- FHA Cash-Out Refinance Loans: These loans allow homeowners to refinance their existing mortgage and take cash out of their home equity. The cash-out refinance loan must be at least 85% of the home’s value, and the homeowner should have a credit score of 580 or more.
- FHA 203(k) Rehabilitation Loans: These loans are designed to help homeowners finance the purchase or refinance of a home and the cost of repairs or renovations. The loan is based on the house’s projected value after repairs or renovations are completed.
- FHA Energy Efficient Mortgage (EEM): These loans are designed to help homeowners finance energy-efficient upgrades to their homes, such as insulation, windows, and HVAC systems. The cost of upgrades is rolled into the mortgage loan.
It’s important to note that FHA loan eligibility requirements and loan terms may vary depending on the lender and the borrower’s financial situation.
What are the FHA Occupancy Requirements?
The Federal Housing Administration (FHA) has occupancy requirements that borrowers must meet to qualify for an FHA loan. Here are the general occupancy requirements for FHA loans:
- Primary Residence: The borrower must occupy the property as their primary residence under 60 days of closing the loan. The property must be one unit -to-four unit residential property.
- Minimum Occupancy: The borrower must occupy the property for at least one year after closing the loan.
- Non-Occupying Co-Borrowers: If a borrower cannot qualify for an FHA loan on their own, they may be able to use a non-occupying co-borrower to help them qualify. However, the non-occupying co-borrower must be a family member or close relative.
- Rental Properties: FHA loans are not designed for investment properties or second homes. The borrower must intend to use the property as their primary residence.
It’s important to note that FHA loans are intended for owner-occupants, and the borrower must certify that they will occupy the house as their primary residence. Failure to occupy the property as the primary residence may result in the loan being called due and payable.
Can You Purchase an Investment Property with an FHA Loan?
You cannot buy an investment property using an FHA loan. FHA loan is available for purchasing a primary home only.
However, you can utilize FHA loans to earn a rental income by renting a part of your home.
Before putting a renters board in your courtyard, you must indicate your intention to the mortgage lender and tick the following requirements.
FHA Investment Property Guideline for Renting the Primary Residence
1. 3.5 % down payment for a credit score of 580 or more, and 10% down payment, for a credit score of 500- 579.
2. To be eligible for the loan for 3-4 unit properties, you must possess sufficient funds to cover at least 3 months’ worth of principal, interest, taxes, and insurance.
3. To qualify, the funds must be in a liquid account and “seasoned,” implying that they have been in your bank account for several months.
4. If the funds are derived from a significant deposit, you’ll need to provide the source of funds to the lender to demonstrate the legitimacy of the money and confirm that it was not simply deposited to qualify for the loan.
5. To avoid mortgage fraud, it’s important to note that if you obtained financing for a home with the intention of using it as your primary residence, you must reside there for a minimum of 12 months before it is rented. This is because placing renters in the property right after obtaining a primary residence loan could be considered fraudulent, and it’s crucial to avoid such activity, as mortgage fraud is a serious matter.
Most people who intend to put their primary residence for rental income would often like to buy up to four-unit houses. However, meeting the above FHA mortgage requirements to purchase the right property is also difficult and exhausting. Also, from the taxation point of view, it is not a profitable idea.
Is Renting the Primary Residence a Good Idea from a Taxation Point of View?
Probably not. As a landlord of a primary residence, your income taxes may become more complex, involving both the IRS and your state’s revenue department. Your rent is considered taxable income, and you may incur a significant tax bill at the end of the year.
There are several potential cons or drawbacks to consider when it comes to the tax implications of renting out your primary residence in the US:
- Tax liability: Renting out your primary residence can create an additional tax liability, as rental income is subject to federal and state income taxes. You’ll need to keep track of your rental income and expenses and report them accurately on your tax return to avoid penalties or fines.
- Complexity: The tax rules related to renting out a primary residence can be complex and may require professional tax advice to navigate. Failing to comply with tax rules and regulations can have significant financial consequences.
- Reduced tax benefits: If you previously claimed deductions for mortgage interest and property taxes upon your primary residence, those deductions may be reduced or eliminated when you start renting out the property. This can result in higher tax bills and reduced tax benefits.
- Capital gains tax: If you eventually sell your rental property, you may be subject to capital gains tax over the profit you made from the sale. This tax can be significant, especially if it has appreciated in value.
- Depreciation recapture: If you claimed depreciation on your rental property, you may be required to pay depreciation recapture tax whenever you decide upon selling the property. This tax can be a significant expense and should be factored into your decision to rent your primary residence.
Now that we know that an FHA loan cannot be used to buy an investment property and renting the primary residence is full of challenges, what alternatives exist for real estate investors who wish to purchase an investment property?
Best Alternative Loan Options of FHA Loans on Investment Property
You can successfully skirt the troubles of an FHA loan by routing through other Non-QM profitable loan options for buying investment properties. Following are the most sort-after loans by seasoned real estate investors who often purchase investment properties like second homes and vacation homes.
1. DSCR Loan
A debt service coverage ratio (DSCR) loan is a type in which the lender evaluates the borrower’s ability to repay the loan based on their projected cash flow. The DSCR measures the borrower’s ability to repay their debts using their net operating income (NOI), which is the income generated by the property or business after all expenses have been paid. DSCR loans are commonly used in commercial real estate financing, where the borrower is purchasing or refinancing commercial property. The lender will evaluate the property’s income potential and use the projected NOI to determine the loan amount and terms.
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Mortgage Lender’s Requirements for DSCR Loan
Mortgage lenders have specific requirements for granting a DSCR loan. Here are some typical requirements that lenders may look for:
- Property Type: DSCR loans are commonly used for buying commercial properties, such as vacation homes, multiunit dwellings, office buildings, apartment complexes, and shopping centers.
- Debt Service Coverage Ratio: The lender will require a minimum DSCR of 1.25 to 1.35. This means that the property’s NOI must be at least 1.25 to 1.35 times the property’s total debt service.
- Loan-to-Value Ratio: Lenders may require a maximum loan-to-value (LTV) ratio of 75% to 80%, which means that the loan cannot exceed 75% to 80% of the property’s appraised value.
- Credit History: Lenders will review the borrower’s credit history, credit score, and utilization.
- Experience: Lenders may require that the borrower has experience in managing similar properties or businesses.
- Reserves: Lenders may require that the borrower has a certain amount of reserves set aside to cover unexpected expenses or emergencies.
- Appraisal: The lender will require an appraisal to determine the property’s value.
The DSCR loan allows borrowers to qualify for a loan based on the property’s projected cash flow rather than the borrower’s current income or assets. However, borrowers should carefully evaluate the terms and conditions of the loan to ensure that they can afford the debt service payments and maintain a positive cash flow.
Complete Guide: DSCR Loans
2. Asset-Based Loans
An asset-based loan (ABL) is a type of financing where a borrower secures a loan by pledging their assets as collateral and can buy multi-unit property without any hassle. The assets could be accounts receivable, inventory, equipment, or other tangible assets owned by the borrower’s business.
The loan amount is based on the value of the assets pledged as collateral and the borrower’s creditworthiness. Typically, lenders will provide up to 80% of the value of eligible accounts receivable and up to 50% of the value of eligible inventory.
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Mortgage Lender’s Requirements for Asset-Based Loan
The lender requirements for granting an asset-based loan (ABL) may vary depending on the lender and the specific circumstances of the loan. However, here are some general requirements that lenders typically consider:
- Collateral: As the loan is secured by collateral, lenders require the borrower to have assets that can be pledged, such as accounts receivable, inventory, equipment, or real estate.
- Financial Statements: Lenders will typically require the borrower to provide financial statements, including, balance sheets, and cash flow statements, income statements to assess the financial health of the business.
- Creditworthiness: Lenders will also evaluate the creditworthiness of the borrower, including credit history, payment history, and the credit scores of the business and its owners.
- Business plan: Lenders may require a business plan that outlines the borrower’s objectives, operations, and financial projections.
- Management Team: Lenders may also evaluate the borrower’s management team to ensure it has the experience and expertise to manage the business effectively.
- Insurance: Lenders may require the borrower to maintain insurance coverage to protect against any loss or damage to the collateral.
- Compliance: Lenders may also require the borrower to comply with various legal and regulatory requirements.
Overall, lenders want to ensure that the borrower can make mortgage payments and that the collateral is sufficient to secure the loan.
Complete Guide: Asset-Based Mortgages: A Guide to Flexible Financing
3. Bank Statement Loan
A bank statement loan allows self-employed or freelance borrowers to qualify for a loan based on their bank statements rather than their tax returns or other financial documents. It is an excellent way of purchasing property for investment purposes.
The lender will evaluate the borrower’s income by analyzing the deposits in the bank account and considering any regular or recurring deposits. The bank statement loan is particularly useful for individuals with difficulty qualifying for a traditional loan.
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Mortgage Lenders Requirements for Bank Statement Loan
Mortgage lenders have specific requirements for granting a bank statement loan. Here are some typical requirements that lenders may look for:
- Self-Employment: Borrowers must be self-employed or work as independent contractors and have at least two years of self-employment history.
- Bank Statements: Lenders will require 12-24 months of bank statements to evaluate the borrower’s income. The borrower must also provide a profit and loss statement to show the credentials of the business/work.
- Credit History: Lenders will review the borrower’s credit history, credit score, and utilization.
- Debt-to-Income Ratio: Lenders will calculate the borrower’s debt-to-income (DTI) ratio, which measures the borrower’s ability to repay the loan based on their income and expenses.
- Loan Amount: Lenders may require a minimum loan amount and may limit the maximum loan amount based on the borrower’s income and other factors.
- Down Payment: Lenders may require a down payment of at least 10-20% of the loan amount.
- Reserves: Lenders expect borrowers to have a certain amount of reserves, which are funds set aside to cover unexpected expenses or emergencies.
- Business documentation: Lenders may request additional documentation such as business licenses, contracts, or invoices to verify the source of income.
Overall, mortgage lenders want to ensure that borrowers have a source of income and can afford monthly mortgage payments. The bank statement loan allows self-employed or freelance borrowers to qualify for a loan without providing traditional income documentation like those in FHA loans or in Fannie Mae and Freddie Mac loans.
Complete Guide: Bank Statement Mortgage
4. Hard Money Loan
A hard money loan is typically used in real estate transactions and is based on the value of the property used as collateral rather than the borrower’s creditworthiness. Hard money loans are typically issued by private lenders or investors rather than traditional banks or financial institutions.
The term “hard money” refers to the fact that these loans are typically secured by a “hard” asset, such as real estate, rather than “soft” assets, such as stocks, bonds, or other types of securities.
Mortgage Lender’s Requirements for Hard Money Loan
Mortgage lenders have different requirements for hard money loans, but some common requirements include:
- Collateral: The property being purchased or refinanced serves as collateral for the loan, and lenders typically require a minimum loan-to-value ratio of 70% to 80%.
- Credit score: While hard money lenders may not place as much emphasis on credit scores as traditional lenders, they will still want to see that the borrower has a history of responsible credit usage.
- Income verification: Hard money lenders may not require traditional income documentation, such as tax returns and pay stubs, but they will want to see evidence that the borrower has the ability to repay the loan.
- Down payment: Hard money lenders often require a significant down payment, typically between 20% and 30% of the property’s value.
- Loan terms: Hard money loans usually have shorter repayment terms than traditional loans, typically ranging from six months to two years. They may also have higher interest rates and fees.
It’s important to note that each lender has its own specific requirements, and borrowers should carefully review the terms and conditions of any loan offer before accepting it. Additionally, borrowers should have a solid plan for how they will repay the loan, as hard money loans can be risky and expensive if not handled correctly.
5. HELOC Loan
A HELOC (Home Equity Line of Credit) loan is a type of revolving credit that is secured by the equity in a borrower’s home. It allows homeowners to borrow against the value of their homes and use the money for various purposes, such as home improvements, debt consolidation, or other large expenses.
HELOCs work like credit cards because they have a credit limit that can be borrowed at any time. The credit limit is determined by the equity in the home and the lender’s criteria. Interest is charged only on the amount of credit used, not the entire credit limit. As the borrower repays the borrowed amount, the credit becomes available again.
Mortgage Lender’s Requirements for HELOC Loan
The requirements for a HELOC loan can vary depending on the lender and the borrower’s creditworthiness, but some standard requirements include:
- Equity in the home: The borrower must have a minimum amount of equity in their home, typically at least 15-20% of the home’s value.
- Credit score: Lenders typically require a good credit score (often 680 or higher) for a HELOC loan, although some lenders may offer loans to borrowers with lower credit scores.
- Income and employment: Lenders may require documentation of the borrower’s income and employment history to ensure they can repay the loan.
- Debt-to-income ratio: Lenders will also consider the borrower’s debt-to-income ratio (DTI), which is the ratio of their monthly debt payments to their monthly income. Lenders generally prefer a low DTI.
- Home appraisal: The lender will typically require an appraisal of the home to determine its value and the amount of equity the borrower has.
- Loan-to-value ratio: The lender will also consider the loan-to-value (LTV) ratio, which is the loan amount ratio to the home’s value. Lenders generally prefer a lower LTV ratio.
It’s important to note that each lender has its specific requirements, and borrowers should ensure they can comfortably manage their payments.
6. No-Doc Mortgage
In a no-doc mortgage, the lender relies on the borrower’s stated income and assets without verifying them through documentation. The borrower may still be required to provide some basic information, such as their name, social security number, and credit score, but the lender does not require proof of income, employment, or other financial information.
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Mortgage Lender’s Requirements for No Doc Loan
As the name suggests, no-doc loans do not require extensive documentation of the borrower’s income and assets. However, these loans are relatively rare and may only be available from a select number of lenders. Moreover, lenders may have varying requirements for no-doc loans, but some general requirements that borrowers may need to meet include the following:
- High credit score: Since no-doc loans carry more risk than traditional mortgage loans, lenders often require a higher credit score from borrowers, typically 700 or higher.
- Large down payment: Lenders may require a larger down payment than usual, often 30-40%.
- Cash reserves: Lenders expect borrowers to have significant cash reserves or assets, such as savings or investments, to demonstrate their ability to repay the loan.
- Established employment: Borrowers may need to demonstrate a stable or strong business history if they are self-employed.
- Property appraisal: Lenders may require a professional appraisal of the property to determine its value and to ensure that it is sufficient collateral for the loan.
Complete Guide: No Doc Mortgage
Benefits of Non-QM Loans
Non-QM (non-qualified mortgage) loans offer several benefits for borrowers who would like to skip traditional mortgage loans due to their unique financial situations or credit histories. Some potential benefits of non-QM loans include the following:
- Flexibility: Non-QM loans are designed to be more flexible than traditional mortgage loans, allowing borrowers to customize their loan terms to meet their specific needs. For example, borrowers may be able to choose an interest-only payment option or a longer loan term.
- No income verification: Non-QM loans may not require traditional income verification, making them a viable option for self-employed borrowers or those with irregular income streams.
- Credit history: Non-QM loans may be available to borrowers with less-than-perfect credit histories or those with recent credit events, such as bankruptcy or foreclosure.
- Investment properties: Non-QM loans may be available for investment properties or non-owner-occupied properties, which are typically not eligible for traditional mortgage loans.
- Faster processing: Non-QM loans may have faster processing times than traditional mortgage loans, as they may not require as much documentation or underwriting.
- Larger loan amounts: Non-QM loans may be available for larger loan amounts than traditional mortgage loans, making them an effective option for borrowers who need to finance a high-value property.
While selecting one of the loan options, you must also have clarity about which type of mortgage you would like to opt.
Types of Mortgages
There are two main types of mortgage loans based on the interest rate structure: adjustable-rate mortgages (ARMs) and fixed-rate mortgages.
- Adjustable Rate Mortgage (ARMs): An ARM is a mortgage loan where the interest rate can change periodically based on an index, such as the prime rate or LIBOR. The interest rate is typically lower than a fixed-rate mortgage at the outset of the loan, but it can increase or decrease over time. The initial rate may be fixed for a certain period, such as 5 or 7 years, before adjusting. Borrowers expecting a rise in income or planning to sell the property within a few years may benefit from an ARM.
- Fixed Rate Mortgage: In fixed-rate mortgages, the interest rate remains consistent for the entire loan term, typically 15 or 30 years. This provides borrowers with the stability of a fixed payment and interest rate over the life of the loan. Fixed-rate mortgages may be a good option for borrowers who prefer predictable payments.
It’s important to note that non-QM loans may come in an adjustable or fixed-rate structure, depending on the lender and the borrower’s qualifications.
How to Apply for Non-QM Loans?
Here are the 7 easy steps to apply for a NON-QM loan.
1. Research lenders: Non-QM loans are typically offered by specialized lenders. Research to find lenders that offer these types of loans and compare their terms and rates. HomeAbroad has a fantastic network of the best mortgage lenders with immense investment property financing experience. Reach out to HomeAbroad can connect with the best lender for free!
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2. Find the Right Property: Non-QM loans are typically used to finance investment properties such as Airbnb rentals. Make sure you find a property in good condition with the potential for appreciation or rental income. You can find the best properties by connecting with the best real estate agents.
3. Gather documentation: You must provide documentation to the lender to prove your income, assets, and other financial information. This may include bank statements, tax returns, pay stubs, and other financial documents.
4. Fill out an application: Once you’ve found a suitable lender, you’ll need to fill out an application for the loan. Be sure to provide the lender with accurate and complete information.
5. Get Approved: The lender will then review your application and financial information to determine whether or not you qualify for the loan. If you do, they’ll provide you with a loan estimate that outlines the loan terms.
6. Underwriting: The lender will review your application and documentation to determine if you qualify for the loan. This may include a credit check, an appraisal of the property you purchase or refinance, and other assessments.
7. Closing: If you are approved for the loan, you must attend a closing to sign the final paperwork and complete the transaction.
It’s important to note that non-QM loans typically have stricter lending criteria and may come with relatively higher interest rates and fees than traditional mortgages. So be sure to review the terms and conditions of any non-QM loan before applying.
FHA loans are a great way to buy principal residence if the borrowers meet the required criteria. However, it is not an option for individuals looking to purchase an investment property. Non-QM loans are an effective and profitable solution to this problem and are trusted by the most seasoned real estate investors. HomeAbroad can connect you with the best mortgage lenders who are experts are financing investment properties. Reach out to HomeAbroad and connect with them for free!
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Frequently Asked Questions
1. Can you use an FHA loan for an investment property?
No, you cannot use an FHA loan to purchase an investment property. FHA loans are intended for owner-occupied properties only, which means the borrower must intend to live in the property as their primary residence.
2. Can you do an FHA streamline on an investment property?
You cannot do an FHA streamline refinance on an investment property. The FHA streamline refinance program is only available for existing FHA-insured mortgages on a borrower’s primary residence. In addition, the borrower must occupy the property as their primary residence, and the loan must be current with no late payments.
The purpose of the FHA streamline refinance program is to make it easier and less expensive for homeowners to refinance their existing FHA mortgage to a lower interest rate or better terms. In addition, it’s intended to help homeowners reduce their monthly mortgage payments and save money over the life of their loans.
3. Can I use an FHA loan if I own a home?
Yes, you can if you meet the occupancy requirements for the property you are purchasing. FHA loans are intended for owner-occupied properties, which means that you must intend to live in the property as your primary residence.
4. What is the minimum investment for FHA?
The minimum investment, also known as the minimum down payment, for an FHA loan is 3.5% of the home’s purchase price. For example, if you purchase a home for $200,000, the minimum down payment required would be $7,000 (3.5% of $200,000).
5. Can you have 2 FHA mortgages at the same time?
The FHA allows borrowers to have two FHA mortgages if they are moving to a new area and must purchase a new primary residence before selling their current home. In this scenario, the borrower can obtain a new FHA mortgage for the new home while keeping the existing FHA mortgage on their current home until it is sold.
However, the borrower must meet specific requirements to qualify for a second FHA mortgage. For example, they must have a valid reason for needing a second FHA mortgage, such as a job relocation or change in family size, and they must also have a good payment history on their existing FHA mortgage.
6. Can you use projected rental income for FHA?
No, projected rental income cannot be used to qualify for an FHA loan. This is because the FHA requires borrowers to use their current income to qualify for a loan, and the income must be verifiable and stable.
7. Can you use a loan for a down payment on an investment property?
Using a loan for a down payment on an investment property is generally not recommended and may not be allowed by most lenders. Most lenders require borrowers to have a certain amount of cash reserves and a minimum down payment that is not funded by another loan.
8. How do I get around a down payment on an investment property?
To get around a down payment on an investment property, you could consider options such as seller financing or partnering with other investors. However, each option has its own risks and limitations, and it’s important to carefully consider your financial situation and the potential costs and benefits of each option.
9. Can you use home equity for an FHA loan?
If you currently have an FHA-insured mortgage and have built up equity in your home, you may be eligible for an FHA Streamline Refinance. This type of refinance allows you to replace your existing FHA loan with a new one at a lower interest rate, without having to go through a complete underwriting process or provide income or employment verification.
10. What is the FHA 100-mile rule?
If you have an existing FHA loan on your current home and plan to apply for a new FHA loan to purchase a new home, the FHA guidelines state that the new property must be located at least 100 miles away from your current home. This requirement is commonly referred to as the “FHA 100-mile rule.”
in the financial services industry domain.
Prior to co-founding HomeAbroad, Amresh has worked for one of