The FHA Mortgage Program only applies to owner occupied properties so you cannot use an FHA loan to finance the purchase of an investment property. Specifically, to meet the owner occupancy requirement for an FHA mortgage, you are required to live in the property within sixty days of your mortgage closing and occupy the residence for at least a year.
The FHA Program, however, does allow you to purchase a multi-unit property with up to four units but you are required to live in one of the units as your primary residence. This means you could use an FHA mortgage to purchase a four unit property, live in one of the units and then rent out the other three units. The rental income you generate from the three units you do not occupy may enable you to qualify for an FHA loan or afford a higher mortgage amount.
If you intend to use an FHA mortgage to buy or refinance a multi-unit property and rent out the units in which you do not live, there are several points to keep in mind about how the rental income is calculated. If you have no history of rental income from a property, such as if you are buying the property, you are required to obtain an income property appraisal report that estimates the rental income and provide any lease agreements, if available.
Review our FHA Mortgage Guide
Estimated rent for the property is calculated as the lessor of 75% of the rental income according to the income property appraisal report or the rental income according to the lease agreement(s). In short, if you have no rental income history for the property, lenders typically apply a 25% discount to calculated the projected rental income. This discount is to account for property vacancies and other events that may reduce your rental income. In some cases, the lender uses a monthly operating income statement for the property to determine the rental income, but this is less common.
The example below shows how rental income is calculated for a multi-unit property when you apply for an FHA mortgage. In this example, the rental income according to the lease agreements is lower than the income according to the income property appraisal report so the lender uses this lower figure.
Property Rental Income According to Appraisal: $50,000
Property Rental Income According to Leases: $45,000
75% of Appraised Rental Income: $37,500
75% of Rental Income According to Leases: $33,750
Rental Income Used for Mortgage Application: $33,750
The table below shows mortgage terms for leading FHA lenders in your area. We recommend that you shop multiple lenders to find the lowest FHA mortgage rate and closing costs. Comparing multiple proposals is the best way to save money on your mortgage.
If you have a two year history of earning rental income from a property, such as if you are refinancing, you are required to provide the Schedule E from your tax returns for the prior two years to verify the rental income. If you have owned the property for less than two years, you must provide documentation such as a deed or closing disclosure to confirm the date you purchased the property.
In this scenario, lenders average your rental income over the prior two years according to your tax returns to determine the income to include in your loan application. If you have owned the property for less than two years, the lender annualizes the rental income based on how long you have owned the property.
The lender subtracts the estimated mortgage payment plus property tax, homeowners insurance and FHA mortgage insurance premium (MIP) from the estimated rental income to determine the net rental income for the property. The net rental income is added to your personal gross income to determine what size mortgage you qualify for. Please note that the net rental income is added to your personal income and not subtracted from your mortgage payment to calculate the FHA loan you can afford.
Use our FHA MORTGAGE QUALIFICATION CALCULATOR to determine the loan you qualify for
The FHA applies additional guidelines to make sure that you can afford the mortgage on a multi-unit property. Specifically, for a three or four unit property, your total monthly housing expense (mortgage payment, property tax, homeowners insurance, FHA MIP -- also known as PITI) divided by the net rental property income cannot be greater than 100%.
For example, if your PITI is $5,000 and your net rental income is only $4,000, you cannot qualify for the mortgage because $5,000 (PITI) / $4,000 (rental income) = 125%. However, if your net rental income is $6,000, you can qualify for an FHA mortgage because $5,000 (PITI) / $6,000 (rental income) = 83%, which is less than the 100% maximum. In short, the higher your net rental income relative to your mortgage payment, the easier it is to qualify for the mortgage.
All of the scenarios above apply to an FHA loan on multi-unit property that you live in. If you are interested in financing an investment property that you do not intend to live in then you need to apply for a non-owner occupied mortgage.
The table below shows investment property rates and fees. We recommend that you contact multiple lenders to find the best rental mortgage terms.
"FHA Single Family Housing Policy Handbook 4000.1." Federal Housing Administration. U.S. Department of Housing and Urban Development, January 2 2020. Web.« Return to Q&A Home About the author