Rising home prices and housing costs have pushed some buyers to consider homes that can serve two purposes: a place to live and a source of rental income. Here, Neighbors Bank breaks down how FHA financing can make that possible in more ways than many buyers realize.
FHA loans are often associated with first-time homebuyers because of their low down payment requirements and flexible qualification standards. Although FHA financing is intended for primary residences, certain owner-occupied properties can also generate rental income.
That means an FHA loan generally cannot be used to purchase a traditional investment property from the outset. However, properties such as duplexes, triplexes and fourplexes can allow an owner to live in one unit while renting out the others. In some cases, an FHA-financed home can also become a full-time rental later.
What is an FHA Loan?
FHA loans, or Federal Housing Administration loans, are government-backed mortgages aimed at helping individuals with lower credit scores or limited financial resources become homeowners.
The loans are issued by FHA-approved lenders, while the federal insurance protects lenders if a borrower defaults.
FHA loans are often used by buyers who may have less cash available for a down payment or who have difficulty qualifying for some conventional mortgages. Eligible borrowers may be able to put down as little as 3.5%, and FHA financing can be used for qualifying properties with one to four residential units.
Unlike financing designed specifically for real estate investors, FHA loans are primarily intended to support homeownership. That distinction is especially important for buyers considering a property that could also produce rental income.
FHA Loans Are Designed for Primary Residences
Because FHA loans are designed to support homeownership, they come with owner-occupancy requirements.
At least one borrower generally must establish the property as a primary residence within 60 days of signing the mortgage and intend to occupy it for at least one year. A property purchased strictly as a rental or investment from the outset generally does not qualify.
FHA Multifamily Homes Combine Homeownership and Rental Income
One of the most common ways an FHA-financed property can generate rental income is through an owner-occupied multifamily home.
FHA loans can be used to purchase eligible multifamily properties, including duplexes, triplexes and fourplexes. The owner must live in one unit as a primary residence, but they can rent out the remaining units.
A duplex, for example, could allow an owner to live on one side while collecting rent from a tenant on the other. This approach is sometimes called “house hacking,” and rental income from the additional units may help offset a portion of the property's housing costs.
Rental Income May Also Help With Mortgage Qualification
Rental income from a multifamily property can sometimes play another role: helping a borrower qualify for the mortgage.
FHA guidelines allow eligible rental income to be considered in certain underwriting situations. The amount that can be counted depends on factors including the property's existing leases, market rent estimates, rental history and documentation.
Projected rent is not generally treated as dollar-for-dollar income. Lenders must account for expenses and potential vacancies when determining how much rental income can be used for qualification.
Three- and four-unit properties can also be subject to additional financial requirements intended to show that the property can reasonably support its housing expenses.
The result is that two buyers purchasing similar multifamily properties may not receive identical treatment. Property characteristics, expected rents and the borrower's overall finances all factor into the underwriting decision.
Accessory Dwelling Units Can Be Another Rental Option
A multifamily building is not the only type of owner-occupied property that may generate rental income.
Accessory dwelling units, commonly known as ADUs, have become increasingly visible as communities look for ways to add housing within existing neighborhoods.
An ADU might take the form of a basement apartment, converted garage, backyard cottage or another independent living area located on the same property as a primary home.
Under FHA guidelines, rental income from an eligible ADU may be considered when qualifying for a mortgage. However, the rules differ from those for a traditional two- to four-unit property, and not every secondary living space qualifies as an ADU. Appraisal, property configuration and local requirements can all affect eligibility.
This creates another way an owner-occupied property may generate rental income without being classified as a traditional multifamily home.
Can an FHA-Financed Home Become a Full Rental Later?
Yes. After meeting FHA’s one-year occupancy requirement, a homeowner can generally move out and convert the property into a full-time rental without refinancing the FHA loan.
The key is that the home must have been purchased and occupied as a legitimate primary residence. FHA financing cannot be used to purchase a property intended to be a rental from the start.
Refinancing Is Another Option
Some homeowners choose to refinance an FHA mortgage into a conventional loan before or after turning a former home into a rental property.
Doing so can make sense in certain circumstances, but refinancing is not automatically required simply because the property later becomes a rental.
A refinance can change the interest rate, monthly payment and loan term. It also offers an opportunity to eliminate FHA mortgage insurance if the homeowner qualifies for conventional financing with sufficient equity.
Can an FHA Loan Be Assumed for a Rental Property?
FHA mortgages are generally assumable, meaning another qualified buyer may be able to take over an existing loan rather than obtaining a new mortgage.
That feature can attract attention when older FHA loans carry interest rates below current market levels.
An assumption, however, does not automatically convert an FHA mortgage into investment property financing. The buyer, loan servicer and property still have to meet applicable requirements.
Anyone considering an FHA assumption involving a rental property should review the specific loan terms and occupancy requirements rather than assuming the mortgage can simply be transferred to an investor.
FHA Financing Can Offer More Flexibility Than It Seems
FHA loans are built around homeownership, but that does not mean a property has to serve only one purpose forever.
For buyers open to living in a multifamily home or a property with rental potential, FHA financing can create room for rental income while keeping homeownership at the center of the purchase. And as circumstances change, a home that began as a primary residence may eventually take on a different role.
The important part is starting with the right intent and understanding the FHA rules before making a purchase.
This story was produced by Neighbors Bank and reviewed and distributed by Stacker.
