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You may have heard of using Federal Housing Administration (FHA) loans for buying a primary residence, but did you know that savvy investors are also using these loans to buy rental properties?

In this article, you’ll learn about the FHA loan program, their requirements, down payment expectations, eligibility for construction loans, their suitability for rental properties, and their potential for house hacking.

 

 

[Disclaimer: We are not accountants, lawyers, or financial advisors, so please consult your own team of professionals about the topics covered in this article.]

 

What Are FHA Loans?

FHA loans are mortgage loans insured by the Federal Housing Administration, which is part of the U.S. Department of Housing and Urban Development (HUD). These loans are designed to help individuals and families buy homes, particularly those who may have limited credit history or less money for a down payment compared to conventional loans. Conventional loans usually require 20%, whereas the down payment for FHA loans can be as low as 3.5%.

What are FHA Loan Requirements?

FHA loans are mortgage loans insured by the Federal Housing Administration, which is part of the U.S. Department of Housing and Urban Development (HUD). These loans are designed to help individuals and families buy homes, particularly those who may have limited credit history or less money for a down payment compared to conventional loans. Conventional loans usually require 20%, whereas the down payment for FHA loans can be as low as 3.5%.

To qualify for an FHA loan, borrowers must meet specific requirements, including:

Credit Score: While FHA loans are more flexible regarding credit scores than conventional loans, a minimum credit score of 580 is typically required for a 3.5% down payment. Lower credit scores may still be considered with a higher down payment.

Down Payment: One of the attractive features of FHA loans is the lower down payment requirement. Borrowers can put down as little as 3.5% of the home’s purchase price. This makes homeownership more attainable for individuals who might not have substantial savings.

Debt-to-Income Ratio: Lenders evaluate a borrower’s debt-to-income ratio, which should generally be no higher than 43%. This ratio considers the borrower’s monthly income compared to their recurring debts. Having student loans will negatively impact your debt-to-income ratio, so you may want to look into ways to lower your loan payments through consolidation or paying off higher interest rate loans. 

Steady Income: Applicants should have a steady employment history or source of income.

Proof of U.S. Citizenship or Legal Residency: Borrowers must be U.S. citizens, permanent residents, or non-citizen nationals.

Can You Get a Construction Loan with FHA?

FHA does offer a loan program known as the FHA 203(k) loan, which allows borrowers to finance the purchase of a home and the cost of necessary repairs or renovations into a single loan. This is a great option for those looking to buy a fixer-upper or undertake significant home improvements. However, this loan is primarily for owner-occupied properties and not for investors or house flippers.

Can FHA Loans Be Used for Rental Properties?

FHA loans are primarily designed for owner-occupied residences, and they come with specific occupancy requirements. Borrowers are generally expected to move into the property within 60 days of closing and live there as their primary residence for at least one year. Therefore, investors who are looking to use FHA loans for their rental properties will be limited to house hacking.

House hacking involves living in one unit of a multi-unit property while renting out the others to help cover the mortgage. With FHA loans, you can buy multi-unit properties of up to four units.

Our personal experience

We have seen many examples of investors in our community using FHA loans to buy rental properties.

In one situation, an investor bought a duplex with three bedrooms and two bathrooms on each side that required quite a bit of fixing up. After purchase, they immediately moved into one side of the duplex and started working on fixing up the other side. Once it was fixed up, they were able to generate enough rent to cover the mortgage payment. From there, they fixed up their own unit while living in it. Once fixed up they rented one of the three bedrooms as a
short-term rental. The total income from this rental allowed them to cashflow on the property! 

   

In another situation, an investor couple used an FHA loan to buy a home with a mother-in-law unit above the garage. They chose to live in the mother-in-law unit and rent out the home as a short-term rental. Since short-term rentals are generally associated with higher revenue, they were able to earn a significant amount of income from their property. They were able to boost their cash-on-cash return even more by self-managing, which was easy to do because they lived there! Not only that, they were able to tap into the tax savings you can get from investing in short-term rentals.

Our thoughts on using FHA loans for rental properties

We see FHA loans as a great way for investors of all types to kickstart their real estate investment journey, especially when they don’t have the funds for the 25% down payment that is typically required for rental properties.

We see a lot of potential scenarios for using an FHA loan for rental properties:

  • Medical students or graduate students: Imagine buying a fourplex during medical school or residency, living in one unit and then renting out the other three units to your classmates. In this scenario, you should do your numbers and buy the type of property that will allow you to cashflow with the three units rented so you are not only living rent free, you are making money!
  • Recent graduates of residency, fellowship or graduate school: FHA loans are great for recent graduates who have a lot of student loan debt and not a lot of money saved up for a downpayment. 
  • Experienced investor: You might even be able to take advantage of an FHA loan if you’re an experienced investor. An FHA loan might be especially useful when you run out of money for the next investment. Using the property as a short-term rental is also highly attractive because you can not only earn a significant amount of cashflow, you can also generate tax savings as well.

FHA loans have the added advantage of financing rehabs, which allow investors to access forced appreciation, which is one of the best ways to significantly grow your equity in a property. 

Work with an investor-friendly lender on your next FHA loan

If you’re considering an FHA loan, you will want to consult with a lender who has a considerable amount of experience working with investors and rental properties because FHA loans aren’t typically used for investment purposes. If you need a referral to an investor-friendly lender, CLICK HERE for an introduction.

 

Do you want to learn how to creatively fund your real estate portfolio and achieve financial freedom? Join the conversation! Follow our Semi-Retired MD  Facebook page and join our Doctors or Professionals  group!

Semi-Retired M.D. and its owners, presenters, and employees are not in the business of providing personal, financial, tax, legal or investment advice and specifically disclaims any liability, loss or risk, which is incurred as a consequence, either directly or indirectly, by the use of any of the information contained in this blog. Semi-Retired M.D., its website, this blog and any online tools, if any, do NOT provide ANY legal, accounting, securities, investment, tax or other professional services advice and are not intended to be a substitute for meeting with professional advisors. If legal advice or other expert assistance is required, the services of competent, licensed and certified professionals should be sought. In addition, Semi-Retired M.D. does not endorse ANY specific investments, investment strategies, advisors, or financial service firms.

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Hi, we’re Kenji and Leti

we provide coaching and mentorship for doctors and high-income earners

Several years ago, we were newlyweds working as full-time hospitalists. On paper, it looked like we had everything: the prestigious careers, the happy marriage, the luxurious rental home, the cars, etc.

But in reality? Despite having worked for several years, we had very little savings. Despite our high income, we had very little freedom in terms of time or money.

One thing was clear: we had to do something.

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