What Are FHA Multifamily Loans And Who Is Eligible?

If you’re thinking of buying a home with several units so that you can live in one and rent out the others for investment income, you might find yourself looking into FHA multifamily loans. While these are great in specific instances, if you’re just looking to rent out a few units, you may not need one.

What Is An FHA Multifamily Loan?

A Federal Housing Administration (FHA) multifamily loan allows borrowers and real estate investors to buy a multifamily home, which is defined by the FHA and other mortgage investors as a property that has five units or more. Homes with up to four units are considered single-family housing, so those properties wouldn’t qualify for this type of loan.

Under the traditional FHA mortgage program, clients can purchase a home with up to four units. The advantage of this is that borrowers can get favorable terms such as a low down payment and they may receive lower interest rates than they would with typical multifamily financing. In addition, requirements for income, credit and debt-to-income ratio (DTI) are less strict than many other loan options.

For Owner-Occupiers

The FHA joined the Department of Housing and Urban Development (HUD) in 1965, becoming a key part of the housing strategy for the U.S. to allow more people to own and occupy homes. The mission of the FHA is to make housing available to home buyers with lower incomes or past credit mistakes that might otherwise keep them from fully participating in the housing market.

While the FHA doesn’t directly make home loans, it insures these loans. This means that lenders take on less risk when they originate these loans in the event that a borrower defaults.

Even if you’re buying a home with multiple units, as long as the total number of units is less than five and you plan to live in one unit as your primary residence, you can likely use a regular FHA loan to finance your purchase.

For Commercial Investors

If you’re a commercial investor looking to buy a property you won’t live in, or if you want a property with five or more units, the owner-occupied program isn’t for you. The FHA also has commercial loan programs that might better suit your financing needs.

Those looking for this type of financing can be for-profit or nonprofit entities.

Rocket Mortgage^® doesn’t offer financing for those seeking to buy five or more units.

How Does An Owner-Occupied FHA Multifamily Loan Work?

Certain aspects of applying for an owner-occupied multifamily home of four units or less are the same as applying for a home with a single unit. You’re going to be qualified based on your credit score, income and existing debts along with the appraisal. However, there are two primary differences when dealing with a home with multiple units.

The first distinction is that rental income is used to determine qualification. This makes sense because the reason to buy extra units is usually to rent them out. Secondly, because buying additional units costs more money, loan limits are higher with each additional unit added to the property.

What Are The FHA’s Loan Requirements?

Most people looking to live in a home and rent out the rest don’t actually need a multifamily home – they need a multiunit single-family home. The FHA has several requirements to qualify for an FHA multifamily loan.

Income

As with any mortgage, the first items a lender will look at in determining your income are W-2s, 1099s and tax returns. However, you'll also have a special appraisal done when you're using rental income to qualify called a 1025. In addition to valuing the property, the appraiser will place a fair market rental value on the units.

One special note for three- or four-unit properties is that they have to generate income equal to or greater than the monthly mortgage payment (including principal, interest, taxes and homeowners insurance) after a 25% deduction designed to account for the time when the property might be under maintenance or you need to find a new tenant.

Credit Score

You need a median FICO^® credit score of at least 580 in order to qualify for an FHA loan. The higher your credit score is, the better rates you’ll be offered. Another thing to be aware of is that lenders look at your credit history in addition to the score itself. As an example, if you’ve experienced a foreclosure, you have to wait 3 years before applying for a new FHA loan.

Debt-To-Income Ratio

Your DTI measures how much of your pretax income goes toward paying debts every month. There are two types of DTI: front- and back-end DTI.

Front-end DTI, also called the housing expense ratio, looks at how much of your monthly income you spend on your mortgage payment alone (principal, interest, taxes and insurance). Your back-end ratio takes into account your mortgage payment plus all of your other existing debts including car payments, student loans and minimum credit card payments.

In order to qualify with a median FICO^® Score of between 580 and 620, you need a housing expense ratio no higher than 38% and an overall DTI no higher than 45%. If your score is 620 or better, FHA systems will approve you with a back-end DTI as high as 67%, although this varies based on other qualifying factors.

Appraisal

Appraisals serve two purposes: to place a value on a home and to make sure it's safe to occupy. The valuation portion of an appraisal is important because lenders can't loan you more than the home is worth. The reasoning for this is that if you have trouble making your payments and go into mortgage default, one recourse a lender has is to take the house back and resell it.

The FHA does have some special safety regulations when compared to other mortgage investors. The most well-known of these is that properties built before 1978 with chipped or peeling paint have to be scraped and repainted prior to closing because of the possibility of lead paint.

Owner-Occupied

Multiunit single-family homes backed by FHA loans must be owner-occupied in at least one of the units. You can’t use an FHA loan strictly to get an investment property.