You’re considering FHA financing for your real estate investment. It’s a popular choice for first-time home buyers and those with lower credit scores. FHA loans are great if you’re looking to live in the property as a Nomad™ before converting it to a rental.
Let’s explore FHA loans in detail.
Eligibility/Requirements
To qualify for an FHA loan:
- Credit Score – FHA loans generally require a minimum credit score of 580. However, some lenders may approve loans with a score as low as 500, though a larger down payment will be required.
- Special Eligibility – FHA loans are backed by the Federal Housing Administration, so they’re more lenient in terms of credit and income qualifications compared to conventional loans. They’re particularly useful for first-time home buyers or those recovering from financial issues like bankruptcy or foreclosure.
Owner-Occupancy Requirement
You must meet the following occupancy rules:
- Owner-Occupancy Requirement – FHA loans are for owner-occupants only, meaning you must live in the property for at least one year. After that, you can convert the property into a rental, which works well with the Nomad™ strategy or for house hackers.
Down Payment
The down payment requirements are flexible but vary based on your credit score:
- Standard Down Payment – FHA loans require a minimum 3.5% down payment if your credit score is 580 or higher.
- Lower Credit Score Down Payment – If your credit score is between 500 and 579, you’ll need a down payment of at least 10%.
- Multi-Family Properties – For 1-4 unit properties, you can still use the 3.5% down payment option as long as you live in one of the units.
Loan-to-Value (LTV) Ratio
Here’s how much you can borrow based on your down payment:
- Standard LTV – If you’re putting down 3.5%, the LTV ratio will be 96.5%, meaning you can borrow up to 96.5% of the property’s value.
- Lower Credit Score LTV – With a 10% down payment (for credit scores between 500-579), your LTV will be 90%.
Interest Rates
FHA loans offer fixed-rate options:
- Fixed Interest Rates – FHA loans typically come with fixed interest rates, providing you with consistent payments over the life of the loan. Adjustable-rate options are less common but available.
Amortization Period
FHA loans have the following standard amortization periods:
- 30-Year Term – Most FHA loans are structured with a 30-year term.
- 15-Year Option – If you’re looking for a shorter payoff period, a 15-year term is also available but will result in higher monthly payments.
Private Mortgage Insurance (PMI)
PMI is required with all FHA loans. For FHA loans it is called a Mortgage Insurance Premium (MIP) instead of PMI but it serves the same function: protecting the lender in case you default.
Here’s what you need to know for FHA loans:
- Mortgage Insurance Premium (MIP) – FHA loans require an upfront MIP payment of 1.75% of the loan amount, plus annual MIP payments added to your monthly mortgage bill.
- Canceling PMI – Unlike conventional loans, you can’t cancel FHA’s MIP unless you refinance into a conventional loan. It’s required for the life of the loan if your down payment is less than 10%. So, to get rid of PMI on a FHA loan you’ll need to pay off the property by either selling it or refinancing it into a loan program that does not have PMI.
Loan Limits
FHA loans have specific loan limits depending on the county:
- County-Specific Limits – FHA loan limits vary by county, with higher limits in areas with higher property values. Check with your lender to get the most up-to-date limits for your county.
Number of Loans Allowed
You can usually only hold one FHA loan at a time:
- Single FHA Loan – You’re typically limited to one FHA loan at a time unless you meet specific exceptions, like moving for work or increasing family size.
If you don’t meet one of the exceptions, you’ll need to refinance into a conventional loan to get another FHA loan.
Seller Concessions
FHA loans allow for a generous amount of seller concessions:
- Up to 6% Seller Concessions – The seller can contribute up to 6% of the purchase price to help cover your closing costs, which can significantly reduce your out-of-pocket expenses.
Waiting Period After Major Financial Events
FHA loans have relatively short waiting periods after financial setbacks:
- Bankruptcy Waiting Period – You must wait two years after a Chapter 7 bankruptcy to apply for an FHA loan.
- Foreclosure Waiting Period – If you’ve gone through foreclosure, the waiting period is three years.
These tend to be better than the waiting periods required for conventional financing making FHA loans more attractive for people recovering from financial setbacks.
Refinancing Rules
Refinancing is an option with FHA loans, but there are specific guidelines:
- Streamline Refinancing – FHA offers a streamline refinance option that allows you to refinance your loan with minimal documentation and no appraisal, as long as you’ve made timely payments.
- Cash-Out Refinance – You can do a cash-out refinance with an FHA loan, but the maximum LTV is 80%.
- Recast – You cannot typically recast an FHA loan.
Property Types Eligible
FHA loans can be used for various property types:
- 1-4 Unit Properties – FHA loans can be used to purchase 1-4 unit properties, making them ideal for house hackers or Nomads™ who want to live in one unit while renting out the others.
Special Loan Features
FHA loans come with a few unique features:
- FHA 203k Loan – If the property needs repairs, the FHA 203k loan allows you to finance the cost of renovations into your mortgage. There are some pretty significant restrictions—like you can’t be the one who does the work on the property—so check with your lender for details on how this works if you want to use a FHA 203k Loan to buy a property and finance the rehab costs in with the purchase.
- Down Payment Assistance – Many down payment assistance programs are compatible with FHA loans, which can help reduce your upfront costs especially for owner-occupants (Nomads™ and house hackers).
Approval and Underwriting Process
The FHA loan approval process is more lenient than conventional loans:
- More Lenient Underwriting – FHA loans are easier to qualify for compared to conventional loans, especially if you have lower credit or a higher debt-to-income ratio.
- Longer Approval Times – Because FHA loans require government approval, they can sometimes take slightly longer to close compared to conventional loans, usually around 30-45 days.
Risks and Considerations
There are a few risks to be aware of with FHA loans:
- Mortgage Insurance Premium – The lifetime requirement of MIP can make FHA loans more expensive in the long run if you don’t refinance into a conventional loan.
- Loan Limits – The lower loan limits of FHA loans may prevent you from purchasing higher-priced properties in some areas.