With all of the benefits that FHA loans provide, many of those who want to enter the world of real estate investing have often wondered whether it’s legal to use an FHA loan for investment property. FHA loans were designed to help first-time homebuyers secure their first primary residence, so there are protections in place to make sure that they are not abused.
In short, investment properties are not directly eligible for FHA loans, as these mortgages are specifically designed for primary residences, with only limited exceptions. While you cannot use FHA loans for investment purposes directly, there is a potential pathway: you can convert a primary residence purchased with an FHA loan into an investment property after a certain period, depending on various factors. However, this approach to real estate funding requires careful navigation as it as not straightforward and there are alternative lending options available for investment property financing that are specifically for investment properties.
At Defy Mortgage, we specialize in providing innovative lending solutions to make homeownership accessible and straightforward, from QM home loans such as FHA loans to non-traditional options in the non-QM such as bank statement loans and P&L loans. Whether you’re an entrepreneur, freelancer, or real estate investor, our non-traditional mortgage options are designed to meet your unique needs. With competitive rates and a user-friendly platform, we make navigating the mortgage process simpler and more efficient.
Drawing from our experiences in providing FHA loans in various US states and investment property loans like DSCR loans in many more, we’ve written this guide to explore how it is possible to legally use FHA-financed properties to pursue investment goals, but only after a certain point in time.
We’ll cover the various methods that people have employed in the past, and discuss the various caveats you should watch out for if you ever decide to use an FHA-purchased home for investment purposes down the line, and more suitable loan options for investment properties.
Let’s jump in and take a closer at occupancy requirements, restrictions, examples and how you can use FHA loans for your next real estate purchase.
What Is an FHA Loan?
An FHA loan is a mortgage insured by the Federal Housing Administration (FHA). These loans have low down payments—as little as 3.5% for qualified buyers—and lenient credit requirements, making them attractive to first-time buyers. However, there are restrictions that limit using an FHA loan for investment property.
What FHA Loans are Intended for
The primary goal of FHA loans is to help individuals achieve homeownership by providing affordable financing for owner-occupied properties. These loans were not designed for real estate investors looking to expand their portfolio but rather to assist buyers in purchasing their primary residence. Due to their reduced down payment requirements and more lenient credit score thresholds, FHA loans frequently appeal to first-time homebuyers who qualify.
However, there are ways to use properties secured with FHA financing as investments. Again, the key point is “time”. These methods typically require working within the restrictions placed on FHA loans to discourage real estate investors from exploiting them.
Key Restrictions on FHA Loans
FHA loans come with several restrictions, with the most relevant ones to real estate investment being:
- The property must serve as your primary residence for at least one year. Borrowers are required to certify occupancy, ensuring compliance with federal guidelines.
- Primary residents must meet the livability standards and move in within 60 days of closing.
- FHA loans cannot be used to purchase purely investment properties. This means that commercial properties, mixed-use properties, short-term rentals, and vacation homes are not eligible.
Failure to adhere to these rules can lead to significant penalties, such as loan denial and legal consequences.
Exceptions and Loopholes: When Can FHA Loans Be Used for Investments?
Although FHA loans were primarily designed to give Americans an easier pathway to achieving homeownership, there are avenues that you can take to enter the real estate investing space using FHA financing, allowing you to enjoy its benefits while earning an income from your FHA-purchased property.
Flipping the Home After the One-Year Residency Period
Once you have fulfilled the FHA’s one-year residency requirement, you may consider flipping the property as an investment strategy. This involves purchasing a home in need of significant repairs, living in it while completing the renovations, and then selling it for a profit.
For instance, imagine finding a home priced significantly below market value due to its condition. By investing in the necessary updates, you could potentially sell the property at a much higher price, taking advantage of the increased market value. This approach allows you to benefit from both short-term gains and the ability to move on to your next investment opportunity.
Refinancing an FHA Loan for Investment Use
Another pathway is refinancing. After fulfilling the one-year residency requirement, you may refinance your FHA loan into a conventional loan, converting the property into an investment. This strategy is common among homeowners who wish to leverage their first property for long-term gains.
Although it doesn’t translate into a regular source of income like a rental, it does let you build up equity, which makes an eventual resale all the more lucrative, or be tapped into in the future in the form of a home equity loan or home equity line of credit (HELOC).
House Hacking Strategies
A popular tactic among real estate enthusiasts, “house hacking” refers to the act of using your home to generate income while you use it as your residence, and FHA loans are often suited for this purpose. Using an FHA loan, you can purchase a primary residence while generating rental income from spare rooms or additional units. Keep in mind though that restrictions may apply given your lender of choice and the location of the home. This approach can help offset mortgage payments and build equity. There are a number of “house hacking” strategies that can help offset the costs of home ownership:
Split the Home With Housemates
Sharing your home with housemates is one of the simplest ways to offset costs. By renting out a portion of your home, you can collect rent while splitting utilities and maintenance expenses.
While sharing your living space may compromise some of your privacy, the financial benefits can outweigh the disadvantages. If you decide to go this route, you should carefully vet potential housemates to find someone who aligns with your lifestyle.
Rent Out Units in Multi-Family Properties
One popular exception to the rule that you cannot use an FHA-financed property purely as an investment is to purchase a multi-family property and live in one of the units. FHA loans allow borrowers to buy properties with up to four units and rent them out, provided they occupy one of the units as their primary residence. This setup essentially works like splitting a home with housemates, without compromising privacy.
However, keep in mind that the FHA accounts for your self-sufficiency test. This test evaluates whether the rental income from the other units in a multi-family property is sufficient to cover the mortgage payment, including principal, interest, taxes, and insurance (PITI). For properties with three or four units, the projected rental income must equal or exceed the monthly mortgage payment. To ensure accuracy, lenders typically use 75% of the projected rental income to account for potential vacancies or maintenance costs.
Rent Out Additional Space
If present on your property, a basement apartment, detached garage, guesthouse, or even a spare room can generate additional rental income. Before diving in, be sure to check your local short-term rental regulations and homeowners association (HOA) rules, as some HOAs prohibit both short- and long-term rentals outright.
If permitted, short-term rentals are a more flexible way to explore space sharing as an additional revenue stream. Platforms like Airbnb and Vrbo allow you to rent out spare rooms, offering a taste of the landlord experience without the commitment of long-term tenants. Women property owners may prefer Golightly, a platform that caters exclusively to women and vets all guests and hosts for added safety.
Extra outdoor space can also be monetized, whether by renting out storage areas, parking for RVs, or even living in an RV yourself while leasing the main home.
If you don’t have any space readily available, you can also set up accessory dwelling units (ADUs)—self-contained living spaces like a converted garage or detached guesthouse—to rent out.
Risks and Consequences of Misusing FHA Loans
While it’s possible to take advantage of FHA loans within legal boundaries, it’s important to note that failure to adhere to any of the guidelines will result in legal consequences. There can also be financial drawbacks to using FHA loans to finance an income-generating property, as well as far-reaching ethical repercussions for overusing FHA loans to build a real estate investment portfolio.
Potential Legal Issues
Using an FHA loan for investment purposes without adhering to the program’s guidelines is considered loan fraud—a serious offense. The consequences of such actions may include:
- Legal Penalties: Failing to work within the restrictions of FHA mortgages may result in severe penalties, up to and including imprisonment. With minor infractions, you may face substantial fines, which can escalate quickly and drain your financial resources.
- Immediate Loan Repayment: Borrowers caught misusing FHA funds may be required to repay the remaining loan balance in full immediately.
- Foreclosure Risk: Non-compliance could also lead to immediate foreclosure if you cannot raise the funds for immediate loan repayment.
Observing the restrictions imposed by the Federal Housing Administration will allow you to avoid these legal repercussions. It’s often best to consult a lawyer before setting out to use an FHA loan for investment purposes, to ensure that you keep well within the bounds set by the FHA.
Financial Risks
Modifying an FHA-financed home to generate income can also result in financial risks:
- Increased Cost of Entry: FHA loans require mortgage insurance premiums (MIP) for the life of the loan. Even if you built substantial equity, the monthly payments on FHA mortgage insurance can erode your profits and diminish your overall returns. Additionally, FHA loans come with stringent property appraisal standards, which could necessitate costly repairs or upgrades.
- Limited Property Choices: FHA loans are primarily intended for primary residences, which limits their flexibility for investment purposes. Strict eligibility criteria, FHA loan limits, and occupancy requirements can narrow your property options, especially in a competitive market. These restrictions may force you to compromise on the property’s location, condition, or potential profitability.
- Stricter Refinancing Rules: FHA loans come with specific restrictions that may limit your ability to refinance. Even if you haven’t violated specific loan terms, individual lenders may impose additional restrictions on top of the FHA’s guidelines, which can make it much more complicated to use the property as an investment.
Ethical Considerations
Circumventing FHA rules undermines the program’s intent to support first-time homebuyers. Although working within the FHA’s restrictions is legal, you should not rely entirely on FHA loans when building your portfolio. Instead, there are alternatives for real estate investors that are accessible, flexible, and customizable to meet your unique needs. Options such as DSCR loans, for example, provide real estate investors with options to use rental income to quality. No tax returns are required.
FHA Loan For Investment Property FAQ
Can I use an FHA loan to purchase a second home if my first home is an investment property?
You can do so as long as you use the second home as your primary residence. Once you have purchased the second home, you will have to move out of your current home and use the second home as your primary residence for at least 12 months after the closing date.
What happens if I move out of my FHA-financed home before the required one-year period?
Moving out prematurely without notifying your lender can lead to penalties, including loan repayment demands and potential legal action. In case you need to move out of your FHA-financed home, you can discuss this with your lender to work out terms and gain their approval.
Are there other loan options better suited for investment properties?
Yes, DSCR loans, and other non-FHA options are often better suited for purchasing investment properties, because they have features that accommodate such property types specifically. Debt service coverage ratio loans (DSCR), for example, define loan terms such as the amount and interest rate according to the property’s income potential rather than the borrower’s personal finances.
How do lenders verify that an FHA loan is being used for a primary residence?
Lenders look at your personal documentation, such as utility bills, ID cards, and tax returns, to confirm residency compliance. This is fairly easy to verify as much of this information, such as your driver’s license, can be looked up on a public database.
Can I refinance my FHA loan to convert it into a conventional loan for investment purposes?
Yes, refinancing is a popular choice for transitioning the property into an investment after meeting FHA guidelines.
Key Takeaway
While the use of FHA loans for investment property is limited, exceptions like multi-family purchases and house hacking provide valuable opportunities for aspiring investors. However, adhering to FHA guidelines is critical to avoid penalties. Remember that these rules require the property to serve as your primary residence for at least one year and prohibit using the loan primarily for investment purposes.
If you’re interested in maximizing the utility of an FHA loan by using it to generate income as well as secure a home, you can explore strategies like renting out spare rooms, creating accessory dwelling units (ADUs), or leveraging multi-family properties to combine homeownership with real estate investment.
Ready to start your real estate investment journey? Connect with Defy for a free consultation on your strategy. Our 75+ lending options include investment property loans such as jumbo loans and fix and flip loans, each fully customizable to fit every investment scenario.
