Federal Housing Administration (FHA) loans make it easier for prospective homebuyers to get the financing they need to buy a home. With a minimum down payment requirement of just 3.5% and a credit score requirement of above 500, they are a lifeline for anyone struggling to buy a home with a conventional mortgage.
However, while it’s easier to get approved, there are still requirements borrowers must meet before getting approved. One of them is that you must have a regular income or work history to prove you can afford repayments. But what if your regular income comes from rental income?
Can I use rental income to qualify for an FHA loan?
The good news is that yes, your rental income can qualify as the required income stream you need to get approved. The rules state that you need to have a steady income source, either two years of work history or another form of stable income.
Rental income qualifies under this but there are some guidelines you need to know about. The way rental income is defined, calculated, and approved isn’t a simple case of looking at your income like lenders would with a job. It’s a more complex approval process.
First, you need to know exactly how rental income is defined by the FHA to see if you qualify.
How is rental income defined by the Federal Housing Administration?
Rental income can vary from small residential properties to large commercial buildings. The FHA has rules on which it will consider rental income. FHA guidelines in HUD 4000.1 define rental income as:
“Rental Income refers to income received or to be received from the subject Property or other real estate holdings.”
The guidelines also state that it will consider two types of residential property as rental income:
“The Mortgagee may consider Rental Income from existing and prospective tenants if documented in accordance with the following requirements. Rental Income from the subject Property may be considered Effective Income when the Property is a two- to four-unit dwelling, or an acceptable one- to four-unit Investment Property.”
So, if the rental property you own provides housing for more than one family but fewer than five, this is known as a two- to four-unit and qualifies under these rules. If your property has one to four residential units, it also qualifies as rental income.
FHA guidelines on the use of rental income
To get approved for an FHA loan on the basis of your rental income, your lender has to make a simple calculation. They must use your net rental income, plus the depreciation from schedule E of your tax returns, and then divide that by 12.
If your rental property is new and you don’t have an official history of being a landlord, lenders will only consider 75% of your rental income on your loan application. This is because they prefer to see a long history of steady income rather than a new income stream.
If the home you intend to purchase will be a rental property as well, you can also use this future income to qualify for an FHA loan. However, the rules around this are tricky. You will need to complete the HUD form 92561 which is used to determine your Self-Sufficiency Rental Income Eligibility.
The rules on this state:
“Net Self-Sufficiency Rental Income is calculated by using the Appraiser’s estimate of fair market rent from all units, including the unit the Borrower chooses for occupancy, and subtracting the greater of the Appraiser’s estimate for vacancies and maintenance, or 25 percent of the fair market rent.”
FHA loan renting restrictions
The only renting restriction for FHA loans is that the property must also be used as your primary residence. You won’t be able to get an FHA loan if you intend to only rent the property out and never live in it yourself.
Does that mean you can’t ever make rental income on a home you buy with an FHA loan? No, there is a simple loophole.
Homebuyers must plan to live in the home for one year before moving out and renting it to others. Beyond that, there are no restrictions on how you use the property once you’ve purchased it.
If you are considering applying for an FHA loan, it’s well worth researching the requirements and speaking to an expert advisor who can point you in the right direction.
Get help with applying for an FHA loan with OVM Financial. Our team of experts are with you every step of the way to help you get the home loans that you need to purchase your property.