Can You Buy A Duplex With FHA Loan?

Purchase a Duplex with FHA Financing

For home buyers, an FHA mortgage is a popular option. The government guarantees FHA loans, reducing the risk for lenders and allowing them to offer more favorable terms to borrowers. These improved terms help more people to become homeowners, but can they assist you if you want to own a duplex?

FHA loans allow the purchase of multi-family homes, which opens up the possibility of buying this type of property to a wider range of people. However, there are some extra requirements that you need to consider if you want to own a duplex with an FHA loan.

We look at what you need to know before purchasing a duplex with this type of mortgage.

Why Choose FHA Loans?

The Federal Housing Administration insures loans, allowing more people to become homeowners. These loans are popular among first-time buyers due to their more flexible and forgiving terms. If qualifying for a conventional loan doesn’t seem easy, an FHA loan may be a better option.

Whether you’re a first-time buyer or not, it can be used to buy single-family homes and multi-family properties containing up to four units.

Can I Qualify for a Duplex FHA Loan?

As with any mortgage, you will have to meet certain requirements to qualify. And with an FHA loan, these are generally more lenient.

You need to meet the income requirements for the loan you want and ensure that your debt-to-income ratio isn’t too high. You need a better credit score to benefit from a lower down payment.

A few more steps are required to qualify when buying a multi-family property instead of a single-family home. However, don’t let this deter you; let’s take a look.

Income Requirements

Even though the FHA backs the loan, lenders need to see that your income covers the mortgage payments. Though there isn’t really a minimum income requirement, it does have to be enough to cover your monthly payments and debt-to-income guidelines.

The real advantage of a duplex purchase is the income it provides. Leveraging the rental income to qualify for the loan will also help cover your mortgage payments.

Debt-to-Income Ratio

The lender assesses your income and compares it to your monthly debt payments. This shows them your DTI ratio, and generally, this should be 43% or less.

When mortgage payments are factored in, your debt payments should not exceed 43% of your income. If you stay within this limit, the lender will view you as capable of affording the mortgage. Some lenders may permit higher DTI ratios, although you might be required to make a larger down payment.

Your Credit Score

FHA loans benefit from more generous credit requirements compared to a conventional mortgage. Depending on your lender, it might be possible to be approved for a loan with a credit score as low as 500. However, with such a low credit score, you will need to have a larger down payment.

The exact requirements for a credit score will depend on the lender.

Down Payment for a Duplex

If you want to benefit from buying a home with a down payment as low as 3.5%, the minimum credit score has to be at least 580. If your credit score is between 500 and 579, you must have 10% of the purchase price as a down payment.

As with other FHA financing, gift money can be used to fund the down payment. If you have a family member willing to help you own a duplex, they must provide a gift letter. The letter should state that there is no expectation that the money will be paid back. They also need to provide documentation that shows the lender where this money came from. 

Non-Occupant Co-Borrowers

If you need further help purchasing a duplex, a family member can become a non-occupant co-borrower. As the name suggests, they can’t live in the home and will have joint responsibility for the mortgage. But if you don’t have the best credit, a non-occupant co-borrower could allow you to buy the duplex.

When using a non-occupant co-borrower, their income and creditworthiness will become part of the mortgage application. This also means that if the home were to foreclose, it would harm their credit history as well.

How to Buy a Duplex with an FHA Loan: Loan Requirements

The process involved in purchasing a duplex differs slightly from a single-family home purchase. You need to find a suitable property with a price within the FHA loan limits for the area. These loan limits can differ between neighboring counties and are adjusted yearly to keep up with the changing housing market.

Loan limits for multi-family homes are larger than for single-family homes. So even though you will likely need a larger mortgage to purchase a duplex, the property could still be within FHA limits for the county. 

The FHA doesn’t allow the purchase of investment properties. When you are acquiring a duplex or other multi-family home, you have to live in one of the units. Rental income is another consideration that could be important in your mortgage application.

Qualify for an FHA Loan with Rental Income

Owning a duplex allows you to use the rental income to help you qualify for and pay the mortgage. Using this income will increase the loan amount available to you. You can usually expect up to 75% of the anticipated rental income to be counted in your application.

An appraiser will have to carry out a market rent analysis so that the lender can properly judge the mortgage application. Market rent analysis should show what the fair rent is for that type of property in the area. This ensures projected rental income is realistic when the unit is occupied.

Since rental properties don’t generally have 100% occupancy, the lender is not going to use all of this income in their assessment to offset your mortgage payments. 

FHA Appraisals When Buying a Duplex

The FHA also needs the appraiser to value the home so that the loan isn’t more than the property’s worth. This prevents the lender from taking much of a financial loss should the borrower default.

The appraiser also has to ensure that the property is safe based on FHA’s minimum property standards. They will use the HUD’s guidelines to make sure residents aren’t going to be harmed because of hazards in the home. While this might sound like a home inspection, they aren’t the same, and you still need to pay for an inspector’s report.

FHA Self-Sufficiency

To qualify for an FHA mortgage on a 3 or 4-unit property, you have to pass the FHA self-sufficiency test. This test checks that the rental income will cover the monthly payment on the property. The income must exceed the cost of principal payments, interest charges, taxes, and insurance.

When buying a duplex, you don’t need to pass this test to qualify. However, rental income will still be an important part of your qualification.

Providing Documentation

If the unit is already rented, you must show the lease agreement to the lender. If it isn’t rented yet, the rental income projection will be used instead.

The lender will also want to see a steady work history for at least the previous two years. You will be expected to provide pay stubs and bank statements to prove your income claims.

Choosing a Lender

This type of mortgage is less common and not every lender offers it. It’s also more difficult to qualify, with more steps required. For these reasons, finding the best lender for your situation can be more challenging.

FHA Closing Costs

With any mortgage, you must pay closing costs when the purchase is finalized. Closing costs can be a significant amount of the purchase price and can often be rolled into the loan. However, if you are unable to pay these closing costs upfront, you will pay interest on them as part of the mortgage.

Closing costs include the fees charged by:

• Appraisers
• Home inspectors
• Title companies
• Lenders
• Banks
• Insurance companies

There might also be charges from other professionals involved in the buying process. All these fees can add up to as much as 5% of the purchase price.

Becoming a Landlord

If you are considering buying a duplex, you have more responsibilities than simply being the owner of a single-family home. While it can be financially beneficial, it isn’t without problems.

Becoming a landlord means being responsible for maintaining the unit and dealing with your tenant. This can mean twice the maintenance you would normally expect with a home.

Sometimes tenants can cause trouble for you and unnecessary damage to the property. While these issues can be relatively easy to deal with since you live next door, managing this relationship can be tricky.

On the other hand, you might have a great tenant who causes you no trouble at all. You would also benefit from the rent money that allows you to pay your mortgage more easily, increasing your equity faster. 

Long periods without a tenant, however, can be financially difficult. To protect against vacancy gaps, having a sufficient financial cushion is essential. For this reason, the FHA has a reserve fund requirement of 3 months’ rent for a 3-4 unit, but does not have a reserve requirement for a duplex. Without spare cash to cover loan payments when you don’t have a tenant, you could be at risk of foreclosure.

Despite the potential downsides, buying a duplex should have very beneficial long-term effects on your finances. However, there are also things you can do to limit the chance of being affected by the potential downsides.

How to Avoid the Pitfalls When Buying a Duplex

Making a success of your multi-unit home purchase will be easier if you avoid the common mistakes other people have made.

Following the Rules

The FHA requires that the home be your primary residence. However, some buyers overlook this requirement, which can lead to problems. 

Home buyers are required to move into the property within 60 days of closing. They are also expected to live in the home for at least 12 months.

You risk losing your home if you do not follow the FHA guidelines. They could also demand that you pay the entire mortgage immediately. This will make you ineligible for future FHA home loans, and you may be fined or suffer other criminal penalties. However, punitive measures like fines or criminal penalties are generally reserved for cases where intentional fraud is proven, rather than an unintentional change in living circumstances

There are a few exceptions to the primary residence requirement, but they are generally strict with this rule.

Forgetting About FHA Mortgage Insurance

The FHA requires mortgage insurance to be paid on all loans. There is an upfront payment of 1.75% and annual premiums of at least 0.15%. The annual fees depend on the loan-to-value amount and are spread across monthly mortgage payments.

With at least a 10% down payment, the mortgage insurance premiums (MIP) can be cancelled after 11 years, otherwise, they will remain for the loan term. The Federal Housing Administration uses this money to pay back lenders when borrowers default, allowing lenders to offer mortgages to more risky clients.

Sometimes borrowers overlook this requirement and don’t account for it in their calculations. In some cases, you might need to refinance to a different loan program to eliminate this charge once you have sufficient equity in the home.

Inspecting the Home

A home inspection is normally recommended, but with a multi-unit property, there can be more issues. If you do not have a home inspection or take the problems seriously, there can be expensive repairs later.

The building might not show any signs of issues, but the home inspection could uncover things you don’t expect. With a home inspection, you can negotiate the repairs, adjust the price, or walk away if this can’t be agreed upon with the seller.

Summing Up Using an FHA Loan To Buy a Duplex

There are many reasons why buying a duplex with an FHA loan is a great idea. It allows you to spend more and helps repay the loan faster, building your equity.

When considering an FHA loan for this purpose, you should understand your responsibilities and the potential downsides. With these potential negatives considered, you should be more ready to become a landlord with help from an FHA mortgage.

About the author: This article was written by Luke Skar of MadisonMortgageGuys.com. As the Social Media Strategist, his role is to provide original content for all of their social media profiles as well as generate new leads from his website.

We provide award-winning customer service to clients who need to purchase a home or refinance an existing mortgage.