If you plan to buy a 3 to 4–unit property and will use FHA financing to buy it, you’ll have to pass the FHA Self-Sufficiency test. Understanding the test and how it will affect your chances of loan approval can help you prepare the most.
The Basics of the FHA Self-Sufficiency Test
The FHA wants lenders to determine if the property you plan to purchase is self-sufficient. In other words, that the monthly mortgage payment the total rent received. The total monthly mortgage payment includes the principal, interest, taxes, and insurance. A property isn’t self-sufficient if the mortgage exceeds the amount of rent you will receive.
Passing the Self-Sufficiency Test
In order to pass the self-sufficiency test, you’ll need to know the net rental income for the property. You can obtain this number from an appraiser. This professional can determine the potential of the rent you can receive for the property according to the current market.
Basically, what the appraiser tells you is how much rent you can charge and expect to make on the home. Next, the lender will determine the vacancy rate in your area. Let’s say the vacancy rate is 10%. The lender would deduct 10% from the rent to account for it.
You will need to compare the net rental income to the total mortgage payment. This means all parts of the mortgage payment, which includes:
- Real estate taxes
- Homeowner’s insurance
- Mortgage insurance
The total mortgage payment can’t be more than the market rent as determined by the appraiser.
This test is one of the largest hurdles in qualifying for an FHA loan on a 3-4 unit property. Passing the test means the home will pay for itself, assuming you receive the designated rent.
Qualifying for the FHA Loan
Just passing the Self-Sufficiency test doesn’t mean you’ll automatically get the FHA loan, though. You still must qualify for the loan. This means you must prove that you meet the following requirements:
- 580 credit score
- 5% down payment
- 31% front-end ratio
- 41% back-end ratio
- Stable income
- Stable employment
These are the basic FHA guidelines; some lenders may have more expansive requirements, especially when it comes to a 3-4 unit property. Lenders take a big risk by providing you with 97.5% financing, especially on a property that you will rent out. However, with FHA financing, you must prove that you will live in one of the units in order to qualify. That is a caveat of the FHA loan and is the only way you can use this financing to secure a rental property.
The self-sufficiency test is there to help you make sure you don’t get in over your head. While it may seem restrictive, it’s there to help you make sure that you don’t take a mortgage larger than you can afford.