FHA-approved lenders receive protection from property owners who default on their loans. With that protection, lenders are more willing to offer loans, creating a better opportunity for everyday Americans to acquire property.
Let’s unpack the details of FHA loans, including whether or not you can use this loan on commercial real estate.
What Is the FHA?
To understand what exactly FHA loans are meant for, it’s important to understand the organization which distributes them.
The Federal Housing Administration, created in 1934, is a branch of the Department of Housing and Development. The FHA’s purview is improving housing in the United States. The FHA pursues policies that facilitate more equitable and accessible housing and residential property ownership for everyday Americans.
The FHA does this primarily by providing mortgage insurance to approved FHA-approved lenders. By backing the lenders of these mortgages, the FHA can provide better access to property ownership. FHA-backed loans are used to acquire mortgages on everything from single-family homes, multi-family homes, residential care facilities, and hospitals.
What Are FHA Loans?
FHA loans are home mortgage loans designed for accessibility among potential borrowers.
These loans are a boon for middle-class and lower-income Americans looking to purchase their first home. Folks with lower credit scores and first-time home buyers are less likely to be issued loans due to their financial status.
FHA loans offset the risks that come with these types of buyers by guaranteeing mortgage insurance to their lenders. Since the FHA steps in and provides insurance on these loans to approved lenders, FHA loans can make homeownership more accessible for the average American.
How Do FHA Loans Work?
The FHA doesn’t issue FHA loans; banks issue them. Borrowers who qualify for FHA loans will receive loans from lenders approved by the FHA.
The Federal Housing Authority operates in large part on the income it generates on its own. While FHA loans offer lower mortgage rates to open access to home ownership, they utilize higher interest rates and require borrowers to buy mortgage insurance.
The income generated by FHA requirements sustains the FHA so that it has surplus funds to cover potential loan defaults by borrowers.
By guaranteeing funds lent to risky borrowers, FHA loans decrease the risk put on lenders. At the same time, FHA loans also encourage borrowers to increase their wealth by getting into property ownership at a level they can afford.
What Are the Requirements for FHA Loans?
The requirements for approval of FHA loans are relatively flexible; these loans are designed to widen access to home ownership. They do not come with the same set of standards as other real estate loans.
While FHA loans are more relaxed with certain requirements, standard loan requirements like proof of income, Social Security number, and proof of residence in the state where the loan is being issued are all necessary components for FHA loan approval.
Lower Credit Scores Can Still Get Approval
People with low credit scores or a lack of credit still have ample opportunity to qualify for FHA loans. FICO considers credit scores within the 500 range “very poor” — while private lenders might decline low credit scores in this range, these folks can still qualify for an FHA loan.
This feature of FHA loans defines their accessibility. Getting approval for loans with low credit scores can be extremely difficult. FHA loans offset this barrier by offering loans to folks with low credit by requiring enrollment in mortgage insurance programs.
Low Down Payments
Down payments are one of the first steps to acquiring a mortgage. FHA loans have a relatively low threshold requirement for down payments; they can get as low as 3.5%. The low down payments available with FHA loans allow aspiring homeowners a greater opportunity to get into a mortgage with less money down.
How Much Can You Borrow With an FHA Loan?
The amount one can borrow with an FHA loan depends on several factors:
- The number of units available on the property
- The location of the property
- Regional trends regarding the pricing of loans
FHA loans have two limits based on whether or not they are in low-cost or high-cost areas. Loans have a higher limit in high-cost areas. In general, the limit is 115% of the local county’s median home price.
Can FHA Loans Be Used for Commercial Real Estate?
The opportunity made available by FHA loans is clear; these loans provide everyday Americans a better chance to become homeowners.
Because FHA loans are designed to promote equitable opportunity for homeownership, they are not ideal loans for commercial real estate enterprises. FHA loans are almost exclusively issued for residential properties: single-family homes, multi-family homes, and condos.
The majority of commercial real estate does not qualify for FHA loans. The zoning of a property is crucial in determining whether or not it meets the qualifications for an FHA loan. Because the FHA’s purpose is in the housing sector, FHA loans cannot be used on commercial properties like storefronts, office spaces, or industrial buildings.
One of the most crucial distinctions for FHA loan approval is that the property the loan is used for must be owner-occupied: the borrower of the loan must live in the mortgaged property. This distinction for FHA loan approval necessarily eliminates the vast majority of commercial real estate from qualifying.
Renting Owner-Occupied Homes
While FHA loan borrowers must live in the mortgaged property in order to qualify for the loan, they still have the opportunity to earn income on their property by renting out rooms.
Suppose an FHA loan is used on a single-family home with multiple bedrooms, condos, or a multi-family home that can accommodate more than one tenant. In that case, owner-occupiers have the opportunity to rent out rooms in their home while abiding by the strictures of the loan requirements.
The borrower of the loan simply needs to demonstrate to the lender that they live or intend to live on the premises.
While not technically a commercial real estate property, this strategy of leasing out rooms in the mortgaged building provides borrowers a means by which they can earn an income on their mortgaged property.
Should You Apply for an FHA Loan?
Depending on your financial goals, an FHA loan could be an advantageous financial move. FHA loans are meant to help you acquire a home. If you are in the market for a new home and need a loan that offers low down payments, FHA loans can give you a leg up in getting into the housing market.
However, FHA loans are not likely to serve your interests if you’re looking for a loan for purely investment purposes. FHA loans function primarily for first-time home buyers with modest incomes. For investment purposes, there are plenty of other loans available that will propel your financial goals.
The Bottom Line
For many people, an FHA loan is a great option to own a home with a low down payment and imperfect credit.
While an FHA loan may not be the right choice for a strict commercial real estate investment, it can be used in the event of an owner-occupied property that pulls double-duty. It could be a smart choice for the savvy homeowner who wants to live in a property and rent out a unit on the side.