What is the FHA self-sufficiency test?

You can use FHA mortgages to buy all kinds of properties, including three- to four-unit ones you plan to use — at least partially — as a rental.

But there’s a catch: In order to qualify, the property must pass the FHA’s “self-sufficiency” test, which ensures that rent from the property can fully cover your mortgage payment.

Are you considering using an FHA loan to buy a multi-family property? Here’s how the self-sufficiency test will play into the process.

What is the 75% rule for FHA loans?

The 75% rule and the self-sufficiency test go hand in hand when buying a multi-unit property with an FHA loan. Under the rule, the FHA will take into account the lesser of 75% of the property’s monthly rent potential (as determined by an FHA appraiser) or 75% of the rent stated in your current lease agreement. This is to account for potential vacancies within the property and is referred to as a “vacancy factor.”

This amount is then compared against the expected mortgage payment on the property, and if it’s enough to cover the payment fully, the home passes the FHA’s self-sufficiency test. If it’s not enough, the property will not pass and, therefore, won’t qualify for FHA financing.

Here’s an example: Say you’re buying a four-unit property with an expected mortgage payment of $2,900 per month. The FHA appraiser determines the home will bring in $4,000 per month in rent. Your lender will then take 75% of that — or $3,000 — and compare it to your expected mortgage payment ($2,900). Since $3,000 is enough to cover that payment, the home would qualify for FHA financing.

Why is the FHA self-sufficiency test required?

The self-sufficiency test is important, as it ensures the property can sustain itself outside of your own personal income. If you were to lose your day job, for example, and have no income coming in, the property itself would still make enough off rent to cover your housing payment and stay current on the loan.

To be clear: You’ll still need to meet the other qualifying requirements of the FHA loan program. The self-sufficiency test is an additional requirement that’s unique to multi-family purchases only.

How the FHA Self-Sufficiency Test is Calculated

You need two numbers to calculate whether a property passes the self-sufficiency test or not.

1. First, you need the total monthly rental income. This is determined by an FHA appraiser or, if you already have a lease agreement in place with your future tenants, the agreed-upon rent stated in that lease. Then, you’ll take 75% of that number to account for a 25% potential vacancy factor (per the 75% rule).

2. Compare the 75% to the mortgage payment your FHA loan will come with. Your lender can help you with this, but it should include your monthly principal, interest, tax, and insurance payments (also called PITI).

All in all, the calculation should look like this:

Monthly rent potential x 0.75 ≥ Monthly PITI payment.

Example Calculation

Since the monthly rent with vacancies factored in ($3,750) is less than the monthly mortgage payment ($4,000), the home would not qualify for an FHA loan.

What happens if you fail the FHA self-sufficiency test?

Many properties fail the self-sufficiency test, often due to overestimated rents or ignoring the vacancy factor in those rents. Fortunately, if a property doesn’t pass the first time around, as in the example above, you have a few options that may help your case.

First, you can make a bigger down payment, which would reduce your loan amount and potentially put your monthly mortgage below the property’s monthly rent potential (thereby passing the self-sufficiency test).

You could also attempt to get a lower interest rate with the same goal. You might be able to do this by increasing your credit score, buying discount points, or shopping around with different lenders.

Finally, you could also explore using other loan programs that do not require a self-sufficiency test, such as a conventional loan, for example.

Tips to Pass the Self-Sufficiency Test

If you’re hoping to buy a multi-family property with an FHA loan, being prepared is key to ensuring it passes the self-sufficiency test.

You should:

• Get an accurate rent appraisal: An official, third-party appraiser is going to be best equipped to give you an accurate calculation of a property’s rent potential (not your real estate agent).

• Don’t forget vacancies: Multi-family properties will have vacancies from time to time, which is why the FHA only considered 75% of a property’s rent potential. Don’t forget this vacancy factor when calculating your potential rental income.

• Choose the property carefully: Focus your search only on properties with strong rent potential and marketability. This will ensure your estimated rents are high enough to cover your mortgage payment.

• Make repairs and upgrades: Ensuring the home is in good condition can increase its rent potential and help the property more easily pass the self-sufficiency test.

Talk to a Neighbors Bank loan specialist if buying a multi-family with an FHA loan is on your radar. We can help you plan ahead for success.