Can someone confirm the 85% gross rent rule for FHA loans?

19 Replies

I was told by my mortgage broker that in order for a property to qualify for an FHA loan, 85% of the gross market rent for all units in a 2/3/4-plex must be more than the PITI, otherwise they won't approve the loan.

In Oregon I'm having a diffcult time finding properties that meet this rule, especially for duplexes, where most of the time my maximum offer would be $50k-$100k lower than market price. 4-plexes tend to meet this a bit, but for the most part it's been really hard to find.

A listing agent for a duplex in town said that he has sold many multifamily properties to buyers using FHA loans and has never heard of the 85% rule and didn't know what I was talking about.

Can anyone confirm that the 85% gross rent rule is actually a thing, or am I just not understanding it correctly? I'm thinking that in order to find a property that meets the 85% rule it's probably going to be in a C class neighborhood because those are the places with more cash flow. Thoughts anyone?

You can only use fha if it's going to be your primary residence. The only thing I know that applies to 85% and fha is how much you can cash out.

yeah that guy doesnt know what the heck he's talking about. gross rent must be greater than PITI for 3-4 units (triplex, fourplex) not for a duplex.

Wow, I've never heard of that 85% rule. Here's where I think the confusion may lie:

You are allowed to count 75% of the rents received from the non-owner-occupied units as your own income in order to qualify for a (higher) mortgage. Here's an example for a quad:

Unit 1: Yours

Unit 2: $650/mo

Unit 3: $650/mo

Unit 4: $500/mo

Total all non-owner-occupied units = $1,800

75% of that: $1,350 -- which you can use as additional monthly income to qualify for the mortgage.

Now, this was the case in December 2013 when I closed on my FHA mortgage for the triplex I own and still live in.

Have you called around to several other mortgage brokers? If this "85% rule" is indeed rubbish as the other respondents and I seem to think, you may want a different broker. ;-)

@Paul Spangler Maybe the mortgage broker has a typo. Or maybe that is lender's own guideline. According to FHA guideline, the property must be owner occupied within 60 days and for at least 1 year. FHA will not insure pure investment properties that it's not owner occupied. So 85% LTV on a pure investment property that's not owner occupied is irrelevant.

There is a 75% rental income limit for rental history less than two years when counting cash flow and assets.  For rental income more than two years, it will be according to financial statements or schedule E on tax return.  So for rental property income that has more than two years rental history, theoretically property can bypass the 75% upper limit when counting income.  

@Steve K. - thanks for adding to the discussion on the 75% rental income rule. Because my triplex was vacant when I bought it, I suppose I had to go with this rule because it didn't have the 2 years' worth of rental income. Do I understand your post correctly to mean that if someone buys an occupied multifamily via FHA they could count 100% of the rents as income if it had been consistently rented for at least the previous 2 years? In essence, my question is: is the 2 year requirement tied to the *property's* rental income or the *potential buyer's* rental income? Thanks for any clarification you can provide!

I spoke with my broker again and he said that the 85% rule only applies to triplexes and 4-plexes for FHA.

It may be the lender's own rule, but it basically says that 85% of the total gross markey rent (all units including the owner occupied one) must be more than the PITI. When the appraiser comes in they will determine market rent for each unit, and if 85% of the gross market rent for all units isn't more than the PITI they won't approve the loan at that amount, and I would either have to get the seller to drop the price or I would have to put more down to make it work.

@Erin A.    For all practical purposes, it's tied to two years of borrower's rental property income. 

**Following discussion is lender and loan underwriter dependent.  There can be different interpretations. This is my interpretation.** The rental income can be tied to property, disregarding the who the property owner is (or was), if rental history documentation is available.  Lenders like to use tax returns to verify because it's a 3rd party data source.  For example. If I acquire a rental property (using conventional loan) in 2014, and I want to use the cash flow from the property as an asset in 2015 to purchase the next property, then it would be great if I can show documentation that the rental property was also a rental in 2012, 2013.  Would I be able to get a 2013 tax return schedule E  on the rental property from the seller?   Most likely not.  However, there are mitigating factors a lender/underwriter can consider.  One possibility is an independent appraisal on market rent.  Another possibility is the Fannie Mae/Freddie Mac Operating Income Statement.  Even if I can produce these documentation, it's up to lender's discretion whether they want to accept the documentation.

I'm curious where your broker got this 85% rule. This seems like an investment rule, which contradicts FHA's mission of guaranteeing owner occupied housing. Regardless, the 50% rule I learned on BP is far more strict.

I considered using a mortgage broker but since I only plan on using an FHA loan for my first property, I thought paying a broker would be a waste of money. I figured all FHA lenders would follow the same rules. In this case it seems your broker is adding an unnecessary layer of complication. Can anyone confirm that a broker can add value to a buyer seeking an FHA loan?

A second issue is buying a property where 85% of gross rents fail to cover the mortgage. That sounds like a bad idea. Perhaps you should focus on four plexes since they seem to be cash flow positive while the duplexes aren't. 

We've been looking for around 5 months now and so far only 2 4-plexes have come on the market that would meet the 85% gross rent rule, both in terrible shape needing at least $50k in repair, and they were both listed around $400k.

I'm having the problem of 1) Not enough inventory and 2) Cashflowing properties are in terrible condition.

After doing the math on most of the multifamiliy properties in my search area, I would have to offer anywhere from $50k-$100k lower than listing price in order for it to meet the 85% rule, and that would only cash flow around $150 per month TOTAL. Is it normal for these places to be priced so high with such little cash flow, or am I just in a tough market?

@Paul Spangler

It sounds like you live in a tough market. It's not uncommon to need a below market price to be cash flow positive. That's why most investors seek unlisted properties. I've read about investors having success in making "low"offers on houses that have been listed for several months. I've also read about buyers making low offers every 30-60 days and having this offer accepted after being rejected several times.

This 85% rule suggests your expenses will be 15% of your gross rental income. From what I've read, this is far too low. BP suggests 10% for maintenance and capital expenses and 10% for vacancy. At this point, you've already exhausted your cash flow and now you're paying for the investment instead of it paying you.

@Paul Spangler  ,

I'm with @Erin A.  on this calculation. 75% of gross rents from non-owner occupied units. When I did it, they use rents from leases if occupied. Or if vacant (in my case), rents from the appraisal. They automatically assumed I would be living in the biggest vacant unit, although I didn't fight them because it didn't impact qualification.

Note that the 75% of non-owner occupied gross rents is added in to your income for DTI purposes. So the 75% of rents DO NOT need to cover everything on their own.. Your personal income and debt service come into the equation..

I am NOT a loan officer or broker. I encourage you to get advice from several (or one good one lol) to nail down the details as of today's underwriting guidelines..

@Steve K., I bought a foreclosed 4 plex with an FHA loan that was vacant, with no rental history of any sorts. Underwriter still used 75% of appraised rents for non-owner occ units to us in underwriting for DTI. My current understanding is that you can't count rental income in excess of the PITI for any given property as excess income to use in your DTI calculation unless the rental income has been on your tax return for 2 years. In other words, for under 2 years, the rental income can only offset that property's expenses, and not be additive to income for the DTI calculation...

Your broker is correct. On 3 and 4 plexes, the 85% projected gross rents of all the units must equal or be more than your monthly PITI. This is a HUD rule and not a lender's specific. HUD will not insure the loan if this requirement is not met. Good luck.

Originally posted by @Paul Spangler :

We've been looking for around 5 months now and so far only 2 4-plexes have come on the market that would meet the 85% gross rent rule, both in terrible shape needing at least $50k in repair, and they were both listed around $400k.

I'm having the problem of 1) Not enough inventory and 2) Cashflowing properties are in terrible condition.

After doing the math on most of the multifamiliy properties in my search area, I would have to offer anywhere from $50k-$100k lower than listing price in order for it to meet the 85% rule, and that would only cash flow around $150 per month TOTAL. Is it normal for these places to be priced so high with such little cash flow, or am I just in a tough market?

My fiancee and I have been looking for about 4 months for a place and have run into this issue on almost every 3-4 unit property we would use FHA for. And the thing is, the rental survey (when the FHA inspector gives the "market value" of the rents) is one of the last steps in the buying process. And like you mention, the monthly payment HAS to be meet the 85% rule, so more down payment (the whole point of FHA is a lower down payment) or lower purchase price. If the rental survey came earlier in the process it might not be that much of an issue, but the fact it is done ~6 weeks after the agreed upon price really makes it tough.

Can anyone perhaps help me with a way around this 85% rule? I am 5 days away from my scheduled closing and everything has been fine until now. This "85% Rule" is causing us issues because the appraisal came back with completely bogus "fair market rents". 

This is a triplex in which each unit should list easily for a minimum of $1400 per month (probably closer to $1600). The appraisal states that fair market value is only $1150, which is actually less then they rent for now.

My real estate agent has already provided the bank with several pieces of evidence illustrating that this appraisal is wrong. Everything from copies of leases, to price listings at area apartment complexes, to listings for other units in 2-4 unit buildings within blocks of the property in question. We are waiting to here back whether or not they will approve the loan based on this information.

I am trying to see if there is anything else I might be able to do to move this forward. Can I ask the bank to allow us to get a new appraisal? Might I be able to switch from FHA to a conventional with 5% down? Is there any chance that the bank will accept this application if the appraisal doesn't explicitly state that the 85% rule is met?

Originally posted by @Paul Spangler :

I was told by my mortgage broker that in order for a property to qualify for an FHA loan, 85% of the gross market rent for all units in a 2/3/4-plex must be more than the PITI, otherwise they won't approve the loan.

In Oregon I'm having a diffcult time finding properties that meet this rule, especially for duplexes, where most of the time my maximum offer would be $50k-$100k lower than market price. 4-plexes tend to meet this a bit, but for the most part it's been really hard to find.

A listing agent for a duplex in town said that he has sold many multifamily properties to buyers using FHA loans and has never heard of the 85% rule and didn't know what I was talking about.

Can anyone confirm that the 85% gross rent rule is actually a thing, or am I just not understanding it correctly? I'm thinking that in order to find a property that meets the 85% rule it's probably going to be in a C class neighborhood because those are the places with more cash flow. Thoughts anyone?

As another lender mentioned above the rent self sufficiency test which is that all gross rents in the building are equal or higher than the PITIA of the property is only required on 3-4 unit buildings. This is a HUD/FHA requirement to ensure that if they had to take back the multi-unit property that they will have enough to service the entire monthly payment. They have factored this risk into this underwriting criteria.

Now the 85% of gross rents is another topic as you've brought up to unrelated topics.

On income producing multi-family 2-4 unit properties you can use the rental rate in your current FHA district which tends to be 85% of gross rents minus PITIA. This 85% rule relates to how the gross rental income will affect your income qualification with FHA not the self sufficiency rule above. These two are independent of each other, but are criteria in FHA's underwriting criteria.

Hope that helped, let me know if you have any questions on this topic.

Originally posted by @Paul Burbank :

Can anyone perhaps help me with a way around this 85% rule? I am 5 days away from my scheduled closing and everything has been fine until now. This "85% Rule" is causing us issues because the appraisal came back with completely bogus "fair market rents". 

This is a triplex in which each unit should list easily for a minimum of $1400 per month (probably closer to $1600). The appraisal states that fair market value is only $1150, which is actually less then they rent for now.

My real estate agent has already provided the bank with several pieces of evidence illustrating that this appraisal is wrong. Everything from copies of leases, to price listings at area apartment complexes, to listings for other units in 2-4 unit buildings within blocks of the property in question. We are waiting to here back whether or not they will approve the loan based on this information.

I am trying to see if there is anything else I might be able to do to move this forward. Can I ask the bank to allow us to get a new appraisal? Might I be able to switch from FHA to a conventional with 5% down? Is there any chance that the bank will accept this application if the appraisal doesn't explicitly state that the 85% rule is met?

 1) if you switch from fha to conconventional you will need a lender who can do freddie home advantage or fannie mae my community because 3-4 unit properties will require 25% down payment min on traditional conventional financing. Additionally, with coventional you'll be using less rental income since the guideline is 75% of gross rents minus PITIA. Just food for thought, you may want to research the implications of both decisions before making the leap.

2) The 85% rule is a fallacy the only thing that is 85% with FHA are max cash out LTV's or 85% of gross rents minus PITIA = net rental income or payment to qualify for or income to be added to your qualifying income.

3) can you order another appraisal? yes, but it is it worth it? no because with FHA they have case ID#'s associated with each property in their database so that means no matter how many lenders you may ask or switch to they will all have to work with that case ID# so the appraisal and all underwriting feedback/results get pushed to HUD through their system. Even if order a new appraisal you'll have to justify why the new appraisal or better results were justified. If the underwriter has a lot of files and doesnt want to deal with it they may just arbitrarily decline the file due to results of first appraisal rental income values etc.. so it really depends on the team, underwriter, loan officer, and bank you're working with.

Originally posted by J. M.:

@Paul Spangler  ,

I'm with @Erin A.  on this calculation. 75% of gross rents from non-owner occupied units. When I did it, they use rents from leases if occupied. Or if vacant (in my case), rents from the appraisal. They automatically assumed I would be living in the biggest vacant unit, although I didn't fight them because it didn't impact qualification.

Note that the 75% of non-owner occupied gross rents is added in to your income for DTI purposes. So the 75% of rents DO NOT need to cover everything on their own.. Your personal income and debt service come into the equation..

I am NOT a loan officer or broker. I encourage you to get advice from several (or one good one lol) to nail down the details as of today's underwriting guidelines..

@Steve K., I bought a foreclosed 4 plex with an FHA loan that was vacant, with no rental history of any sorts. Underwriter still used 75% of appraised rents for non-owner occ units to us in underwriting for DTI. My current understanding is that you can't count rental income in excess of the PITI for any given property as excess income to use in your DTI calculation unless the rental income has been on your tax return for 2 years. In other words, for under 2 years, the rental income can only offset that property's expenses, and not be additive to income for the DTI calculation...

The 75% of gross rents minus PITIA is a general rule for conventional financing however it sometimes get intermingled with FHA financing. However, with FHA the discount rate used to determine net rental income is depending on the HUD jurisdiction in which the property is located. In orange county I've been successful with using 85% of gross rents minus PITIA of the subject property. Some banks may go more conservative to 75% to reduce their own risk however its important to know this distinction because it could be the difference between getting the loan and not especially with people who have tight DTI ratios.

My second point about the above is the "self sufficiency," rule that every is mentioning is not measured by taking 85% of gross rents to meet the entire PITIA of the property if its done in the actual underwriting guidelines you take the entire gross rents of all units and compare it to the PITIA of the property if the total monthly gross rents are the same or greater then it meets the self sufficiency tests for 3-4 unit properties.

Regarding the income being above being more than the PITIA or monthly total obligation, this wouldnt happen anyway atleast on owner occupied properties because income on rental property is underwritten separately and added to income while liabilities are added as an obligation you have to qualify for. So in essence the net rental income after the 85% formula is applied is not "netted," against the full monthly obligation or PITIA but rather the underwwriting for income and the obligation being qualified for is completely separate.

Its only "netted," against the payment on non owner occupied 1-4 unit properties in conventional financing. So there might be some confusion about that above in regards with rental 1-4 unit properting income underwriting guidelines.

Originally posted by @Albert Bui :
Originally posted by @Paul Burbank:

2) The 85% rule is a fallacy the only thing that is 85% with FHA are max cash out LTV's or 85% of gross rents minus PITIA = net rental income or payment to qualify for or income to be added to your qualifying income.

Can you perhaps point to somewhere that this is explained? Such as somewhere on the FHA website? It would go along way towards making my case and I can't seem to find anything on it myself. I have several people telling me that this is in fact a rule in the way it is being interpreted. My loan officer, the underwriter, a local mortgage broker who my agent knows very well, etc; My loan officer even went above the underwriter to his bosses and they said this was in fact a rule and this property does not meet the requirements for satisfying it.

Also, just to be clear, I am having no problems getting income qualified with this property. My dti and all that is good(they used 75% of rents as income not 85%). We have the nessceary funds to close, down payment, reserves etc;. We have cleared every hurdle except this one even getting a commitment letter from the lender and everything. Today is the last day to either get an extension from the seller or walk away empty handed. 

The last minute issue is that they are saying this property does not qualify for FHA financing currently because 85% of the gross rents for the property(including the owner occupied unit) are not equal to or greater than PITI. If you can tell me where it says this is in fact not a rule or not being interpreted correctly maybe this can be saved yet but short of that I am at a loss. I cannot argue with the lender who holds all the cards any more then I already have without some sort of substantial evidence stating they are wrong. And even then I may be sol.

@Paul Burbank  (just came across your question when researching another thread), here is a link that makes sense in the context of your dilemma):- 

http://www.trulia.com/voices/Home_Buying/FHA_loan_...

..."So you take the net rental income from the appraiser’s estimate of fair market rent from all units, including the unit you will be occupying, less the appraiser’s estimate for vacancies or 15% (whichever is greater). That amount can't be less than the monthly housing payment (principal, interest, taxes, insurance, mortgage insurance, and HOA fees, if any). If that amount is less than the monthly housing payment, then a down payment greater than 3.5% would be needed (to get that amount to no less than the housing payment)...

In short, you need to find a BETTER "deal"! Hope it's gone well for you this last year...

Create Lasting Wealth Through Real Estate

Join the millions of people achieving financial freedom through the power of real estate investing

Start here