If you’re looking for a multifamily property – a duplex, triplex, or fourplex – and want to use FHA, you may run into a common scenario: An ADU on the property.
FHA has an interesting rule when it comes to 2-, 3-, and 4-unit properties with an Accessory Dwelling Unit (ADU): The ADU must be considered an additional unit, not an ADU.
According to the HUD 4000.1 handbook, “For any property with two or more units, a separate additional dwelling unit must be considered as an additional unit.”
This isn’t the case with a single-family home. The property is still considered a 1-unit home even if there’s an ADU on it.
FHA’s provision for ADUs on multifamily properties can be good or bad for you as the buyer. Let’s see when it’s advantageous and when it can kill the deal.
See if you are eligible to buy a multifamily home with FHA.
In this article
- Buying a duplex or triplex with an ADU
- Buying a fourplex with an ADU
- Can an ADU on a single-family be another unit?
- How does FHA define ADU?
- Homes with more than one ADU
- Rental income on an ADU
- Multifamily home plus an ADU is a great idea
Buying a duplex or triplex with an ADU
As mentioned, duplex and triplex properties are considered one extra unit when an ADU is present.
This can be a good thing because you can add 75% of the potential rental income from the ADU to help you qualify.
For instance, you’re buying a duplex with an ADU. You’ll live in one unit. The other main unit will bring in $1,000 per month and the ADU will bring in $500. Together, you can add $1,125 per month to your qualifying income.
However, because the property is a 3 or 4 unit in FHA’s eyes, make sure it passes the Self-Sufficiency Test.
Related: FHA 3-4 Unit Self-Sufficiency Test Calculator
Buying a fourplex with an ADU
This is where FHA’s rule can bite you. Remember that FHA says, “For any Property with two or more units, a separate additional Dwelling Unit must be considered as an additional unit.”
Say you are buying a 4-unit with FHA. But there’s a problem: there’s also an ADU on the property.
According to FHA rules, this ADU would need to be considered an additional unit. But FHA does not allow 5+ unit homes. Anything over 4 units is considered a commercial property.
So, this deal is dead in the water unless you want to get a commercial loan on it, which will require way more than the generous 3.5% down for FHA.
Unfortunately, there’s no way the appraiser is going to “look past” this ADU or forget to mention it on the appraisal. And once the lender sees the appraisal, you’re dead in the water.
Can an ADU on a single-family property be considered another unit?
On paper, an ADU is just an ADU, but in real life, you find all sorts of gray areas around what an ADU actually is.
This matters, because whether an ADU is considered an ADU or another unit can make a big difference in whether you can use rental income to qualify, and even the value of the property.
For instance, a 1,500 square foot home has a detached 1,300 square foot “ADU” on the property with similar amenities and quality of construction. Is it an ADU or another unit?
According to HUD 4000.1, “As part of the highest and best use analysis, the Appraiser must make the determination to classify the Property as a Single Family dwelling with an ADU, or a two-family dwelling.”
So a lot comes down to the highest and best use of that additional structure, according to the appraiser. It might come down to local zoning and how common ADUs versus duplexes are in the area.
Without derailing the true purpose of this post, check out Ryan Lundquist’s deep dive on whether a structure is an ADU or additional unit.
In short, it’s risky to make an offer or order an appraisal on a single-family home with an ADU, hoping the appraiser classifies it as another unit.
See if you are eligible to buy a multifamily home with FHA.
How does FHA define “ADU”?
All of this begs the question as to what FHA actually considers an ADU.
In its own words, an ADU is usually, “subordinate in size, location and appearance to the primary Dwelling Unit and may or may not have separately metered utilities or separate means of ingress or egress.”
It can be created within or detached from the main unit. You can think of it as a standalone living structure where someone would not have to use amenities from the main home.
FHA says it is a “separate additional living unit, including kitchen, sleeping, and bathroom facilities.”
The problem is, a 2-unit home also has a separate residence, and sometimes those two units aren’t identical.
Again, FHA leans heavily on the appraiser to determine whether a structure is an ADU or another unit when it comes to single-family. For duplexes and triplexes, the ADU is always another unit, per FHA.
1-4 unit homes with more than one ADU
According to FHA, properties with more than one ADU are not eligible for financing.
HUD says, “The Appraiser must notify the Mortgagee of the deficiency in MPR or MPS if more than one ADU is located on the subject Property.” This seems to indicate that a property does not meet Minimum Property Requirements (MPRs) if there are 2 or more ADUs on it.
However, there is some gray area here, too. What if you find a duplex with two ADUs? FHA says that those ADUs should be considered two additional units, not ADUs, making it a fourplex. But at the same time, it says a property can’t have 2 ADUs.
Disclaimer: There is always a risk of a lender or appraiser interpreting this a different way. However, if the appraiser can make the case that the highest and best use of the 2 ADUs is as separate units, the property might be eligible.
You should speak to the lender and an appraiser in your area about the particular property. The appraiser might say that they can’t be called additional units. Or, the lender might say they don’t want to take the risk of calling them additional units.
This is certainly a tricky situation. You should be hesitant to make an offer and order an appraisal on the property. But there’s always a chance it could work.
How does the lender determine rental income for an ADU?
Let’s go back to the original topic, buying a duplex or triplex with an ADU. How will rental income on the additional units, including the ADU, be determined?
Again, the appraiser has a big role.
Assuming the property is not currently rented, the appraiser will complete a market rent analysis, called a Comparable Rent Schedule or Fannie Mae Form 1004/Freddie Mac Form 1000. As the name suggests, this form tells the lender the market rent for the unit.
The appraiser will also complete an Operating Income Statement, or Fannie Mae Form 216/Freddie Mac Form 998.
As far as the ADU income on a duplex or triplex, the appraiser will estimate market rent just like any other unit in the home. He or she will look at size and function and compare that with similar units in the area.
If the ADU is much smaller than the standard home units, expect rental income from the ADU to be less than for units in the main structure.
If the ADU is rented, you can simply supply current lease agreements to prove income.
Yes. For duplexes and triplexes, FHA considers the ADU an additional unit, not an ADU. So you can count rental income from the ADU toward qualification.
Not typically. A single-family property with an ADU is not considered a 2-unit home. FHA does not allow rental income from a single-family residence, even if there’s an ADU on it.
The appraiser might call it an additional unit in the appraisal. In this case, you can likely buy it as a duplex with an FHA loan and use rental income from one unit to qualify.
Multifamily with an ADU can be a great idea
A multifamily with an ADU might be passed over by the typical buyer, but you’ve recognized an opportunity to own a home and generate rental income.
FHA provides an easy way to become a homeowner and investor with one transaction – all with just 3.5% down. And buying a multifamily home with an ADU provides an extra unit from which to collect rent.
Do your due diligence, but buying the property could be a very good idea.