It sounds perfect – buy a home with two accessory dwelling units (ADUs) with just 3.5% down using FHA and rent out the ADUs.
If only it were that simple.
Unfortunately, FHA does not finance homes with two ADUs on the property.
The HUD 4000.1 states, “The Appraiser must notify the Mortgagee of the deficiency in MPR or MPS if more than one ADU is located on the subject Property.”
“MPR” refers to HUD’s minimum property requirements. Any home receiving FHA financing must meet MPRs.
So if you have found a great opportunity but it has two ADUs, you probably know why it’s such a good deal.
See if you can use FHA to buy a home with an ADU.
Can the appraiser call the property a duplex with an ADU (or a triplex)?
One possible solution, though, is if at least one of the ADUs is similar in size and construction to the main home.
Admittedly, this is a long shot, but worth exploring.
If the appraiser can believably call the property a duplex, then you might be okay. FHA can finance a duplex with an ADU.
This might happen if the appraiser thinks one of the ADUs is similar enough to the main home to call it a duplex. It helps if the property is legally a duplex, has all appropriate permits, looks like the main home, and duplexes are common in the market.
According to FHA, “the Appraiser must make the determination to classify the Property as a Single Family dwelling with an ADU, or a two-family dwelling. The conclusion of the highest and best use analysis will then determine the classification of the property.”
Yes, this means that the appraiser has the power to call it a single-family home with two ADUs, a duplex with an ADU, or even a triplex.
Related: FHA Self-Sufficiency Calculator
FHA defines an ADU as “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.”
So if both ADUs are “subordinate” in nature to the main home, the deal is probably not going to work.
Asking an appraiser
Modern lending laws say that the borrower may not have contact with the appraiser, as this could result in value manipulations.
So, you likely won’t be able to talk to the appraiser who works up the report on the home.
However, there’s nothing stopping you from contacting any appraiser in your area to get their take on the exact property.
All appraisers must follow the same guidelines and are trained similarly. If one appraiser is reasonably confident that a property is a duplex with an ADU, chances are another appraiser would too.
That being said, there’s always a risk that one appraiser will interpret a property differently than another, so proceed with caution.
A possible exception: A duplex with two ADUs
Another very obscure rule in the FHA handbook says, “For any Property with two or more units, a separate additional Dwelling Unit must be considered as an additional unit.”
In other words, a duplex with an ADU must be considered a triplex, at least for the purposes of an FHA loan.
Taking this one step further, then, a duplex with two ADUs should be considered a fourplex. After all, it is a “property with two or more units” with separate dwelling units.
If you encounter this situation, inquire with both your lender and a local appraiser. Don’t make an offer on the property without being fairly certain that the lender can consider it a fourplex.
If you do, build in a rock-solid financing contingency so you can get out of the deal if you can’t secure financing.
What about conventional?
Fannie Mae conventional loans are even more restrictive than FHA. It does not allow two ADUs on the property, nor does it allow a 2-4 unit property with an ADU.
The home needs to be a single-family house with an ADU to qualify.
However, you may not use future income from a single-family with an ADU to qualify, and that goes for conventional and FHA.
An ADU property is a great opportunity
Finding an affordable property with an ADU is a great way to become a homeowner and dip your toes into real estate investing at the same time. And even if it has two ADUs, it’s worth exhausting all possibilities for financing.
Homes with an ADU are in high demand, so if you find a good one, it might be the opportunity of a lifetime.
The possible exception: A duplex with 2 ADUs