FHA Self Sufficiency Test
What is an FHA Self Sufficiency Test? In order to understand that, we first need to understand exactly what the FHA is, and what role they play in the purchasing of property in the U.S.
What is the FHA
The FHA, or Federal Housing Administration, is often thought to be a lender. This concept is incorrect. The FHA does not supply any financing itself, but rather provides insurance to those who do.
Because they are insurers, most of what they deal with is regarding risk management. All the rules and regulations that they put in place for those - the mortgage brokers - that they insure are there so that they can minimize the risk of non payment and ultimately their own financial future.
In order to achieve the utmost accuracy regarding risk assessment, the criteria for buyers differs depending on the property that they are attempting to purchase.
There will be different costs and risks associated with a person buying a family home, as opposed to a person buying a triplex for investment purposes.
What is the FHA Self Sufficiency Test
The FHA Self Sufficiency Test applies only to those who are attempting to purchase a 3-unit or 4-unit property, also known as a triplex or a quadplex. If you are buying a single unit property or a duplex, then you will not need to worry about this.
Properties with several units in them are often more expensive in terms of purchase price, but they can also have other cost implications such as maintenance, taxes, insurance etc.
In order to minimize their risk, the FHA needs to ensure that the property is self-sufficient before they are willing to enter into any agreement with the mortgage broker.
Requirements for the FHA Self Sufficiency Test
In order to ensure that the property is self sufficient, the FHA requires several criteria to be true. Firstly, the full mortgage payment needs to be calculated at the interest rate that is offered by the mortgage broker.
Once that is completed, the rental income of two units (if you are purchasing a triplex) or three units (if you are purchasing a quadplex) needs to be calculated.
It is not all the units because in the majority of cases the purchaser will live in one of the units. The FHA needs to ensure that the property is still self sufficient even if one of the units is the purchaser's residence, and not bringing in any income.
In fact, the FHA now requires that you prove that one of the units will be used for your primary residence.
After that calculation, 75% of the determined possible rental income must exceed the monthly mortgage repayment. Only once this can be proven has the FHA Self Sufficiency test been successfully completed.
How to Complete the FHA Self Sufficiency Test
Many banks and other financial institutions provide documents for the FHA Self Sufficiency Test. These documents will assist in all relevant calculations, but they do not assist in getting the initial numbers such as the monthly mortgage repayment or the possible rental income. Those can be difficult and time consuming to get.
Calculating Rental Income for the FHA Self Sufficiency Test
This can not be done on your own. Although it is possible to estimate your rental income yourself, those numbers can be too easily manipulated, so the FHA will require proof.
This means that you will need to get a professional appraiser in, and that this appraiser will have to be certified by the FHA to conduct the estimations for the Self Sufficiency Test.
The appraisers will then determine several figures:
- Firstly, they will determine the value of the entire property
- and the possible net rental income according to the going rates in that area.
- They will also determine the vacancy rate.
The vacancy rate is the amount of rental properties that are standing empty in the area. In larger cities, the vacancy rate is often not an issue as popular areas often have more demand than there is a supply for. However, if you are buying in a smaller town the vacancy rate might be higher.
The vacancy rate is used to determine the proportion of your property that is likely to stand empty, thus receiving no rental income.
It will be subtracted from the net rental income by the mortgage broker in order to determine an accurate figure for possible rental income.
Calculating Mortgage Repayment for the FHA Self Sufficiency Test
In order to calculate the monthly repayments you do not need to get anyone in. This step, although very difficult, can be done yourself.
This is said to be one of the most critical steps in the Self Sufficiency test. The reason for its complexity is simply the amount of factors that need to be taken into account.
The first thing that you need to consider is the principal amount. This is the total amount of the loan. The starting figure.
Then you need to consider the interest and the amount that that will add on to your repayment every month. This is variable, and is easiest to work out if you already have an offer from a bank that you negotiated.
Then you need to calculate taxes. These are predominantly property taxes, although taxes on rental income may also be requested.
In cases of property tax, the total can be split into 12 equal months in order to complete the calculation. Information on tax can be provided by the real estate agent and can be proven by the previous owner.
Lastly, you need to take any sort of insurance into account. All mortgages require mortgage insurance, but you will also have homeowners insurance which needs to be added in.
After all of these have been added together, the costs still need to be exceeded by 75% of the possible rental amount.
Conclusion
It can be difficult to complete an FHA Self Sufficiency Test. But, there is a reason for it. If you do not think that you would be able to complete the test successfully, perhaps the investment is too great a risk, and should be carefully reconsidered.
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