FHA Loans for Renters Who Want to Become Homeowners

May 26, 2022

FHA mortgage loans are available for a wide variety of housing including condos, manufactured homes, and multi-unit properties. Some who are currently renting a property may wish to own that building as their home; a landlord who is willing to sell may work out an arrangement with a tenant to purchase the home.

But there are certain lending rules that make this procedure more complex; knowing FHA guidelines for FHA mortgage loans in these circumstances can help you save time and money.

FHA Loan Rules for Renters Purchasing from Landlords

Buying a home from a landlord is not a problem per se, but FHA loan rules in HUD 4000.1 require certain documentation and procedural requirements be met. For example, there is a rule about “identity-of-interest” issues between landlord and tenant.

Identity-of- interest transactions require a 15% minimum down payment unless conditions for certain exceptions are met.

This larger down payment requirement is a problem for some borrowers but there are some exceptions to this rule that can put the down payment back to the minimum 3.5% (or whatever down payment the FHA loan applicant qualifies for based on credit scores and credit history).

The FHA Definition of Identity-Of-Interest Transactions

What constitutes an identity of interest transaction that would require the higher down payment? HUD 4000.1 states, “An Identity-of-Interest Transaction is a sale between parties with an existing Business Relationship or between Family Members.”

HUD 4000.1 adds that a business relationship is defined as an association between individuals or companies entered into for commercial purposes.

The Exceptions to the Higher Down Payment Requirement for Identity-Of-Interest Transactions

FHA loan rules provide an exception in cases where the borrower is buying a principal residence that belonged to another family member who also used the home as the main address and not an investment property.

Exceptions are also possible on homes owned by another family member, “in which the Borrower has been a tenant for at least six months immediately predating the sales contract. A lease or other written evidence to verify occupancy is required.”

Caveats to These Exceptions

FHA loan rules address something called an inducement to purchase, which would require the FHA home loan amount to be lowered dollar-for-dollar for any “inducement” offered by a seller.
This is required when the consideration offered by the seller either exceeds six percent of the price of the home or meets other conditions defined by the FHA and/or the lender and state law as an inducement.

HUD 4000.1 advises lenders that situations where the landlord allows the borrower to live in the property rent-free or at below-market rents prior to the FHA loan. HUD 4000.1 states on page 159:

“Rent may be an inducement to purchase when the sales agreement reveals that the Borrower has been living in the Property rent-free or has an agreement to occupy the Property at a rental amount considerably below fair market rent.”

However, there are cases where rent below fair market is not considered an inducement to purchase-this is true when a builder “fails to deliver a Property at an agreed-upon time”, and allows the buyer to stay in the property “or other unit for less than market rent until construction is complete”.

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