The FHA Self-Sufficiency Test, Explained

What the test checks

FHA insures loans on one- to four-unit homes as long as a borrower lives in one of the units. For two units, the usual income and debt rules decide whether you qualify. For three and four units, HUD adds a test of the property itself, set out in its Single Family Housing Policy Handbook 4000.1: the building must be able to carry its own mortgage from rent.

The Handbook defines net self-sufficiency rental income as the rental income the property produces over and above principal, interest, taxes and insurance (PITI). The standard is that the PITI divided by the monthly net self-sufficiency rental income may not exceed 100 percent. Put the other way round, net rent has to cover the whole payment.

The test applies to:

• a single-family residential property with three or four dwelling units; and
• a property with two dwelling units and one accessory dwelling unit (ADU), or three units and one ADU, which the Handbook also treats as three- to four-unit property.

A duplex without an ADU isn't subject to it. That doesn't make a duplex easier to buy on rent alone; it just means the lender looks only at your income and debts.

How the rent is figured

Net self-sufficiency rental income starts from the appraiser's estimate of fair market rent for every unit, including the one you will live in. HUD then subtracts the greater of the appraiser's estimate for vacancies and maintenance or 25% of the fair market rent. Three details matter:

• It is the appraiser's rent, not yours. Current leases and the listing's projections don't set the number; the appraisal does. A rent schedule that comes in below the leases lowers the net rent.
• Your own unit counts as rented. The market rent of the unit you will occupy is in the total, even though you won't pay yourself rent. That helps the test, but it also means a property can pass while you still pay part of the mortgage yourself.
• The vacancy factor is never below 25%. If the appraiser estimates more for vacancies and maintenance, the larger figure is used.

What goes into the payment

The PITI side is HUD's full monthly mortgage payment, not just principal and interest. For a typical FHA purchase it includes principal and interest on the loan, with the upfront mortgage insurance premium if it is financed; the monthly share of the annual mortgage insurance premium; property taxes; and hazard insurance, plus flood insurance, association dues, ground rent or special assessments where they apply. Every one of those makes the test harder to pass.

Mortgage insurance is easy to forget. FHA charges an upfront premium of 1.75% of the base loan, usually added to the loan, and an annual premium paid monthly, so both the loan amount and the monthly payment are higher than the price and rate alone suggest.

A worked FHA self-sufficiency test example

Take a $640,000 fourplex bought with 3.5% down at 6.5% for 30 years. The appraiser puts market rent at $1,650 a unit, $6,600.00 a month in all. Taxes are $7,200 and insurance $3,000 a year, and the upfront premium is financed.

The payment is 103.1% of the net rent, so this fourplex fails by $153.60 a month. If the appraiser estimated vacancies and maintenance at 30% instead of 25%, the larger figure would apply and the ratio would be 110.5%: the property would fail.

To run your own numbers, including the highest price that passes and the rent you would need, use the FHA self-sufficiency test calculator.

Reserves and the rest of the loan

Passing the test isn't the whole approval. For three- to four-unit properties, the lender must also verify and document reserves equal to three months of PITI after closing, whether the loan is approved through HUD's automated scorecard or manually underwritten. In the example that is $15,310.80. Reserves are your verified liquid assets less what you pay at closing; they don't include cash taken out at settlement, equity in another property or borrowed funds.

You also need to qualify on income and debts, and at least one borrower must move in within 60 days of signing the mortgage and intend to live there for at least a year. The self-sufficiency test is an extra hurdle on top of those rules, not a replacement for them.

When to run the test

Run it before you make an offer, with conservative rents, and again when the appraisal comes back with the appraiser's own rent schedule. Because the rent side is fixed by the appraisal, the levers you control are on the payment side: the price, the down payment, the rate and the term. A larger down payment lowers the loan and, above 5% down, the annual mortgage insurance rate. If a property fails, the guide to what to do when it fails walks through each option, and the calculator shows the price that would pass.

What to gather before you run it

The test is only as good as its inputs, so collect these before you rely on a result:

• Market rents for every unit, including the one you will live in. Before the appraisal, use conservative figures from comparable rentals; once it arrives, use the appraiser's.
• The property tax bill and an insurance quote, plus flood insurance if the property needs it and any association dues.
• Your loan terms: price, down payment, rate and term, and whether you will finance the upfront mortgage insurance premium.
• Your cash: enough for the down payment, closing costs and three months of the full payment in reserves after closing.

With those in hand, the test is a few minutes' arithmetic, and it tells you the price and rent at which the property works before you are committed to it.