FHA drafts guidance to expand financing on homes with ADUs

The Federal Housing Administration (FHA) published a new draft version of a Mortgagee Letter (ML) on Thursday that would update the mortgage insurance requirements on single-family homes with accessory dwelling units (ADU). The proposal is designed to offer additional flexibility for calculating market rent and using ADU rental income to help qualify for FHA-insured mortgage financing.

“If finalized, these updates would allow more borrowers to qualify for FHA financing for properties with ADUs, including 203(k) renovation loans,” the FHA said in its announcement. “FHA’s action today advances the goals of the Biden-Harris Administration’s Housing Supply Action Plan.”

While FHA policy does permit the purchase, rehabilitation or refinance of properties with ADUs, current policy does not allow for the inclusion of rental income from an ADU in a potential borrower’s qualifying income, FHA explained.

“This [ML] establishes protocols for the Appraiser’s analysis and reporting of [ADU] market rent on appraisals and for consideration of this rental income in underwriting forward mortgages and performing the financial assessment for Home Equity Conversion Mortgages (HECM),” the draft ML reads.

HECM is the FHA-sponsored reverse mortgage program, and the related financial assessment requires lenders to assess a borrower’s financial and credit history to determine their ability to cover a reverse mortgage loan’s monthly obligations. The related financial obligations for HECM loans include property taxes, homeowner’s insurance and homeowner’s association fees, if applicable.

In addition to adding more loan flexibility, the proposal would help to address issues with housing availability and affordability, according to FHA Commissioner Julia Gordon.

“FHA is at the forefront of the Administration’s efforts to increase housing supply and affordability,” Gordon said in a statement. “At a time when housing supply is constrained and ADUs are gaining popularity nationwide, an updated policy has the potential to expand opportunities for low- and moderate-income homeowners to benefit from the wealth-building potential of ADUs while supporting the affordable housing needs of their communities.

The popularity of ADUs has increased in recent years. On the West Coast, Seattle saw a 250% ADU construction increase from 2019 to 2022. In California, demand for ADUs is quickly outpacing supply, according to reports.

Washington state’s Senate also recently passed a bill that would lift restrictions on the construction of “middle housing,” which refers to duplexes, fourplexes and ADUs.

The draft ML has been posted to FHA’s single-family “drafting table,” which includes instructions for stakeholders to submit comments on the proposed guidance.