On October 16, 2023, the Federal Housing Administration (“FHA”) announced new policies applicable to Single Family Title II Forward Mortgages that expand financing options for properties with an accessory dwelling unit (“ADU”). The definition of ADU is provided as “a single habitable living unit with means of separate ingress and egress that meets the minimum requirements for a living unit.” The ADU can be added to, created within, or detached from a one-unit primary residence, to which it is subordinate in size.
Mortgagee Letter 2023-17 provides guidelines for consideration of actual or prospective rental income from an ADU in the calculation of borrower’s effective income used to qualify for an FHA-insured mortgage. In addition, property eligibility and appraisal protocols have been updated to support ADUs.
The new policies include the following updates:
- A single-family residential property with only one ADU is considered as a one-unit property which creates a single interest in real estate. If a single-family residential property has more than one ADU, each additional dwelling unit will be considered an additional unit on the property. For example, a single-family residential property with two ADUs would be treated as a 2-unit property.
- For a one-unit property with an ADU, a Fannie Mae Form 1004/Freddie Mac Form 70, Uniform Residential Appraisal Report, and Fannie Mae Form 1007/Freddie Mac Form 1000, Single Family Comparable Rent Schedule must be documented and verified.
- Rental income from an ADU may not exceed 30 percent of the borrower’s total monthly effective income. Effective income is calculated as net subject property rental income added to borrower’s gross income.
- When no prior history of rental income has been established for properties with an existing ADU, 75% of the lesser of fair market value rent reported by the appraiser or rent stated in a lease agreement may be considered to help qualify a borrower. For a 203(k) Rehabilitation Mortgage with no prior history of rental income, that is taken to add a new ADU, 50% of the lesser of fair market rent reported by the appraiser or rent stated in a lease agreement may be considered. When the property has a history of rental income, the borrower must provide the prior two years of tax returns with Schedule E.
- A one-unit property with an ADU cannot use rental income as effective income for cash-out refinance loans. Rental income may be considered for effective income for two- to four-unit subject properties.
- For a one-unit property with an ADU, reserves equal to at least two months’ PITI must be documented and verified. One- and two-unit properties without an ADU are only required to document and verify reserves equal to one month’s PITI after closing. Three- to four-unit properties must require reserves equal to three months PITI.
- Requirement for analysis and reporting of ADU rental history or market rent in appraisals.
- A single-family one-unit property with an ADU has been added to the eligible property types that can be financed as new construction.
The announcement includes a stated motivation for the change in that “FHA recognizes that ADUs can serve to enhance the generational wealth-building potential of homeownership.” The policies are also intended to increase the stock of affordable housing and help borrowers sustain long-term homeownership.
The new policies became effective on October 16, 2023 with the publication of Mortgagee Letter 2023-17. The changes will be included in a future update to HUD Handbook 4000.1. Feedback on the changes will be accepted by HUD through November 16, 2023.
