FHA Amends Policy on Accessory Dwelling Units

The U.S. Department of Housing and Urban Development (HUD), through the Federal Housing Administration (FHA), has announced a new policy which allows lenders to count income from small units of housing built inside, attached to, or on the same property as a primary residence (Accessory Dwelling Units [ADU]) when underwriting a mortgage.

The change in policy allows for the inclusion of rental income from the ADU in the borrower’s qualifying income, and would allow more borrowers to qualify for FHA financing for properties with ADUs, including 203(k) rehabilitation mortgages. ADUs can be rented out to tenants, thereby adding to the supply of housing in a community. In addition, this new policy will enable more first-time homebuyers, seniors, and inter-generational families to leverage the power of ADUs to enhance the generational wealth building potential of homeownership.

The announcement supports the Biden Administration’s Housing Supply Action Plan and reinforces the importance the Administration places on addressing the nation’s affordable housing challenges and increase access to homeownership.

“Increasing the supply of affordable housing and helping families to create generational wealth is what today’s action making it easier to finance an accessory dwelling unit is all about. This is a part of our work to help address the critical shortage of affordable housing in communities across the country and help people increase the value of their homes,” said HUD Secretary Marcia L. Fudge. “The Biden-Harris Administration is committed to increasing the housing supply so that more people have access to quality housing that they can afford so that their families can thrive.”

The new policies issued by the FHA:

• Allow 75% of the estimated ADU rental income for some borrowers to qualify for an FHA-insured mortgage on a property with an existing ADU. This additional income flexibility will help to increase access to homes with ADUs for homebuyers with limited incomes, allowing them to benefit from the wealth-building opportunity of a property with an ADU.
• Use 50% of the estimated rental income, for some borrowers, from a new ADU the borrower plans to attach to an existing structure, such as in a garage or basement conversion, to qualify for a mortgage under FHA’s Standard 203(k) Rehabilitation Mortgage Insurance Program. This will enable more homeowners with limited incomes to build ADUs, helping them sustain homeownership and expanding the production of ADUs as rental housing.
• Include ADU-specific appraisal requirements for appraisers to clearly identify, analyze, and report on ADU characteristics and the estimated rent the ADU can be expected to generate. The guidance provided in the Mortgagee Letter will assist appraisers to more accurately determine the market value of a property with an ADU and also will help advance the maturation of ADU valuation, thereby increasing access to ADU financing as more cities and states remove zoning barriers.
• Add ADUs to the types of improvements that can be financed under FHA’s mortgages for new construction. This allows new homes to be built with ADUs from the ground up, an important source of ADU production in addition to rehabilitating existing structures.

“With our new ADU policy, we’ll help households of more modest means maximize the potential benefits of homeownership to build wealth,” said Assistant Secretary for Housing and Federal Housing Commissioner Julia Gordon. “This new policy also contributes to the supply of affordable housing in many neighborhoods where it’s most needed and least available.”

FHA defines an ADU as a single habitable living unit with a means of separate ingress and egress that meets the minimum requirements for a living unit. An ADU is a private space that is subordinate in size and can be added to, created within, or detached from a primary one-unit single-family dwelling.

“The new policies provide greater flexibility for the use of rental income from ADUs, which will help more borrowers qualify for FHA-insured financing on homes with ADUs,” said Deputy Assistant Secretary for Single Family Housing Sarah Edelman. “We’re pleased that we’ve had such widespread support from the housing industry–support that has helped us deliver this meaningful solution for the nation’s homebuyers.”

FHA-approved lenders may begin offering borrowers mortgages on properties with ADUs under the new policies effective immediately.