Saving for a down payment is one of the largest obstacles homebuyers face. This is especially true for first-time homebuyers . Luckily, the Federal Housing Administration (FHA) created a program to help people just like you. Whether you have only a small down payment or you have less than perfect credit, the FHA Loan can be a perfect fit
In this guide, we discuss what it takes to qualify for an FHA loan and its best uses.
FHA Loan Basics
First, let’s explore the FHA loan basics. You may assume that the FHA underwrites and funds its loans, but they do not. Instead, FHA-approved lenders provide the approval and funding. The FHA guarantees the loans for the lender. In other words, the government (FHA) will pay the lender back if you (the borrower) stop paying your mortgage.
It is the loan guarantee that makes it possible for FHA lenders to write loans for borrowers who otherwise may not find a loan approval. Each lender may have its own ‘special’ requirements or charge different rates/fees than another. We help you find the perfect FHA loan.
FHA Loan Qualifying Requirements
FHA loans have flexible underwriting guidelines. In general, you must meet the following requirements. Keep in mind, though, these are the ‘minimum’ requirements. Each FHA lender can require extra guidelines should they feel it is necessary to reduce the risk of foreclosure.
The guidelines are as follows:
- Minimum 580 credit score to make the lowest down payment of 3.5% – If you have a credit score between 500 and 579, lenders may still provide the loan, but with a 10% down payment.
- Maximum front-end (housing) debt-to-income ratio of 31% – This means that a maximum of 31% of your gross monthly income (income before taxes) covers your mortgage payment. Your mortgage payment includes the principal, interest, real estate taxes, homeowner’s insurance, and mortgage insurance.
- Maximum back-end (total) debt-to-income ratio of 56.99% – Your total monthly debts include the new mortgage payment plus any existing monthly debt. Think of payments like credit cards, car payments, student loans, alimony, child support, or personal loans. The total payments should take up less than 56.99% of your income before taxes.
- Stable income/employment – FHA lenders like to see a two-year employment history at the same job. If you stay within the same industry, but change jobs to earn more money or take a better position, you may be able to use a shorter than 2-year employment history.
In addition, all borrowers must have a clear CAIVRS report. The Credit Alert Verification Reporting System tracks all defaulted federal loans. This includes government-sponsored mortgages, student loans, and Small Business Administration loans. If you have federal debt that has not been repaid, you may not qualify for an FHA loan.
Passing the FHA Loan Appraisal
Many people fear the FHA appraisal, but it is nothing more than an appraisal you would see on any other loan. The appraiser’s job is to ensure that the home is worth as much as you agreed to pay for it. This helps ensure there is enough collateral for the lender to write the loan. The FHA does require appraisers to make sure the home meets its Minimum Property Requirements. This is where people often think FHA loans are ‘tough.’ However, the MPRs make sure the home is safe, sound, and sanitary.
In short, the home must be free from any safety or health hazards. Any issues the appraiser finds must be fixed before you will be able to close on the FHA loan.
Getting an FHA Loan After Bankruptcy or Foreclosure
The FHA is lenient in its requirements regarding getting a mortgage after a bankruptcy or foreclosure. If you had to throw in the towel and file BK or you lost your home in foreclosure, the FHA grants some leniency:
- Chapter 7 Bankruptcy – You can apply for an FHA loan two years after your Chapter 7 BK discharge. The discharge is the date the court wiped your credit clean, allowing a fresh start.
- Chapter 13 Bankruptcy – 12 months after you file for Chapter 13 BK and begin making payments on your restructured debt, you can apply for an FHA loan. Your trustee must approve the new debt before the bank can close on your loan, though.
- Foreclosure – You can apply for an FHA loan three years after your foreclosure is filed.
FHA Down Payment Rules
As we discussed above, a minimum 3.5% down payment is necessary if you have a credit score of at least 580. If you have a credit score between 500 and 579, a down payment of 10% of the purchase price is required. Fortunately, the entire down payment does not have to come from you – the FHA allows gift funds.
You can receive gift funds from an approved source:
- Family members (blood or marriage)
- Employer
- Charities
You can receive 100% of the down payment as a gift as long as there is no expectation of repayment. You prove this with a signed and dated gift letter from the donor. In the gift letter, the donor should state the amount of funds he or she is donating, the reason (purchase of a house), and that he does not expect repayment of the funds.
FHA Seller Concession Guidelines
Sellers cannot help with the down payment. The down payment gift must come from someone without an interest in the sale (it must be an arm’s length transaction). However, the seller can help you with your closing costs. The seller can contribute up to 6% of the lesser of the sales price or appraised value of the home. For example, if you buy a home that is worth $150,000, the seller can contribute up to $9,000 toward your closing costs to help you close on the loan.
FHA Mortgage Insurance Rules
All borrowers with an FHA loan pay FHA mortgage insurance. It is a part of the ‘deal.’ The first part, the upfront mortgage insurance is due at the closing. Upfront mortgage insurance is 1.75% of the loan amount. Using the $150,000 priced home from above, you would owe the following:
- Down payment – $5,250
- Upfront mortgage insurance – $2,533
The upfront mortgage insurance is a closing fee that sellers can help with as a part of the 6% seller credit.
FHA loans also require annual mortgage insurance. This amount is added to your monthly mortgage payment. The average borrower with a loan amount less than $625,500 and an LTV greater than 95% pays 0.85% of the loan amount.
Lenders divide the annual insurance premium owed by 12. You pay 1/12th of the amount due every month. Your $150,000 home would require annual mortgage insurance payments of $102 per month. This is in addition to the principal, interest, real estate taxes, and homeowner’s insurance.
Unlike conventional loans, though, borrowers pay MIP or mortgage insurance premium for the life of the FHA loan.
How Much Can you Borrow?
Another difference between FHA loans and conventional loans is the loan limits. Conventional loans have one loan limit for everyone – $484,350. FHA loans, on the other hand, set the limits by county. The loan limit for each county is 115% of the area’s average home price.
The FHA does set a floor and ceiling or minimum and maximum loan amount. The FHA’s floor for 2019 is $420,680 and the ceiling is $970,800, both for single-family homes. Most counties and parishes have loan amount maximums that land somewhere in between these two numbers.
FHA Refinance Options
FHA loans are great for homebuyers, but there are great refinance programs as well. The FHA offers a cash-out refinance and a streamline refinance option.
The FHA cash-out refinance has the same qualifying requirements as the FHA purchase loan. The difference is that you need 15% equity in the home. In other words, you can borrow up to 85% of the home’s current value. If your home is worth $150,000, you can borrow up to $127,500. Any amount above what you owe on your current loan, you can receive as cash-in-hand. Many borrowers use this money for home improvements, pay for college, or debt consolidation.
The FHA streamline refinance is like a rate/term refinance. You cannot take cash out of the home’s equity. But you can refinance to get a lower interest rate or better term on your loan. The qualifying requirements are much less involved with the streamline refinance. The FHA requires only that you made your last 12 FHA mortgage payments on time and that you benefit from the refinance in some way.
Bottom Line
FHA loans are great for borrowers with less than perfect credit or little money to put down on the home.
As a Mortgage Broker , we have many options for your FHA loan needs. We will help you find the loan that suits your qualifications and budget the best, helping to make you a homeowner with ease.
