What is an FHA Loan: 2022 Guide

What Is an FHA Loan?

An FHA loan is a mortgage product that is backed by the Federal Housing Administration. The FHA is part of HUD or Housing and Urban Development. FHA Loans were established by the National Housing Act on June 27th, 1934 to facilitate home financing, improve housing standards, and increase employment in the home-construction industry in the wake of the Great Depression.

The FHA’s primary goal was to make housing more accessible to homebuyers by insuring their loans against default.  By insuring the loans, it prompted banks to lend more to buyers who otherwise could not buy. FHA loans have less restrictive credit requirements and easier down payment options.

It is important to note that FHA does not lend money to borrowers, they simply  the loans in the event a borrower defaults.FHA and other government-backed programs make it possible to buy a home without putting 20% down.

Who are FHA Loans For?

The FHA Loan can be used for any type of homebuyer. However, while anyone can use an FHA loan that meets the requirements, they tend to work really well for the following types of homebuyers. 

• First-Time Homebuyer: Someone who has never purchased a home or hasn’t purchased a home in the last 3 years. 
• Low Credit Borrowers: Buyers who’ve had past credit issues or suffer from low credit scores
• Low Down Payment Buyers: FHA loans are great for buyers who can’t save 5%,10% or 20% down. 
• High DTI Buyers: FHA works well for buyers with high debt to income ratios

FHA Loan Requirements

What are the Credit Requirements for FHA Loans? 

FHA Loans are one of the easiest loans to get approved for, but there are still certain requirements you must meet in order to qualify. 

What’s the minimum credit score to qualify for an FHA Loan? 

The minimum credit score to qualify for an FHA Loan is 500. 

However, that’s only part of the battle. With a credit score that low it’s going to be a manual underwrite.  

Manual underwrites are what’s called underwriter discretion.

 This means the underwriter alone determines if you will qualify for the loan.

Typically to get an automated approval you will need at least a 580 credit score to qualify. 

Scores under 580 have different down payment requirements as well which we’ll discuss below. 

Can I get an FHA Loan After Bankruptcy? 

FHA Loans are one of the easiest loans to get if you’ve had to file for bankruptcy. 

While Conventional Loans will require you to wait up 4-7 years after filing bankruptcy; FHA is much sooner. 

FHA Bankruptcy Waiting Period: 

• Chapter 13: Borrowers who’ve filed for a Chapter 13 bankruptcy can apply for an FHA Loan once they’ve made 12 on-time monthly payments. 
• Chapter 7: Borrowers who’ve filed for a Chapter 7 Bankruptcy must wait until 2 years have passed from their official discharge date. 

What Are FHA Student Loan Guidelines? 

If you have student loans you’ve probably figured out that they can complicate the loan process. 

The reason for this is that most people have their student loans in deferment. 

Deferred Student Loans:

These are loans that you aren’t currently required to make monthly payments on. 

It gets complicated because lenders still make you count a payment for those loans. 

FHA student loan guidelines are: 

• If the payment on your credit report is $0 for your student loan we have to use .05% of the total balance owed as a monthly payment. 
• If the payment on your credit report is more than $0 we can use that monthly payment. 

This is important because these figures are added to your monthly debt payment which will affect your debt-to-income ratio. 

Can I get an FHA Loan if I Have Collections? 

A collection account is a debt that you owe that went unpaid.If the debt remains unpaid long enough the lender or bank will refer that loan to a collection agency.The job of the collection agency is to “collect” the debt. 

If you have collection accounts on your credit report, FHA is one of the most flexible mortgage programs to qualify for. FHA doesn’t require you to pay off your collection accounts in order to qualify for a mortgage. 

FHA Collection Requirements: 

Medical Collection:

 These types of collection accounts are not counted toward you 

Standard Collection Accounts: 

A standard collection account is anything other than medical collection.

If the total of all of your collection accounts exceeds $2,000 FHA will require those to be counted against you. 

FHA will take the total amount of collection accounts owed and multiply them by 5%.

That 5% must be included in your monthly debt obligations. This will increase your debt to income ratio. 

So if you have $5,000 in owed non-medical collections x 5% would be $250 per month added into your monthly debt obligations. 

As long as your debt-to-income ratio is low enough you can purchase a home using FHA without having to pay them off. 

Charge-Offs: 

Charge-off accounts are accounts that the lender has written off as a loss.

You are still legally obligated for the debt and it can still be sold to a collection agency. 

FHA does not require lenders to factor in charge-off accounts so we don’t have to use those balances as monthly debt. 

FHA Loan Down Payment Requirements 

The minimum down payment requirement for an FHA Loan is 3.5% if you have a credit score of at least 580.If your credit score is in the 500-579 range your minimum down payment will be 10% down. 

One of the things that make the FHA loan so popular is the down payment requirements. FHA has one of the lowest down payment requirements of any program. If you find yourself in the lower credit category you should also be prepared to need reserves as well.

What Are Reserves? 

The down payment on your FHA loan can come from the following:

• Checking and Savings Accounts
• Investment Accounts
• 401k and Retirement Accounts
• Gift Funds

Your down payment cannot come from loans or money you have laying around in cash. 

FHA Loan Income Requirements

There is no minimum amount of money you must earn each month in order to qualify for an FHA loan. The amount of income you’ll need to earn is solely dependent on how much house you want to buy. The more expensive the home the more expensive your monthly payment will be.

The higher the monthly payment, the more monthly income you’ll need in order to qualify. The primary way lenders determine how much income you’ll need is through something known as Debt-to-Income Ratio. 

Debt-to-Income ratio or DTI is the amount of money you spend each month divided into the amount of money you earn each month. Lenders will use your gross monthly income and the total amount you spend on your debts.

Common debts included in DTI: 

• Credit Card Payments
• Auto Loans
• Personal Loans
• Student Loans 
• Child Support Payments
• Mortgage Payment 
• Boat/RV/Motorcycle Loans
• Tax Payment Plans
• Bankruptcy Payment Plans

The lender is going to take these monthly debt payments and divide them into your monthly gross income. 

Let’s say you earn $5,000 each month in gross income.

Your annual income would be $60,000 per year.  

And let’s say you have a total of $1000 a month in debt payments.

The house you want to buy is $250,000 and that payment will be $1500 a month with taxes and insurance. 

This puts your total monthly debt at $2500 per month.

$2500 \ $5000 = 50%. 50% would be your back-end debt to income ratio. 

FHA says your debt-to-income ratio can’t exceed 50%.

So you should be in ok unless you have poor credit.

For borrowers with poor credit, you’ll want to stay under 50% and if you have very bad credit you’ll want to be around 40%. 

For higher credit score borrowers you can actually push those DTI limits to 56.9% 

FHA Loan Limits: What’s Your Max FHA Loan Amount?

In 2022 the FHA Loan limits have increased by $65,000 on single-family homes. 

The new FHA Loan limit for 2022 is $420,680. This is the maximum loan amount you can get with an FHA loan. 

The 2021 FHA loan limit was $345,360 which is an increase of nearly $65,000. 

Please remember these are just the maximum limits, the amount you will actually qualify for will depend on your down payment and debt-to-income ratio. 

FHA Mortgage Insurance

FHA’s mortgage insurance is known as Mortgage Insurance Premium. (MIP)

The reason FHA has mortgage insurance is to provide the insurance on the loan that allows banks to lend to buyers without putting 20% down. 

FHA’s MIP is an additional payment you’ll make on your loan.  Let’s see what FHA MIP includes and what it costs. 

Upfront Mortgage Insurance Premium (UFMIP): The Upfront insurance premium is an amount that is charged to each FHA loan borrower upfront. 

The UFMIP is equal to 1.75% of your total loan amount. This amount can be financed into your loan amount or paid upfront.

The vast majority of home buyers choose to finance this into their loan. 

A $250,000 loan will carry 1.75% UFMIP which would be $4375 added into your loan amount or due at closing. 

Monthly Insurance Premium (MIP):  The monthly mortgage insurance premium is the amount you’ll pay each month in mortgage insurance. FHA charges 0.85% of the total amount owed annually for mortgage insurance. 

If you owe $250,000 your annual insurance will be .85% of that balance which is $2125 per year.  $2125 divided by 12 would be $177.08 which would be your monthly mortgage insurance payment. 

How to Get Rid of PMI on an FHA Loan

Unlike Conventional Loans, the mortgage insurance you pay on FHA Loans doesn’t go away unless you put 10% down.For most borrowers putting 3.5% down, their mortgage insurance will continue for the life of the loan. 

Many homeowners will refinance their loan to a Conventional loan after they have built up some equity. A Conventional loan doesn’t have mortgage insurance once you have at least 20% equity.

What Type of Homes Qualify for an FHA Loan

FHA allows you to finance many different types of homes with the FHA loan.  You can use your loan on many different property types as long as they are your primary residence. 

Single Family Homes

A single-family home is a free-standing building. They are designed to be used by one family with no shared walls on its own land. Single-family homes are your typical “sticks and bricks” style homes. They are by far the most popular type of home. 

Condos

A condominium or condo is very similar to an apartment. The difference is that with condos each unit has an owner and the rest of the property is shared. 

FHA does allow you to purchase condos using the FHA loan but they do have different requirements than your standard sticks and bricks. 

The condo needs to be on the HUD (Housing and Urban Development) Master Condo List.

Buildings on this list have already been certified to meet the FHA minimum property eligibility requirements. 

Townhomes 

Townhomes are also eligible for FHA Loans. Townhomes are a bit easier to qualify for since you typically own the land as well as the unit you are purchasing.

As a result, townhomes don’t have any special requirements in order to purchase them. 

Manufactured Homes 

Manufactured homes are any home that is manufactured off-site and put together on site. This can include modular homes, single-wides, double-wides, and triple-wides. 

You can use your FHA to purchase a manufactured home. Some lenders will restrict the types of manufactured homes you can buy. 

Single-wide manufactured homes are the toughest to qualify for. This is because most lenders won’t do them. 

Single-wides can have: 

• Higher credit score requirements
• Higher interest rates

Another thing to consider is that many lenders will also have higher credit score requirements in order to purchase a manufactured home. 

We can help you purchase a manufactured home even if you have a credit score as low as 580. 

Fixer Upper

FHA will allow you to purchase a home that needs minor or major repairs. However, you cannot use the standard loan program to do so. 

For homebuyers looking to purchase a fixer-upper, you’ll need to look into the FHA 203k loan. 

The FHA 203k loan allows you to purchase or refinance a home and rehab it.

Some lenders may impose higher credit score restrictions on this program such as a minimum score of 620. 

FHA 203k loans usually also have higher interest rates since the loans pose additional risk. 

How Much Are Closing Costs on an FHA Loan?

The closing costs on FHA aren’t all that different from any other loan.As with any loan you apply for, FHA Loans will have pretty standard fees. 

FHA closing cost charges include: 

• Lender Fees
• Title Fees
• Government Fees
• Appraisal Fees
• Insurance 
• Taxes
• Filing Fees

FHA does have one additional fee that conventional loans don’t: UFMIP.As we discussed earlier this is the upfront mortgage insurance premium that FHA charges all borrowers.Most will finance this into the loan so it doesn’t factor into your closing costs. 

Potential homebuyers should expect to pay between 2%-5% in closing costs. The good news is that FHA also allows the seller to cover your closing costs.FHA allows the seller to pay up to 6% of the purchase price back to the buyer in the form of closing costs assistance. 

While it’s not guaranteed it’s very common that our clients receive at least a portion of their closing costs paid by the seller.Most of our first-time homebuyers get the seller to cover at least $5000 towards their closing costs.

See Today’s FHA Interest Rates

Types of FHA Loans

FHA offers a variety of different loan types to meet the needs of the majority of home buyers. Most people know about their standard purchase program but they also offer these programs as well. 

FHA Streamline Refinance 

An FHA Streamline Refinance is the refinance of an existing FHA-insured mortgage requiring limited borrower credit documentation and underwriting. 

Two Types of Streamline Refinances: 

Credit Qualifying: A credit qualifying streamline refinance is a refi where the borrower allows the lender to pull their credit and has their terms based on their current credit score. 

Non-Credit Qualifying: A non-credit qualifying refinance is one in which the borrower does not use their current credit score to qualify for the loan. 

Benefits of an FHA Streamline Refinance: 

• No Appraisal Required 
• No Verification of Employment or Income 
• No Credit Check Required 
• Reduced Closing Costs 
• Reduce Your Interest Rate 

Streamline refinance are great for current FHA borrowers who want to take advantage of lower rates or need to reduce their monthly payments. 

With the non-credit qualifying options, even borrowers whose credit scores have dropped may qualify. 

FHA 203k Loans

An FHA 203k loan or sometimes called a rehab or renovation loan is a program that allows financing a home and the cost of the repairs it needs. 

Benefits of FHA 203k Loans: 

• Buy a home that needs repairs 
• Purchase a home cheaper than a move-in ready home 
• Potential for higher equity 
• Less competition in hot housing markets 
• Ability to make the house “your own” 

The 203k loan is a great program for homebuyers looking to purchase a home in need of major or minor repairs.While FHA doesn’t restrict this program from first-time homebuyers, they should beware that these loans cost more both upfront and over the long run. Many buyers who use an FHA 203k loan will use an FHA Streamline refinance to reduce their monthly costs. 

FHA Construction Loans

A construction loan is a loan that allows you to build a home.  The FHA One Time Close Construction Loan allows you to buy and build a home from the ground up even financing the lot if needed. 

Benefits of FHA Construction Loans: 

• Reduce costs by using one loan to build
• Flexible credit requirements 
• Lower down payment requirements over traditional construction loans 

The drawback of FHA Construction  Loans: 

• Very few lenders offer them 
• More red tape and paperwork ( a lot more) 
• The process takes longer than standard FHA Loan 

Overall if you have time and the desire to build your own home, but don’t have 20% down of a 720 credit score an FHA Construction loan might be a good fit for you. 

FHA Disaster Loans 

If you’ve been the victim of a federally declared natural disaster you may qualify for an FHA 203H (Disaster ) Loan. The 203H loan is designed to make recovering from a disaster easier. 

The main qualification requirement is that the home you lived in prior to the disaster must be totally destroyed.  FHA will require proof that your home is no longer fixable or liveable. 

Benefits of FHA 203H Disaster Loan: 

• No down payment required 
• Can rebuild a current home or purchase a new one
• Not required to purchase in the disaster area
  
  FHA offers a variety of different loan types to meet the needs of the majority of home buyers. Most people know about their standard purchase program but they also offer these programs as well.

How Does FHA Compare With Other Loans?

So by now, you know at least a little bit about the ins and outs of FHA loans.You understand their credit, income, and down payment requirements. You may be wondering, how does FHA compare with other loan programs? Let’s dive in

FHA vs. Conventional 

Conventional loans are a popular alternative to FHA Loans. Conventional loans have stricter credit requirements than FHA but also offer a few benefits you don’t get with FHA. 

Conventional Loans Requirements:

• Minimum credit score of 620
• Requires 3%-%5 Down
• Maximum Debt-to-Income Ratio of 50% 

Pro’s of Conventional Loans: 

• PMI falls off when you reach 20% equity 
• Less restrictive appraisal requirements 
• Higher loan limits 

Drawbacks to Conventional Loans: 

• Higher credit score requirements 
• Less flexible for past credit issues
• Higher interest rates

READ: FHA vs. Conventional Loans

FHA vs. USDA Rural Development 

USDA Rural Development loans are another great alternative to FHA Loans. USDA Loans or RD loans as they are often called is a popular program for first-time homebuyers. 

The Rural Development loan doesn’t require a down payment, has lower mortgage insurance, and allows you to roll in your closing costs if the home appraises for more than you paid for it. 

Pros of USDA Rural Development Loans: 

• No down payment required
• Cheaper mortgage insurance of 0.35% 
• Can roll closing costs into the loan 

Drawbacks of USDA Loans: 

• You must earn under the income limit for your area
• Only homes in eligible areas will qualify 
• Can take longer to close 

If you’re eligible for both programs, deciding on which one will likely come down to what area you want to purchase a home in. 

Pro’s and Cons of FHA Loans

Pro’s 

• Lower Credit Scores Accepted
• Lower Down Payment Needed
• Gift Funds Allowed
• Seller Can Pay Closing Costs 
• A Co-Borrower is allowed (even if they won’t live there) 
• Multiple programs to fit your needs

Con’s 

• Lower loan limits than Conventional 
• Upfront Mortgage Insurance 

• Mortgage Insurance is permanent 
• You still need a down payment to qualify 

Is an FHA Loan Right For You?

By now you’re probably wondering if the FHA loan is right for you.  If you are in the market for a loan with flexible credit requirements, low down payments, and no income restrictions, FHA could be the loan for you. 

If you’ve decided that the FHA Loan is the right loan program for you your next question is how do you get qualified. 

As a borrower, you have many different options when choosing the right lender to work with. 

There are online lenders who do everything through an app, local lenders that work for large companies, and your local independent mortgage broker. 

Bayou Mortgage is an independent mortgage broker and we’d love to help you. We are a low-cost option, that provides low wholesale rates and great local service.