Are you going to buy your first home but you have a lower credit score and want to purchase the house on lower down payments? FHA loan is your option to choose from. Read the article to know more about the loan requirements.
An FHA loan is a mortgage insured by the Federal Housing Administration which dispatches the loans via a variety of lenders including big banks, lenders, and credit unions. The loan is provided with as low a down payment as 3.5% of the loan value with a lower credit score of 580 or higher. The agency has not set stricter limitations on being the qualifier of the loan. You may qualify for the loan if you have debt or a lower credit score. You might be a qualifier of the loan even with a bankruptcy or other financial issues on your record.
In order to know what is FHA loan and what are the FHA loan requirements, give the article a thorough read so that you get to understand the process and better decide to go for it. There are various types of FHA loans, each with its own benefits, check them out to get the best deal for you.
What is the FHA?
The Federal Housing Authority is also known as the Office of Housing within the Department of Housing and Urban Development (HUD). It was founded by President Franklin Delano Roosevelt and was created in part of the National Housing Act 1934.
The Great Depression of the 1930s along with the stock market crash and the Dust Bowl drought gave a severe shock to the housing market. Nearly half of the American homeowners were left at default on their mortgages. In that background, FHA was created as part of the National Housing Act of 1934 to stem the tide of foreclosures and help people to get homeownership in a more affordable and reasonable way.
It established a 20% downpayment of the mortgage as a new norm to gain 80% insurance of the house’s value for the borrowers. Previously, the rate was limited to 50%-60%.
Today, the FHA insures loans for 8 million Americans. They provide mortgage insurance loans applied by FHA-approved lenders. The insurance is provided to single-family homes, multiple-family properties, hospitals, and residential care facilities throughout the country to protect the lenders from losses.
What is an FHA loan?
A Federal Housing Administration is a government assured home mortgage loan which can be received by the individual via any bank or other agency which is approved by the agency. FHA loans require a borrower as low down payment as 3.5% than many conventional loans with lower credit scores of 580 or higher. FHA loans are usually ideal for first-time homebuyers who don’t have much savings or face credit challenges. According to FHA’s 2020 report, more than 83% of all the borrowers of their loans were those purchasing their first home.
The FHA-approved lenders include the banks, credit unions, and nonbanks which are being protected in case of default. Because the insurance protects the lenders, that is why they are willing to offer favorable terms to the borrowers who might not otherwise qualify for the house loan. Note that only FHA-approved lenders can issue an FHA-insured loan.
The loan can be used for buying a new home, or refining single-family houses, two-to-four unit multifamily houses, condominiums, and certain manufactured homes. There are some specific types of FHA loans that can be used for new construction or renovating an existing home.
What is the difference between an FHA loan and a conventional loan?
The FHA has made the procedure of their loan borrowing much easier than a conventional loan, which is a mortgage that is not insured or guaranteed by the federal government. Other than that, the following are some more differences:
- FHA rules are more liberal regarding the gifts of down payments from family, employers, and charitable organizations.
- FHA loans allow lower credit scores than conventional loans, while in some cases lower monthly mortgage insurance payments.
- FHA may include closing costs that are not required by convention loans.
|Conventional loans||FHA loans|
|Require higher credit scores||Allow lower credit scores|
|Have more liberal property standards||Have stricter property standards|
|Have slightly smaller down payments||Allow slightly higher down payments|
|Requires private mortgage insurance when the down payment is less than 20%, and the insurance may be canceled||Make FHA mortgage insurance mandatory regardless of the down payment amount, and it cannot be canceled unless you transform it into a conventional loan|
How do FHA loans work?
The FHA loans essentially work in the same way as other house loan programs. You are required to fulfill certain criteria that will make you a qualifier for the loan based on your income, employment history, credit history, and verify if you have or can get the gift of down payment and closing costs.
FHA loans are offered in a fixed time of 15 and 30-year terms with fixed interest rates. The agency’s flexible underwriting terms allow those borrowers who are not qualified for a private mortgage to have a loan to get the ownership of a house. As the lenders facilitate the process, borrowers are required to pay FHA mortgage insurance which protects the lender from a loss if the borrower fell short to pay the obligatory amount.
Mortgage insurance is required on most loans when the borrower is done paying 20% of the payment. All borrowers are required to pay two mortgage insurance premiums which are the following:
Upfront mortgage insurance premium: This is 1.75 percent of the loan amount which the borrower pays at the time of receiving the loan.
Annual mortgage insurance premium: Depending on the term of the loan, it is 0.45% to 1.05% of the loan amount and initial loan-to-value ratio, or LTV. This premium amount is paid on monthly basis and divided into 12 terms.
Understanding the above statistics in the example would be that if you borrow $150,000, the mortgage insurance premium that you will pay would be $2,625 and the annual premium would range from $675 ($56.25 per month) to $1,575 ($131.25 per month) depending on the term.
FHA mortgage premiums would be canceled after 11 years for most of the borrowers in case they have financed 90% or less of the property’s value. In other words, those who have put 10% of the down payment and stay current with the monthly mortgage payments, would be exempt from paying further premiums after 11 years.
Loans that have an initial ratio greater than 90% will carry insurance until the mortgage is fully repaid. FHA lenders cannot charge the borrowers more than 3 to 5% of the loan amount in closing costs, and the FHA allows up to 6% of the borrower’s closing costs, such as fees for an appraisal, credit report, or title search, to be covered by sellers, lenders or builders.
However, the flexibility of the FHA loans may work best if:
- Your credit score is between 500 and 619
- You need a loan amount that is at or below the current FHA loan limit for the property you are buying
- You want to buy a fixer-upper home with a 3.5% down payment and roll the renovation cost to the loan amount
- Your debt-to-income (DTI) ratio (a measure of your total debt compared to your income) is higher than the 50% conventional DTI ratio maximum
- You had a bankruptcy in the past two years or more
- You can’t qualify for the conventional loan
- You need to qualify for a mortgage with the income of a co-borrower who won’t live in the home
- You have had a foreclosure in the past three years or more
How to qualify for the FHA loan?
The FHA loans work in the same way as the private home loans. FHA demands the following requirements from the borrowers to be fulfilled for lending guidelines
- Have a FICO score of 500 to 579 with a 10% down payment, or a FICO score of 580 or higher with a down payment of 3.5%
- Have verifiable income through pay stubs, bank statements, and federal tax
- Have verifiable employment history of two or more years
- Ensure that the potential property is FHA-approved appraiser and meets HUD guidelines
- Use the amount of loan for a primary residence
- Have a front-end debt ratio (monthly mortgage payments) of no more than 31% of gross monthly income
- Have a back-end debt ratio (mortgage plus all monthly debt payments) of no more than 43% of gross monthly income (lenders could allow a ratio up to 50% in some cases)
- Have to wait for one to two years after bankruptcy, or three years after foreclosures (lenders may make exceptions on these waiting periods of borrowers with extenuating circumstances)
Types of FHA loans?
Besides the 15 and 30 years term loans, FHA offers a variety of different programs for the borrowers to meet their needs and help those who are not qualified for other types of private home loans.
- FHA streamline refinance: borrowers who already have a current FHA loan may enjoy purchasing FHA streamline refinance program which allows you to take a new loan with better terms where you are not needed to provide income documentation and home appraisal.
- FHA rate-and-term refinance: With this type of loan, you can refinance an FHA or non-FHA loan up to 97.75% of your home’s value with low credit scores and add the closing costs to the low amount.
- FHA cash-out refinances: Borrowers who have FICO scores as low as 500 may borrow 80% of their home’s value through this type of loan.
- Energy-efficient mortgage (EEM): The EEM allows the homeowners to add the cost of energy-saving upgrades to the balance of a purchase or refinance loan.
- FHA 203(k) loan: With FHA 203 (k) rehab loan, borrowers can purchase or refinance a home and roll the renovation cost into one loan.
- FHA GPM/GEM loan: With this program, the borrowers are given the option to choose the loan with lower initial payments which increase as their income rises (known as a graduated-payment mortgage or GPM) or the choice to increase principle payments and pay off the loan faster (called a growing equity mortgage or GEM).
- Home equity conversion mortgage (HECM): This policy allows the older homeowners (age 62 and above) with significant equity or those who own their outright to withdraw a portion of their home’s equity. The amount to be withdrawn will vary by the borrower and depends on the age of the youngest borrower or eligible non-borrowing spouse, current interest rates, and the lesser of the home’s appraised value or the HECM FHA mortgage limit or sales price.
- 245 (a) loan: This type of loan is geared at borrowers whose incomes will increase over time. The borrower starters pay the lower monthly premium that goes up with time. There are five specific plans available: three plans that allow five years of increasing payments at 2.5%, 5%, and 7.5% annually. Two other plans set payment increases over 10 years over 2% and 3% annually.
What are the requirements for the FHA loan?
FHA loans flexible their terms of getting the loan as they already give low-score borrowers a low-down-payment home loan option with lenient and qualifying guidelines. Below is the list of requirements that you need to get prepared before you start your application process for the loan:
- FHA Credit score
If you are making a down payment as low as 3.5%, you’ll need at least a 580 FICO credit score. Borrowers with a 10% down payment, have to have a 500 FICO credit score.
- FHA foreclosure and bankruptcy waiting period
If you’ve lost your home to foreclosure, you can’t file a loan request immediately. You have to wait for three years before you can take out an FHA loan. With a Chapter 7 bankruptcy, the waiting period is reduced to two years. This waiting period is much shorter than the conventional waiting period which is typically 7 years for foreclosure and four years for bankruptcy.
- FHA CAIVRS
The Credit Alert Verification Reporting System (CAIVRS) tracks whether people are following up on government-backed loans including:
- Small Business Administration loans (SBA)
- Federal student loans
- US Department of Agriculture loans (USDA) loans
- US Department of Veterans Affair (VA) loans
If you don’t owe much to the loans, paid your debts in full, or are under a repayment plan approved by the agency, then you are eligible to apply for an FHA loan. In the opposite case, you have to wait for three years after the federal government pays your lender’s insurance claim.
- FHA down payment
As long as you have at least a 580 credit score, the minimum down payment you’ll have to pay would be 3.5%. For the credit score of 500-579, you’ll need 10% down. The down payment can be made by any family member, close friends, employer, or charitable organization.
- FHA DTI ratio
The DTI ratio is the percentage of your gross monthly income from where you make monthly debt payments. FHA lenders require a maximum of 31% of the front-end DTI ratio which you have to pay him, that focuses on housing payments. You also have to make an end DTI ratio which encompasses all of your remaining debt payments, including housing. It should not exceed 43% in most cases.
- FHA cash reserves
Cash reserves are the leftover amount of cash you have on your hand after considering your down payment and closing cost, or other compensating factors. For lenders, this amount is a kind of guarantee that how many mortgage payments you could make in a financial crunch, and they may help you qualify for the loan with a high DTI ratio.
- FHA occupancy requirements
FHA requires you to live in a one-to-four unit house as your primary residence for a year after buying it for extending your loan application. You can enjoy one added benefit of the FHA loan by purchasing a multi-family house with a 3.5% down payment and using the rental income from other units to qualify as long as you live in one of the units for 12 months.
- FHA income and employment requirements
The agency demands to prove your stable income and employment for the past two years. If you have taken frequent job gaps and changes, you have to provide extra explanation and documentation. However, there are no income limits or homebuyer education requirements.
- FHA appraisals
You need to provide an FHA appraisal regardless of your down payment amount for the FHA loan. The appraisal guidelines are more frim than those of conventional loan guidelines.
- FHA property standards
There is a condition for having minimum property standards for safety and living conditions. With an FHA financing loan, you can buy a one-to-four unit home in a subdivision, an FHA-approved condominium project, a cooperative unit, or a manufactured home attached permanently to a foundation.
- FHA amendatory clause
Through FHA amendatory clause, the homebuyers get the right to back out of a purchase contract if the appraisal does not match the sales price. It is also called an “escape clause” which must be signed before signing the purchase contract on an FHA loan.
- FHA loan limit
The agency has set the limit of $420,680 for most parts of the United States for 2022. Buyers from the high-cost areas can borrow up to $970,800 for a single-family home whereas limits are higher for multifamily homes and special exception areas such as Guam, Hawaii, Alaska, and United Virgin Islands.
The following table shows the FHA loan limit for regular, high-cost, and exception areas for one-to-four unit homes.
|Number of units||FHA standard loan limits||FHA high-cost area and special exception loan limits|
How to apply for the FHA loan?
Here is a six-step guide for you to follow the application process.
- Shop several FHA-approved lenders
As the matter of fact, you have to buy the loans from government-approved lenders, so you need to check on them because not all lenders provide the same type of FHA loans. Compare three to five lenders in terms of rates and costs, mortgage brokers, mortgage banks, or your local banks. You can also put your basic financial information into an online rate comparison tool and let the lenders call you within your best-offered rates.
2.Complete an FHA loan application
You can get the loan application form from the website or the particular agency and enter the relevant information. If you are buying a home, you need basic information handy about your income, down payment funds, and monthly debts as you fill out the application.
3. Give the lender permission to verify your credit scores
Being part of the application process, the lender has the right to verify if you meet the minimum criteria of the FHA credit score requirement.
4. Provide two years of employment and income history
In order to provide your income and employment history, you need to collect pay stubs for the last 30 days, and the last 2 years of W-2s or federal tax returns along with employer contact information. You need to check with your loan officer in order to confirm if you are applying for a special FHA program, like an FHA streamline refinance or reverse mortgage, in that case, you won’t need much paperwork.
5. Document your down payment sources
Being part of the application process, you have to show to the lenders the sources from where you will pay the down payment and closing cost funds. For that, you need to produce two months’ worth of bank statements or a letter of explanation to describe your income sources. Some lenders may also want to see if you have a few months’ worths of cash reserves in the bank if your credit score is lower than 580 or your DTI ratio is high.
6. Explain and document any defaulted federal debt
FHA-approved lenders use CAIVRS to check that you are not a defaulter of student loans or any other federal debts.
Conventional loans vs. FHA loans
Although the process of applying for a conventional loan is similar to that of FHA loans FHA provides many lenient terms to the customers that’s why it is most likely to be purchased by people who are first-time home buyers.
|Loan features||Conventional mortagage||FHA mortgage|
|Minimum down payment||3%||3.5% with a 580 credit score|
|DTI ratio||45% with exceptions up to 50%||43% with exception up to 50%|
|Minimum Credit score||620||500-579 with a 10% down payment|
|Maximum loan limit||Higher loan maximums than FHA loan limits||Lower loan maximums than conventional loans|
|Mortgage insurance||● Typically no upfront mortgage insurance
● Waived with a 20% down payment
● 0.15% to 2.5% annual PMI paid monthly
● The lower the credit score, the higher the MI premium
● Can request PMI cancellation after reaching 20% equity
|● 1.75% UFMIP
● 0.45% to 1.05% annual MIP
● Same premiums regardless of credit score
● Required regardless of down payment
● Can’t cancel MIP with 3.5% minimum down payment; can be canceled after 11 years with 10% down
|Appraisal requirement||Can be waived on eligible purchases and refinance program||● Required on all purchase loans
● Waived on streamline refinance program
Pros and cons of FHA loan
If you are planning to get the FHA loan for buying a new home or renovating the existing one, you need to keep the benefits and disadvantages of the service in mind. Here are some of the pros and cons of getting the FHA loan.
- Low down payment requirement
If you have credit scores of at least 580, you have to pay as low a down payment as 3.5% of the value of the property. In case your scores are between 500-579, you may have to put down 10%.
- Good credit is not required
You are eligible to get the FHA loan with credit scores as low as 500 which can benefit you a lot especially if your credit history is shaky.
- Down payment help allowed
As long as you are not falling short of meeting the requirements of FHA, the agency permits the FHA gifts and down payment assistance.
- Sellers can help with closing costs for an FHA loan
The agency allows the home sellers to pay up to 6% of the closing costs for a loan. Conventional lenders on the other hand may cap a seller’s contribution at 3% of the closing costs, although some may allow sellers to pay up to 6%.
- Mortgage insurance can be costly
The FHA loans require you to pay mortgage insurance which can be costly as you have to pay a one-time upfront mortgage insurance premium and an annual premium that is collected on a monthly basis. The one-time premium is generally equal to 1.75% of the home purchase price and can be financed in the mortgage or cash, but the payment has to be in combination. The annual premium depends on the loan amount and loan-to-value ratio.
- Limit on how much you can borrow
There is a loan limit based on median home prices in metro areas and counties. For instance, in 2020, the FHA maximum for a singly family home in a low-cost area was $331,760 and for high-cost areas, it was $765,600. In this regard, Alaska, Guam, Hawaii, and the Virgin Islands are exceptions with a maximum of $1,148,400 for a single-family unit. These loan limits are not static forever, so do check the limits at the time when you are planning to apply for the loan. There is a search tool on the website of the Department of Housing and Urban Development that you can visit to identify the mortgage limits by state and county. This way you will come to know how much you can borrow based on the place you live.
- If you have good scores, consider other options
If you have a strong credit score but don’t have enough money for a large down payment, you may still think of other available options because of mortgage premiums. Note that if you are not putting 20% down you’ll likely have to pay private mortgage insurance or PMI.
FAQs for FHA loans
Is it easy to get an FHA loan?
FHA loans are comparatively easier to get because they have lower credit score requirements, especially for the people who are first-time buyers of homes. While conventional loans start from a 620 credit score, FHA allows getting the loan if you have a FICO credit score of 580. The agency also allows a higher debt-to-income ratio, which is good news for those borrowers who have big debts to pay such as student loans, and auto loans. Finally, FHA only requires 3.5% of the down payment while the whole down payment can be paid through gift funds or down payment assistance if the borrower is able to find financial aid.
What are the qualifications for an FHA loan?
There are no strict restrictions on who can apply for the loan. Anyone can apply and you don’t have a need to be a first-time home buyer. However, you should take notice of the following things:
- Need a credit score of 580 or higher
- Debt-to-income ratio of 45% or less
- Down payment of at least 3.5%
- A steady and documented employment and income history
- You must plan to live in the home as your primary residence
- Home needs to pass an FHA appraisal
- The mortgage must be within the current FHA loan limits
What is the downside of the FHA loan?
The biggest drawback of the FHA loan is its expensive mortgage insurance. You can cancel the mortgage insurance in conventional loans, but in FHA loans, the mortgage insurance cannot be canceled once you build up equity. However, it is possible to refinance out of an FHA loan and into a conventional loan without private mortgage insurance once you have paid 20% equity. If you have lower credit and other hurdles for the mortgage qualifying, the agency can help you get into a home now with a plan to refinance and lower your overall costs later.
Is there a maximum income for FHA loans?
You can apply on any income status as there are no income limits to apply for the loan. However, you must meet the criteria of FICO credit score and remain under the maximum debt-to-income limit.
What banks do FHA loans?
Most lenders are FHA-approved which include big banks, mortgage lenders, and credit unions. As the marketplace for FHA loans is huge, the lenders offer lower FHA rates and low FHA fees due to competitive pressure among the lenders, so you can visit multiple lenders unless you get the best deal. Also, because different banks use different methods to underwrite, it might be the case that your FHA loan is declined by one bank but can be approved by another bank. As long as you meet the requirements of the agency, you can apply unless your loan gets approved.
How much FHA loan can I get approved for?
The loan amount you can get approved for depends on a number of factors including your credit score, debt-to-income ratio, interest ratio, down payment, and more. However, FHA sets a loan limit that you cannot exceed which is based on the area you are living in and the number of home units you are buying. You can consult with your lender to get pre-approved to see how large of an FHA loan you qualify for.
What types of homes meet FHA requirements?
FHA insurance a list of different properties including single-family detached homes, 2-unit homes, 3-unit homes, 4-unit homes, condominiums, mobile homes, and manufactured homes. If you are buying a multiunit home, you are required to reside in one unit. In addition, FHA home buyers can purchase the property in any neighborhood of the United States, whether in any 50 states, the District of Colombia, or other US territory.
What kinds of mortgages does FHA do?
FHA offers fixed 30-year term mortgages and 15-years term mortgages as standards. Buyers can also use an FHA 5/1 adjustable; rate mortgage (ARM) if they wish. FHA also provides purchase-and-improvement loans through which you can use by buying a home that needs repair, construction loans through which you can buy a home that is newly built, and energy-efficiency loans through which you can finance the energy efficiency improvements into your loan. The agency also provides a full line of FHA refinances products such as low doc FHA streamline refinance.
How do I get rid of FHA mortgage insurance?
The only way to get rid of the FHA mortgage insurance is to refinance the premiums into a non-FHA loan. The most popular type of loan to refinance into is a conventional mortgage.
How much does FHA mortgage insurance cost?
You have to pay both an upfront mortgage insurance premium (UMIP) when the loan closes and the annual fee (MIP) which is divided into monthly mortgage payments. The upfront mortgage fee is 1.74% of the loan amount, while MIP is based on the home value but is often around 0.85% of the loan amount.
Are FHA loans assumable?
Yes, the agency will allow the borrowers to assume the existing FHA mortgage on a home being purchased. The buyer is though not exempt from being qualified for the mortgage with the existing terms, but in the rising mortgage rate environment, it can be appealing to assume a home seller’s loan. For instance, five years from now on, the buyer of the FHA-insured home can inherent a seller’s sub 3% mortgage rate. This way home selling can be easier.
What does loan-to-value mean?
The loan-to-value (LTV) is the other way to mention down payments. Your LTV ratio compares the home value to your loan amount or in other words, the amount you are borrowing after your downpayment. For example, if you submit a 3.5% down payment for the loan, your LTV would be 96.5% because you are borrowing 96.5% of the purchase price. LTV is also important for the refinance because it mentions how much you still owe on your mortgage compared to your home’s current value.
Can you buy a house to rent out with an FHA loan?
You can’t buy a proper rental property with your FHA loan, however, you can buy a multi-unit home. You can live in one unit while renting out the other units. The rent from the other units can partially or fully offset your mortgage payment.
Has the coronavirus made getting the FHA loan more difficult?
Not that much. In the early days of the coronavirus pandemic, the lenders imposed restrictions. Since FHA lenders can set the requirements for the borrowers, this affects FHA home buyers along with the conventional borrowers. But later on, lenders loosened the restrictions as the mortgage rates continued to drop. With more stay-home orders from the government, most of the borrowers have applied for the FHA loans online.
The Federal Housing Administration (FHA) provides home loans with lenient borrowing guidelines that might not otherwise qualify for conventional loans which require stricter requirements. The FHA loans are more popular in first-time homebuyers because they have limited savings and some credit issues. Because FHA loans are government-backed, the lenders offer lower mortgage rates than conventional mortgages.
The FHA loan is a mortgage made by an FHA-approved lender and insured by Federal Housing Administration which allows borrowers to purchase a home with lower credit scores and lower down-payments than the conventional loans. There are no restrictions on the income limit or other requirements. Anyone can get a loan whether you currently or previously owned a home. And unlike many other low-down-payment conventional loan programs, there are no low to moderate-income restrictions, as long as you provide your income and employment documentation of at least the past two years, the FHA does not impose heavy restrictions.