The Federal Housing Administration (FHA) loan is one of the greatest tools for first time and repeat homebuyers. With a minimum down payment of 3.5%, great rates, and lenient credit guidelines, the FHA loan has enabled millions of people to buy a home who would not have been able to otherwise.
What is an FHA Loan?
You could think of FHA as a giant insurance company. It doesn’t actually do the lending. Rather, this government-run agency insures lenders against financial loss in case the borrower defaults on the loan. Due to solid financial backing, lenders can approve many low to moderate income borrowers for 3.5% down mortgages. Without FHA many first time buyers would be locked out of home ownership.
What Can an FHA Loan be Used For?
FHA loans are strictly for owner-occupied homes, meaning you will live in the home you will buying. No second homes or rentals are allowed.
You can buy a single-family (1-unit) home, as well as a duplex, triplex (3-unit) or four-plex (4-unit) as long as you live in one of the units.
You can also use an FHA loan to buy a manufactured home, condo, or to rehab a home that is in need of repairs. FHA loans are truly one of the most versatile loans available.
Who Can Apply for an FHA Loan?
FHA loans are open to US citizens, and also for permanent resident aliens and non-permanent resident aliens who provide proof they are eligible to work on the U.S.
FHA loans are not limited to first time homebuyers, nor are there maximum income limits or geographic restrictions associated with the program. If you’ve purchased a home before, you may qualify for FHA. But if you currently own a home with an FHA loan on it, you will probably not be allowed to purchase another home with FHA until you’ve sold your previous home.
Those who have defaulted or are delinquent on a Federal debt may not be eligible. However, for most homebuyers, FHA is a great tool to gain access to homeownership.
FHA Pros and Cons
FHA has more lenient credit guidelines. Those with less-than-perfect credit may qualify.
FHA loan interest rates are lower than low-down-payment conventional loans.
Minimal down payment of only 3.5% of the purchase price. Keeps more cash in your pocket.
You can opt for the FHA 203k option if the home is in need of repairs.
The seller can pay most if not all your closing costs.
Requires less income and assets than other loan types.
You can use gift money for the down payment.
You may be able to use a co-signer (non-occupant co-borrower).
If you choose to refinance in the future, the process is streamlined.
FHA Mortgage insurance remains in place for the life of the loan in most cases. You would have to refinance into a conventional loan to cancel mortgage insurance.
FHA cannot be used for second homes or investment properties.
Typically, you can’t qualify for an FHA loan if your current home is financed with FHA.
The property has to be in fairly good condition. Otherwise, an FHA 203k loan must be used.
FHA Qualification Process
The FHA loan is examined by a lender in much the same way as other loan types. You will apply with an FHA approved lender (most lenders are FHA approved) and verbally give the loan representative your personal information, and income and asset amounts. The lender will pull your credit report to make sure you have acceptable credit history.
If you qualify, the lender will issue a pre-approval and you can start looking for a home within the price range approved. You will submit documentation such as paystubs, W2s, two years of tax returns, and bank statements. If all goes well, you will receive a final approval, sign loan paperwork, and you will own your home.
FHA Credit Score and Debt-to-Income Ratio
FHA’s minimum credit score for the program is 500, but a lenders generally set higher guidelines. Some lenders may require a minimum credit score as low as 580 or as high as 640.
The lender will look at your debt-to-income ratio. This is the amount of debt you will have, including your new house payment, compared to your gross income. For instance, if you make $5000 per month, and your credit card, auto loan, student loan, etc payments, plus your proposed house payment equal $1750 per month, you have a debt-to-income ratio of 35%.
FHA official ratio requirements are 29% for the house payment itself, and 41% for the house payment plus all other monthly debt payments. So, again, if your income were $5000 per month, you would be allowed a $1450 house payment (principle, interest, property taxes, homeowner’s insurance, and HOA dues if any). Additionally, the total house payment and all monthly debt payments allowed would be $2050.
With that said, loans can be approved at higher debt-to-income levels. I personally have seen FHA loans approved at 50%+ ratios, so it’s worth applying even if your debt ratios are above the standard levels.
FHA Mortgage Insurance Rates 2020
FHA requires both upfront and ongoing monthly mortgage insurance fees. For most borrowers, the upfront fee 1.75% of the loan amount and 0.85% yearly. (FHA mortgage insurance rates were reduced in January 2015.)
The upfront mortgage insurance is usually financed into the loan amount, but it can be paid in cash at closing of the loan. The yearly premium is paid in monthly installments with each mortgage payment.
For instance, a $250,000 loan would require $4,375 in upfront mortgage insurance, resulting in a $254,375 total loan amount. In addition, the borrower would pay $177 per month in FHA mortgage insurance.
FHA mortgage insurance rates are determined by loan amount, loan term, and the loan-to-value. Here are current FHA monthly mortgage insurance rates. Keep in mind that the yellow box represents the vast majority of all FHA loans.
FHA Loan Limits
The geographic location, as well as the property type, determine the maximum FHA loan amount. For instance, a single family (1-unit) home in Burke County, North Dakota has a limit of $356,362.
But, in Los Angeles County, California, the FHA limit for the same type of home is $822,375. Quite a difference.
Additionally, FHA loans have higher loan limits for 2-, 3-, and 4-unit homes. In Miami-Dade County, Florida, the limit for a single-family home is $402,500, but $774,050 for a 4-unit home.
To look up limits for your geographic location, see HUD’s website.
I’m Ready to Apply for an FHA Loan
Without FHA loans, many would-be homebuyers would not be able to overcome traditional barriers to homeownership like the initial out-of-pocket expense or less-than-perfect credit. If you’d like to start your home ownership journey, apply today.