If you lack traditional funding to purchase a home, it may be time to explore alternatives. Since 1934, the Federal Housing Administration (FHA) has provided a path for low and middle-income Americans to be approved for loans to buy a home. The FHA is one of the world’s largest mortgage insurers that provides insurance on home loans made by government-approved lenders and banks.
Consider applying for an FHA loan if you want to purchase a single or multifamily property, including a condominium. Learn more about FHA loan basics, such as eligibility requirements, approval limits, and the application process.
The Basics of FHA Loans
An FHA loan is a special type of mortgage loan insured by the Federal Housing Administration. The FHA only approves loans from government-approved banks and lenders. FHA loans are also called FHA-insured mortgages. An FHA loan is a mortgage that requires a smaller downpayment and less rigid approval criteria than traditional mortgages.
In contrast to typical types of mortgages, FHA loans allow you to pay less for the down payment on your home. A lower down payment helps people who can afford a house, but not a traditional 6% upfront downpayment. Additionally, FHA loans are available to people with less than perfect credit scores. Generally, you can be approved for an FHA loan even if your credit score is too low for conventional loan approval.
Unlike traditional loans, FHA loans require an up-front mortgage insurance premium. In addition, with an FHA loan, you’ll pay an annual mortgage insurance premium (MIP). Your up-front MIP is 1.75% of the amount of your base loan. You can pay it as part of the closing costs on your new home, or you can choose to add it to your overall loan amount.
You’ll pay your annual mortgage insurance premium in monthly installments for an FHA loan. Your monthly payments are .45% to 1.05% of your base loan amount. Typically, you’ll need to make monthly payments for 11 years or more for the length of your loan, which could be 15 years or more. The FHA loan term, your total loan amount, and your loan-to-value ratio determines the time you’ll pay monthly MIP installments.
How Can Getting an FHA Loan Help Me?
FHA loans can be beneficial if you’re in a lower-income or moderate-income bracket. For first-time homebuyers, FHA loans are usually the most affordable mortgage option.
Since the federal government insures FHA loans, banks and other lenders are often more willing to approve FHA loans for people who have credit trouble. If you know that your credit score is low, you may want to apply for an FHA loan before trying more conventional loans. If you don’t have a lot of money to use for a down payment, you may be able to save time and get approved more quickly by applying for an FHA loan first.
Am I Eligible for an FHA Loan?
To determine your eligibility for an FHA loan, your bank or lender will check your citizenship, residency, employment, and income. You’ll need to meet occupancy and credit score requirements. Your lender will also evaluate your financial history.
Citizenship and Residency Requirements
FHA loans are open to U.S. citizens and citizens of other countries. Although you don’t need to be a U.S. citizen to qualify for an FHA loan, you must be a legal resident of the U.S. to be eligible. If you have resident or nonresident alien status, you’re eligible to apply. You will need to provide documents to prove your residency status, and you must have a Social Security number.
Employment and Income Requirements
FHA loan approval requires steady employment. You can show proof of stable employment and income by providing copies of your tax returns.
If you’ve been self-employed for over 12 months but less than 24 months, your bank or lender will look at your employment history in the 24 months before you became self-employed. You’ll need to show proof of regular income over those 24 months. You will need to complete a year-to-date balance sheet for the current year, and you should also submit a profit-and-loss statement.
Your bank or lender may require you to meet the minimum income requirements for FHA loan approval. First, your bank or lender calculates your front-end ratio. The lender estimates the front-end-ratio by dividing your monthly mortgage payment by your monthly gross income.
To qualify for your FHA loan, the combined monthly total for your mortgage payment, mortgage insurance, homeowners insurance, homeowners association fees, and property taxes will need to equal an amount that’s less than 31% of your gross income.
Next, your bank or lender will calculate your back-end ratio. You might also see this ratio referred to as your debt-to-income ratio. Your bank uses this ratio to see how much of your monthly income is spent paying off debts. Credit card purchases, loan payments, child support payments, and mortgage payments are all included in your monthly debt calculation.
After adding up all your monthly debts, your bank or lender will divide that sum by your gross monthly income. The number from that calculation will be multiplied by 100 to arrive at the figure for your back-end ratio. You can qualify for an FHA loan if your back-end ratio is less than 43% of your gross income.
FHA loans are only approved for borrowers who own or reside in the home. In addition, if you use an FHA loan for your home, you’ll need to make that home your primary residence. You must live in the house for most of the year. The home’s address should be on your driver’s license, utility bills, tax returns, and other legal documents.
Credit Score Assessments
To assess your credit score, your lender looks at your credit reports, credit card activity, student loan payments, utility bills, and past rent payments. In some cases, you may not have an established credit history, and you may not use traditional credit. In these situations, your bank or lender will use your rent payments, credit card statements, and other payment histories to develop a credit history. Alternatively, the lender or bank could use a non-traditional merged credit report to assess your credit score.
While conventional loans typically require a credit score of at least 620, you can qualify for an FHA loan with a minimum credit score of 500. Since this score falls on the low end for credit scores, you’ll need to be able to make a larger down payment to be approved for an FHA loan with this score.
If your credit score is between 500 to 579, you must make a 10% down payment for FHA loan approval. This amount is still considerably less than the down payment required for conventional mortgages, which can reach up to 20%.
If you have a higher credit score, you can qualify for an FHA loan that requires a lower down payment. In fact, with a credit score of 580 or higher, you can be approved for a 3.5% down payment.
Generally, lower credit scores and lower down payments equal a higher interest rate on your FHA mortgage. Before your lender assesses your credit score, you may want to ask about steps you can take to improve your score.
You may also want to consider increasing your savings or other accounts so you can make a larger down payment.
Financial History Evaluations
Your financial history evaluation begins with your bank or lender examining the prior two or three years of financial records. Generally, they will want to see that you’re reliable and that you’ve made credit card, rent, federal student loans, and other payments on time. They’ll also check to make sure that you’ve paid taxes on time.
Your FHA loan application could be adversely affected if you’ve fallen behind on your taxes or federal student loan payments. If you don’t agree to a repayment plan, your lender may reject your FHA loan.
A recent bankruptcy or foreclosure can complicate your FHA application approval. You’ll need to wait two or three years after bankruptcy or foreclosure before applying for an FHA loan.
However, if you can demonstrate that you’ve taken steps to re-establish good credit, an exception could be granted. This would mean that you could apply even if your bankruptcy or foreclosure happened less than two or three years ago.
If you have any judgments, federal debt, or collections you owe, you’ll need to show your lender that you will have all of these paid off or resolved before closing on your new home. This is particularly important in cases where you have judgments against you.
For the best chance of FHA approval, start your FHA loan application after making on-time payments for at least the past 12 consecutive months. You can include the month you make your FHA loan application as part of the 12 straight months.
How Much Money Can I Get With an FHA Loan?
Your new home’s region determines borrowing limits for FHA loans. In most areas, FHA loan limits allow you to borrow up to 115% of the median home price in the county of your new home. For example, if your new home sits in an area designated as a lower-cost region, you can borrow up to $420,680 for a single-unit property.
For regions categorized as higher-cost areas, the borrowing limit for a single-unit property is around $970,800. In Alaska, Hawaii, and other “special exception regions” with very high construction costs, you can borrow up to $1,456,200 for a single-unit property.
How Can I Apply for an FHA Loan?
You can apply for an FHA loan by contacting a government-approved lender that provides FHA-insured mortgages. The Department of Housing and Urban Development maintains a database of FHA-approved lenders searchable by city and state. Before visiting a bank or lender, make sure it’s on the list.
Where Can I Learn More About FHA Loans?
To learn more about FHA loans that may fit your needs, visit Finance is us. We are dedicated to providing you with the guidance you need to make the right loan decisions.
Disclaimer: All content on this site is information of a general nature and does not address the circumstances of any particular entity or individual, nor is the information a substitute for professional financial advice and services.