An FHA loan, insured by the Federal Housing Administration, provides valuable assistance to buyers with limited savings or lower credit scores. This type of mortgage offers a helping hand to those who may face financial constraints, making homeownership more accessible and achievable.
FHA loan: What is it?
An FHA loan is a mortgage insured by the Federal Housing Administration, which falls under the U.S. Department of Housing and Urban Development. These loans are often suitable for first-time home buyers or individuals facing limited savings or credit challenges, as they require a minimum down payment of 3.5% for borrowers with a credit score of 580 or higher.
Even if you don’t meet the requirements for a conventional mortgage or have a bankruptcy history, you may still qualify for an FHA loan. While the federal government doesn’t directly issue these loans, it provides insurance to lenders, giving them confidence to offer favorable terms to borrowers who may not qualify for a conventional home loan.
FHA loans are available through private, FHA-approved lenders, including banks, credit unions, and nonbanks. They can be utilized for purchasing or refinancing various types of properties.
- Single-family houses
- Two- to four-unit multifamily homes
- Condominium units
- Certain manufactured homes
Certain types of FHA loans can be utilized for financing new construction or renovating an existing home. However, regardless of whether it’s an existing property or new construction, an FHA appraisal is required. If the property meets the government’s standards, you can utilize an FHA loan to purchase or refinance it.
FHA Compared to Conventional Loans
Generally speaking, qualifying for an FHA loan is typically easier compared to a conventional loan, which is a mortgage not backed by the federal government. Here are some key distinctions between FHA and conventional loans:
- Credit score and history: FHA loans have more lenient credit score requirements than conventional loans. If you’ve experienced credit difficulties, such as bankruptcy, you may find it easier to qualify for an FHA loan.
- Mortgage insurance: Unlike conventional loans, all FHA loans mandate mortgage insurance. However, the amount you pay varies based on your down payment size. With a conventional loan, mortgage insurance is generally not necessary if you make a 20% down payment or once you attain 20% equity in your home.
- Gift funds for down payments: FHA rules are more flexible when it comes to monetary gifts that can be applied to your down payment, whether they come from family, employers, or charitable organizations.
- FHA appraisal: To be eligible for an FHA loan, the property must undergo an appraisal to ensure that it meets the government’s health and safety standards. An FHA appraisal is distinct and separate from a home inspection, a requirement that conventional loans do not have.
- Closing costs: FHA loans may involve closing costs that are not obligatory for conventional loans.
In summary, FHA loans provide greater accessibility and flexibility compared to conventional loans, making them an attractive option for many borrowers.
Requirements For FHA Loans
The FHA establishes minimum requirements for borrowers seeking an FHA loan. However, each FHA-approved lender has the flexibility to set its own underwriting standards, as long as they align with the FHA’s minimums. For example, one lender may require a minimum credit score of 600, while another may require a minimum of 620.
Lenders also have the autonomy to set their own interest rates and fees. To ensure you secure the most favorable FHA mortgage rate and loan terms, it’s advisable to explore multiple offers from different FHA-approved lenders and make comparisons.
Generally, when applying for an FHA loan, you can anticipate the following basic requirements.
Credit Score Requirements For FHA Loans
As per the FHA, the minimum credit score required for an FHA loan is 500. If your score falls between 500 and 579, you are eligible for an FHA loan, but a down payment of at least 10% is necessary. On the other hand, if your credit score is 580 or higher, you can qualify for a down payment as low as 3.5%. It’s important to note that these guidelines are set by the FHA, and individual lenders may choose to impose higher minimum credit score requirements.
Debt-To-Income Ratio Needed for Approvals
Your debt-to-income ratio (DTI) is a metric that compares your monthly debt payments to your pre-tax income. This includes expenses like rent or mortgage payments, as well as auto or student loans and credit card balances. Lenders generally prefer a lower DTI when approving loans.
For FHA loans, the DTI requirements vary based on your credit score and other compensating factors, such as available cash reserves. If your credit score falls between 500 and 579, the FHA typically requires a DTI of less than 43%.
Although it is still possible to obtain an FHA loan with a DTI higher than 50%, meeting specific compensating factors is necessary, and the available options may be limited.
Using Gifted Funds For Down Payment
For an FHA loan, a minimum down payment of 3.5% is required if your credit score is 580 or higher. If your credit score falls between 500 and 579, you will need to make a down payment of at least 10% of the purchase price.
But here’s the good news: you don’t have to rely solely on your savings to meet the down payment requirement. FHA allows you to use gift money, as long as the donor provides a letter with their contact information, explains their relationship to you, specifies the gift amount, and confirms that no repayment is expected.
FHA-Approved Professional Appraisal
When purchasing a property with an FHA loan, it is necessary for the property to undergo an appraisal conducted by an FHA-approved professional. This appraisal serves to ensure that the property meets the minimum requirements set by the FHA. It is important to note that the FHA appraisal is distinct from a home inspection. While the appraisal aims to determine the property’s value and assess its worth as an investment, the home inspection focuses on evaluating basic safety and livability standards. In the case of an FHA 203(k) renovation loan, the property may undergo two appraisals: one to assess its current state and another to estimate its value once the renovations are completed.
Mortgage Insurance Required
FHA mortgage insurance is a mandatory inclusion in every loan. Initially, when you secure an FHA mortgage, you’ll make an upfront payment for mortgage insurance, which can be rolled into the total loan amount. Subsequently, you’ll make monthly mortgage insurance payments. The duration of these payments varies depending on the size of your down payment.
- If your down payment is less than 10%: You will be required to pay FHA mortgage insurance for the entire duration of the loan.
- If your down payment is 10% or more: You will need to pay FHA mortgage insurance for 11 years.
In contrast, with a conventional loan, you have the opportunity to cancel private mortgage insurance once you attain 20% equity in your home. However, FHA mortgage insurance cannot be terminated in the same manner.
The Different Types of FHA loans
The FHA provides a wide range of loan options, catering to both general purchase needs and specific requirements. To explore the complete list of FHA loan products and their eligibility criteria, please visit HUD.gov. Here are a few commonly sought-after options:
Home Purchase: Basic Home Mortgage 203(b)
The FHA-backed Basic Home Mortgage 203(b) is the standard loan for single-family homes. It is important to note that only primary residences, and not vacation or second homes, are eligible for FHA-insured loans.
FHA Refinance Loans
Consider refinancing your FHA loan to achieve a lower interest rate, shorten your mortgage term, or gain funds for significant projects like home renovations. The following options are available:
- FHA rate and term refinance: This choice can reduce your interest rate or shorten the loan duration.
- FHA streamline refinance: This option saves time and paperwork as it does not require a new appraisal.
- FHA cash-out refinance: With this loan, you replace your current mortgage with a larger one. The difference is provided to you in cash.
- FHA 203(k) refinance: This loan allows you to roll the cost of repairs or renovations into your mortgage amount. However, the upgrades must meet FHA eligibility requirements.
FHA Renovation Loans
- FHA 203(k) rehabilitation mortgages: This option enables borrowers to finance the renovation of fixer-uppers by combining purchase and renovation costs into a single loan. The standard 203(k) loan allows borrowers to finance improvements that exceed $5,000. Alternatively, the FHA limited 203(k) loan permits borrowers to finance improvements up to $35,000.
- Title 1 Property Improvement Loans: These loans are also available to finance home repairs and enhancements. Homeowners can secure this loan without the need to refinance their existing mortgage, and the funds can be used in conjunction with a 203(k) loan. However, the borrowing limit for a single-family home is capped at $25,000.
Other Specialty FHA Loans
- Energy-efficient mortgages: An energy-efficient mortgage enables homeowners to finance energy-saving home improvements. To qualify for this financing, the home must undergo an energy assessment conducted by a qualified professional.
- Construction-to-permanent loans: This loan type assists borrowers in financing the purchase of a home that is still under construction by making installment payments to the contractor. Once the home is completed, the loan converts into a permanent mortgage. Qualifying for these loans can be more challenging and time-consuming compared to traditional purchase mortgages.
- Manufactured homes: This refers to homes that are sometimes called mobile homes. Manufactured homes can be purchased using FHA financing, as long as they meet HUD requirements. For instance, HUD mandates that a manufactured home must have a minimum size of 400 square feet and be designed for use as a dwelling attached to a permanent foundation.
Limits on Loan Amounts For FHA
Regardless of the type of FHA loan you’re interested in, there are mortgage amount limits that vary by county. In 2024, FHA loan limits range from $498,257 to $1,149,825.
- Low-cost county limit: For single-family homes in low-cost counties, the upper FHA loan limit is $498,257. An example of such a county is Lucas County, Ohio, where Toledo is located.
- High-cost county limit: In the highest-cost counties, the upper limit for FHA loans is $1,149,825. This includes counties like San Francisco County, California.
Some counties fall in between, with FHA loan limits reflecting that. Denver County, Colorado, for instance, has a 2024 FHA loan limit of $816,500. To find the FHA loan limit in any county, you can visit HUD’s website.
Applying For an FHA Loan
To apply for an FHA loan, you will need to provide personal and financial documents. These may include, but are not limited to:
- A valid Social Security number.
- Proof of U.S. citizenship, legal permanent residency, or certain eligible work statuses.
- Bank statements for at least the past 30 days. Additionally, you will need to provide documentation for any deposits made during that period, such as pay stubs.
Your lender may be able to automatically retrieve some required documents, such as credit reports, tax returns, and employment records. However, certain circumstances, like being a student or lacking a credit score, may necessitate additional paperwork.
Benefits of FHA loans
- Enjoy lower minimum credit score requirements compared to conventional loans.
- Benefit from down payments as low as 3.5%.
- Debt-to-income ratios of up to 50% allowed (in some cases, potentially higher with compensating factors).
Getting the Best Rates for FHA Mortgages
When shopping for an FHA loan, it’s important to ensure that your financials are in the best possible shape. This includes obtaining your credit reports from the three main credit reporting agencies – Experian, Equifax, and TransUnion – and promptly addressing any errors you may come across. If feasible, consider paying down larger balances, which not only improves your debt-to-income ratio but also boosts your credit score. While FHA loans have more lenient requirements compared to other types of loans, having a higher credit score and DTI will likely result in a better interest rate.
One of the notable features of FHA loans is their low down payment requirement. However, if you’re able to make a higher down payment than the minimum, it portrays you as a more reliable candidate to lenders, which can lead to lower interest rate offers. Once you’re confident in your application, it’s advisable to compare mortgage rates from at least three FHA lenders. Even slight differences in the interest rate can save you – or cost you – thousands of dollars over the duration of your home loan.