The Ultimate Guide to FHA Loans
In Financing Your Home Purchase, by Anthony Bayardelle
What is an FHA loan?
An FHA loan is a loan that is backed by the Federal Housing Administration (FHA), a sub-department of the federal department of Housing and Urban Development (HUD).
Given their low down payment amount, FHA Loans are incredibly popular, especially amongst first-time housing buyers. according to The Mortgage Report, almost one in five buyers in the US uses an FHA loan for their home purchase.
How Does an FHA Loan Work?
An FHA loan doesn't mean you actually borrow money from the federal government for your house. Under the hood, what happens is you secure a mortgage using a lender that is approved by the FHA. This means you are still borrowing money from a traditional financial institution, it's just one on their list of qualified lenders.
The FHA then “guarantees” your loan (basically, they vouch for you), which gives you the added credibility to overcome the added risk the lender bears from a lower down payment.
In exchange, an FHA loan necessitates that you pay two different types of mortgage insurance:
Upfront Mortgage Insurance Premium (UFMIP)
Annual Mortgage Insurance Premium
(These take the place of PMI, which is the type of mortgage insurance necessary on a traditional mortgage if you pay less than a 20% down payment.)
An UFMIP can be paid at the time of closing or rolled into your loan as a whole. It was 1.75% of your overall loan amount as of 2018, but this figure can change from year to year. Your Annual MIP is actually paid monthly. These payments are somewhere between 0.45% and 1.05% of your total mortgage amount, varying based on your loan length, amount, and other factors.
These are extra fees that would not be paid for a traditional mortgage, that are necessary for an FHA loan.
What Down Payment is Needed for an FHA loan?
One of the main selling points of an FHA loan is that they offer a low minimum down payment as low as 3.5%.
Compared to the 20% down payment usually suggested for a traditional mortgage, this is a significant upside for first-time buyers who might not have a lot of capital up front, but have a steady stream of income.
As with other loans, if you have the money you can always pay a higher percentage of your sale value as a down payment. This not only has the potential to lower the interest rate you will end up paying, but it can also compensate for a lower credit score. We'll talk more about this below.
Are FHA Loans Available for All Houses?
No, there are some restrictions on the types of homes you can purchase with an FHA loan. First, it has to be a loan for your primary residence. You can't get an FHA loan for a second home, vacation home, or investment property.
An FHA loan is also only available on one to four unit properties, so if the home you're looking at is more units than this, you will need to find a different type of loan.
FHA Loan Limits
There are also FHA loan limits specific to individual states and even individual counties. This means that you can't get an FHA loan on a house whose total sale price is above the FHA loan limit in that county.
Overall, the standard FHA loan limit as of 2019 is $314,827 for a one unit home. This goes up to $403,125 for a two-unit home, $487,250 for a 3-unit home, and $605,525 for a 4-unit home. However, these are the standard limits, so you would want to look up your local FHA loan limits before you get too far down the road, as it might be different in your specific county.
These loan limits vary as you might expect them to. An FHA loan limit in a rural town would be far lower than the loan limits in a bigger city or more expensive area.
How much do you have to make to qualify for an FHA loan?
More than a specific amount of money you have to make, what matters is your debt to income ratio (DTI). this ratio is basically a comparison between how much money you bring in monthly and how much you spend each month (your debt).
There are actually two different debt-to-income ratios that people look at: your front-end DTI ratio and your back-end DTI ratio.
Front-End DTI Ratio
Your front end debt to income ratio is isolated to just housing costs. This means that will compare your monthly income to how much you would spend on your mortgage. It doesn't take into account any other factors are expenses, so it's not as helpful of a figure to represent your overall financial well-being.
Back-End DTI Ratio
The back-end debt-to-income ratio, in contrast to the front-end ratio, looks at all of your different recurring debt in comparison to your monthly income.
This means that things like car payments, credit card debt, or other loans you might have are all accounted for within your back end DTI ratio. The comprehensive nature of this figure makes it a slightly more popular formula for calculating your financial standing in terms of home loans.
DTI Ratio for an FHA Loan
Overall, you want about 31/43 DTI ratio to qualify for an FHA loan. This means that your potential mortgage payment should account for no more than 31% of your total monthly income (front-end DTI) and your total debt including your mortgage payment should account for no more than 43% of your gross monthly income (back-end DTI).
Obviously, as with most things, there are exceptions to this rule.
People who have verified amounts of cash they can use towards their home purchase, income sources that are not reflected in their DTI income calculations, four other types of residual income may be able to get by even with DTI ratio is higher than this recommended rule of thumb.
If you want to know your specific eligibility for a certain loan, the only way to know for sure what you qualify for is to talk to a mortgage specialist.
What Credit Score do I Need for an FHA Loan?
This is partially dependent on your down payment amount.
Usually, with the 3.5% down payment that is standard with an FHA loan, you have to have at least a 580 credit score in order to secure an FHA loan. However, if you can afford to make a 10% down payment, borrowers can typically have as low as between 500 and 579 as a credit score and still secure an FHA loan.
This means that even with the 3.5% down payment, you can usually get an FHA loan even if your credit score dips below the 620 recommended for a traditional mortgage. If your credit score is too low you can possibly compensate with a higher percentage of a down payment.
However, it is important to remember that your credit score does affect your eventual interest rate. The lower your credit score, the higher you can expect your interest to be.
How do I qualify for an FHA loan?
There are a huge number of factors at play to determine whether or not you qualify for an FHA loan. Truly, the only way to really know for sure is to talk to a qualified mortgage lender.
However, here's some of the main factors that they will look at:
The length and stability of your employment history
Your ability to pay a 3.5% (or 10% with a lower credit score) down payment
You must be legally able to live in the US
You have to be over 18
You should have no higher than a 31/43 debt to income ratio
Credit score of at least 580 (or 500 to 579 with a 10% down payment)
At least two years out of back bankruptcy (if applicable)
3 years out of foreclosure with re-establish good credit (if applicable)
The property must be FHA loan eligible and pass appraisal standards
The Big Picture
If you are a first-time home buyer or have lower amounts of capital to devote to a downpayment, this could be an excellent home loan choice for you.
The standards for qualification for an FHA loan there is a guideline, Zoe exceptions are always possible. The only way to really know if you are qualified is to talk to you a mortgage expert. If you want a free, no-sales consultation call to learn about your specific options, you can schedule one using the button below.