The Federal Housing Authority (FHA) was created by Congress in 1934 to help stem a rising tide of foreclosures and make homeownership more affordable.
While the FHA does not originate loans, it is one of the largest mortgage insurers in the world; insuring almost 47 million mortgages since its inception.
What are FHA Loans?
FHA loans are mortgages issued by private lenders and insured by the Federal Housing Administration. Lenders can be banks, credit unions, or non-bank entities, but they must be approved by the FHA to issue FHA-insured loans. By working with approved lenders the FHA helps by lowering the risk for the residential loan issuer, which gives more buyers access to loans they need. Because the FHA insurance protects lenders from borrower default, FHA lenders are more willing to offer favorable terms to borrowers who do not meet stricter Fannie Mae or Freddie Mac criteria.
FHA loans are known for their flexibility. This famed flexibility also applies when homeowners encounter circumstances that impair their ability to pay their mortgage, such as loss of employment or reduction in income. The FHA can provide options to distressed homeowners to help them prevent foreclosure. Although the insurance cost associated with FHA loans passes down to the homeowner, the borrower can phase out the insurance as the loan is paid off. The equity built up over time secures the loan. Working with a mortgage broker for this type of loan offers the borrower protection because the lender has to follow the FHA’s servicing guidelines.
FHA Loan Requirements
Although FHA loans have looser qualifications than conventional loans, they still have minimum requirements. Moreover, certain lenders may add additional stipulations. To ensure that you get the best FHA mortgage rate and loan terms, borrowers should shop more than one FHA-approved lender and compare offers.
Here are the minimum requirements for FHA loans:
Prospective homeowners with credit scores of 580 and above qualify for the lowest down payments. Borrowers with credit scores of 500-579 can still qualify for FHA loans, but they will need to come up with a larger down payment.
If your credit score has dipped below 500, it’s beneficial to raise your score before considering buying a home. However, you may also consider that a family member may apply to be a non-applicant co-borrower or co-signer, which will help reduce the loan risk. Any family member with a responsible credit history can serve as the co-borrower or co-signer.
If you have a credit score of 580 and the minimum down payment requirement for an FHA loan is only 3.5%. A credit score of 500-579 would require a down payment of 10% of the home’s purchase price.
Debt-to-Income Ratio (DTI):
The FHA loan requires a specific debt-to-income ratio (DTI). The front-end DTI ratio is 46.99% and the back-end DTI ratio is 56.99%. In other words, monthly debt payments cannot exceed the set DTI ratios of a borrower’s gross income. DTI includes debts that are in deferment. For instance, for student loans in deferment, FHA loan underwriters will include 1% of the loan’s total as the monthly payment amount.
Applicants who rent will typically include rental payments in DTI calculations. However, if projected monthly housing expenses will be lower with a mortgage than with rent, the lender will use the lower mortgage payment for calculations.
Documented Steady Employment/Income:
FHA home loan borrowers must have a steady employment history or have worked for the same employer for the past two years.
No History of Foreclosure:
The FHA requires that all borrowers be free from foreclosure for at least the last three years.
In addition to borrower qualifications, all properties insured by the FHA must also meet the agency’s minimum standards. Here are general guidelines for property requirements:
- The loan must be for a principal residence. Within 60 days of closing, at least one borrower must occupy the property.
- The property cannot be purchased for investment.
- The property must undergo an FHA appraisal. An FHA appraisal includes an inspection—which is separate from a home inspection—that assesses a home on whether it is worth the purchase price and meets minimum safety and habitability standards.
- The property cannot be a flip. In other words, the borrower cannot buy a property using an FHA-backed mortgage within 90 days of a prior sale.
- Borrowers must take title to the property in their names or the name of a living trust at settlement.
Do FHA Loans Have Income Requirements?
There are no minimum or maximum income limits associated with FHA loans. However, borrowers must have:
- Two or more established credit accounts, such as a credit card and a car loan.
- No delinquent federal debt or judgments (tax-related or otherwise) or debt from previous FHA-insured mortgages.
- Signed, dated documentation for cash gifts that help with the down payment.
Although the FHA insures the loan, individual lenders make the final decision as to whether or not to finance a property. It is also the lenders’ prerogative to determine their specific qualifications, such as a higher credit score or a better debt-to-income ratio. It’s advisable to speak directly with your lender to review their preferred requirements.
What are FHA Closing Costs?
All mortgages have closing costs, and FHA loans are not excluded. However, you may find that your FHA closing costs are less than those enforced by most commercial lenders.
Typically, FHA loan closing costs amount to approximately 2%-5% of the purchase price of the property. These fees cover the cost of home appraisals, origination fees, titles and other mandatory costs. While 2%-5% may sound like a relatively small amount, this depends on the value of the property you’re buying, so it’s important to factor them in when planning your budget.
Keep in mind that closing costs vary from one FHA-approved lender to another, so be sure to shop around and compare lenders before making your decision.
Applying For An FHA Loan
Applying for FHA loans requires several personal and financial documents, including:
- A valid Social Security number.
- Proof of US citizenship, legal permanent residency, or authorization to work in the US.
- Bank statements for the past 30 days, and usually longer.
- Documentation for any deposits made into your bank accounts, such as pay stubs.
- Credit reports.
- Tax returns.
- Employment records.
The lender may be able to automatically retrieve some required documentation, like credit reports, tax returns, and employment records.
Exceptional circumstances, such as student status or insufficient credit history, may require extra documentation.
FHA Loan Limits
The FHA will only insure properties up to a published maximum price. The loan limits are updated annually and are influenced by conventional loan limits set by Freddie Mac and Fannie Mae. The type of home—such as a single-family or duplex—also impacts these limits.
In 2020, FHA loan limits range from $369,000 to $707,700.
Here are the FHA loan limits in Cook County:
- 1-unit: $368,000
- 2-unit: $471,100
- 3-unit: $569,450
- 4-unit: $707, 700
Counties with mid-range housing prices also have mid-range FHA loan limits. HUD’s website lists the FHA loan limits for every county in the nation.
Who are FHA Loans Best Suited For?
True to its original mission, the FHA helps lower-income borrowers and those that may not qualify for a conventional loan (Fannie Mae criteria) from a mortgage company. Allowing a minimum down payment of 3.5% with a 580 FICO score, FHA loans assist buyers with lower credit scores and savings.
Contrary to popular belief, FHA loans are not limited to first-time homebuyers. Many people refinance with FHA-insured loans or are repeat FHA buyers. However, FHA loans are indeed the most popular option for first-time homebuyers.
For borrowers with good credit and a medium down payment of 10-15%, FHA loans are often more expensive than conventional loans. On the other hand, FHA loans are usually the least costly option for those with lower credit scores and down payments. However, there are no hard-and-fast rules, as much depends on the current market.
FHA loans can be easier for individuals with lower credit scores and down payments to qualify for than conventional loans. They also give the borrower refinancing options and offer more protection from foreclosure.
What About Borrowers Who Do Not Meet FHA Requirements?
FHA’s standard underwriting criteria considers many income and debt-related factors. If a borrower’s situation deviates somewhat from the established criteria, manual underwriting can be used. Lenders will carefully review the applications from such non-standard borrowers before determining whether to approve or deny a loan.
FHA Loans at A and N Mortgage
As an FHA-approved lender, A and N Mortgage is proud to offer FHA loans to first-time buyers, with a low income and poor credit history. We’re committed to helping you buy a property, regardless of your situation.
Provided you meet the standard criteria and can show that you’re eligible for an FHA loan, A and N Mortgage can help you to take your first steps up the home buying ladder. With a dedicated team of Mortgage Consultants and Loan Officers, we can help you find the right home loan and even secure your pre-approval so you can start house hunting straight away.