FHA loans
What is an FHA Loan and who is the FHA?
An FHA loan is a mortgage that you can get through an FHA-approved lender. It's a type of mortgage that is insured by the Federal Housing Administration, also known as the FHA. This insurance is what makes offering these types of loans attractive to lenders because it reduces their risk if you don't pay the loan back, or default on your mortgage. The FHA guidelines also make it possible for people with lower credit scores and lower incomes to qualify for a mortgage. In a nutshell, an FHA loan is a new-homebuyer-friendly mortgage.
What is the minimum down payment needed on an FHA Loan?
The lowest possible down payment on an FHA mortgage is 3.5% (i.e., $3,500 per $100,000 loan). To be eligible for this low down payment, however, your credit score must be at least 580 or higher. FHA guidelines do allow borrowers with credit scores as low as 500 to be eligible, but they would need to have a 10% down payment if their credit score is below 580. Also, it's up to the individual lender to decide if they want to approve borrowers below a 580 credit score. Not all lenders will do this.
Downpayment tips on getting approved for an FHA loan
While you don't need a huge downpayment with an FHA loan, it's important to demonstrate that your down payment money is not tied to any sort of loan or credit advance. It can be gift, such as from your parents, but you'll need a "gift letter" from them stating that the funds are indeed a gift and not a loan. Also, don't even try to use a credit card cash advance as a source for your down payment! That won't fly with the lender's underwriting department.
What is the lowest eligible credit score to qualify for an FHA loan?
FHA loans are made available to people with credit scores as low as 500. Not all lenders however will accept a 500 credit score. Lenders are not forced by the FHA to accept borrowers with 500 credit scores. However, if they do accept a 500 score borrower, then they can't require more than a 10% down payment on an FHA loan. The FHA guidelines say that a 500 - 579 credit score would require you to make a 10% down payment. Anything above 580 and you can make a low 3.5% down payment. When a lender pulls your credit and checks your credit score, they usually look at your credit report on all 3 credit bureaus: Experian, Trans Union, and Equifax. Each of these bureaus will have its own credit score for you. The lender will typically use the middle value. So if one bureau reports a 600, and another reports a 580, and the 3rd credit bureau says your credit score is a 590, the lender will use the 590 number.
What is the maximum debt to income ratio (DTI) allowed on an FHA loan?
To comfortably qualify for an FHA loan, you'll want your total debt-to-income ratio to be 43% or lower. Your debt-to-income ratio, known as DTI, is your total debts divided by your income. For example, if your total debts include a student loan, a car loan, and a credit card balance and the total of all those payments is $1500 per month, and you make $5000 per month pre-tax income, then your DTI debt-to-income ratio is $1500/$5000 = 0.30, or 30%. Lenders can make exceptions and accept a higher DTI than 43% in some cases. For example, if you have a really good credit score and you have a lot of cash reserves in the bank, or if your earning potential looks really good, then they could approve you with an even higher DTI, such as 45% or even up to 50%. In general, however, the lower your DTI the better your odds of getting approved for an FHA loan.
Is mortgage insurance required on an FHA loan?
Yes. Mortgage insurance on an FHA loan is required. You'll have to pay something called an "up front mortgage insurance premium" (or UFMIP, for short) which is 1.75% of the loan amount. And then you also have to pay a recurring "annual mortgage insurance premium" (or MIP, for short) which is anywhere between 0.15% and 0.75% of the loan amount. Both of these premiums are typically rolled into your mortgage payment so that it's just part of your monthly payment. However, you can pay the UFMIP up front in one cash payment if you wanted. The reason FHA requires this mortgage insurance is because the risk is somewhat higher on FHA loans due to relaxed credit scores and down payments. Mortgage insurance protects the lender if you default on your mortgage (not to be confused with Homeowners Insurance). The premiums you pay for insurance go into a reserve fund at the FHA, and they use that to pay the lender if a mortgage goes into default.
What is the maximum amount I can borrow on an FHA loan?
The max you can borrow through an FHA loan depends on the county and state that the property is in. These FHA loan limits are based on the median home sales price in the area. Some areas in the U.S. are considered "high cost areas", such as Fairfax County VA, San Francisco CA, and New York NY. These areas have a higher FHA loan limit. Also, the FHA limits are higher for multi-unit properties such as duplexes, triplexes, and multi-family up to four unit properties. If you use an FHA loan to buy any of these types of homes, the limit is higher than a single-family home in the same county.
What kind of employment history do I need to get approved for an FHA loan?
While there is no specific employment history requirement for an FHA loan, you'll want to be able to demonstrate a stable employment history with few or no gaps. You'll typically have to provide the last 2 paycheck stubs and a copy of your last two years of tax returns to show that you've been making a steady income for some time. Get together your W2 forms and tax return forms (ie form 1040 etc) over the past 2 years and have them ready to provide to your lender. With an FHA loan, there's no income limit (as there is with some other programs like Home Possible® and HomeReady®), so if you make a high salary, you don't have to worry about "making too much money."
Is primary residence a requirement of an FHA loan?
Yes. In order to get an FHA loan, you have to live in the house that you're buying for at least one year. An FHA loan can't be used for an investment property or vacation home. Beware, because it's considered "occupancy fraud" if you lie about your plan to live in a house with an FHA mortgage loan.
What are the interest rates on an FHA loan?
FHA mortgage loan rates are typically lower than, or very competitive with, conventional mortgage rates because of the government backing of the loan. This insurance makes lenders more comfortable with offering competitive rates for even those with less than perfect credit history and finances. The interest rate you get on an FHA loan will depend on your income and credit score, however, and there's no single guaranteed rate for everyone. Other factors that can affect your FHA loan rate are: how much you are borrowing (the loan amount), how much of a downpayment you're making, and your debt to income ratio (DTI).