What is an FHA Loan?
FHA loans, i.e. loans insured by the Federal Housing Administration (FHA), are the most popular mortgage products in the United States. They’re flexible, give borrowers with less-than-perfect credit access to financing, and typically have lower interest rates than conventional mortgages.
Here are the FHA loan basics:
- You must have a minimum FICO credit score of 500. If you have a credit score of 580+ you will pay lower interest rates and be allowed a lower down payment.
- 3.5% down payment required with a FICO credit score of 580+. A 10% down payment is required if your credit score is between 500 and 579.
- Your total monthly payment (i.e. mortgage payment, property taxes, mortgage insurance, homeowners’ insurance, and HOA fees, if applicable) can’t equal more than 31% of your gross monthly income. Sometimes you can get a waiver and take out a loan which has a monthly payment equal to 40% of your gross monthly income.
- Typically, your total debt-to-gross income ratio can’t exceed 43%. Sometimes you can get a waiver to have a 50% total debt-to-gross income ratio.
- You can choose between 15 and 30-year loan terms and fixed and adjustable interest rates.
- All FHA loans require mortgage insurance (also known as MIP or PMI). You will have to pay an upfront fee of about 1.75% of the loan amount (this can be included in the loan amount) and a monthly premium that will vary depending on the length and size of your loan.
- If you put at least 10% down on the house and pay down your mortgage to 78% loan to value, you can petition your mortgage company to waive further mortgage insurance.
- You must live in the home you purchase.
- You can use an FHA loan to purchase up to a four-unit property if you plan to live in one of the units and rent out the rest.
- The FHA limits loan amounts based on the area in which they originate. This means the FHA will approve higher loan amounts in areas where homes cost more and lower loan amounts in areas considered low-cost.
FHA lenders are mortgage companies who have been approved by the Federal Housing Administration to issue FHA-insured loans. To find an FHA lender in your area, check out HUD’s website for their searchable index.
If all this sounds pretty good, you’re not alone—40% of the mortgages in the U.S. are FHA loans. Here’s how to know if one’s right for you:
- You’re a U.S. citizen. The FHA requires a valid social security card in order to borrow.
- You have decent but not stellar credit. Most conventional mortgage lenders require a minimum credit score of 620. And if your score hovers around that floor, you’re likely to pay a higher interest rate and qualify for less loan dollars than you would with an FHA loan. Conversely, FHA lenders reward you if your score is at 580 or above.
- You don’t have the 10-20% down payment required by conventional lenders. As long as your credit score is 580 or above, you will only have to put down 3.5%.
- You need help with the down payment. Whether you’re receiving the entire down payment as a gift or need to apply for a grant, if you need help coming up with the down payment, an FHA loan could be right for you. Conventional mortgages typically only allow part of the down payment to come in the form of a gift, and they don’t allow you to get assistance from an outside organization.
If you need help coming up with the required down payment, the FHA website has a list of assistance programs, sorted by state.
- You are planning to live in the home. The FHA only lends on owner-occupied dwellings. If you’re planning to purchase up to a four-unit building, in which you will live in one unit and rent the rest, you can still apply for an FHA loan.
- You have steady employment. To qualify for an FHA loan, you must have worked at the same company for the past two years.
- You can afford the mortgage insurance. Adding 0.85% of the loan amount to your monthly mortgage payment could make a huge difference for some people. So make sure to consider your total monthly obligation (mortgage payment, property taxes, homeowners’ insurance and mortgage insurance) before you pursue this type of loan.
- You’re not looking to buy a high-end home. FHA loans are meant to help people get into the housing market who otherwise might not have the opportunity. So they aren’t for the luxury market. If you want to buy a home in a high-cost market, the maximum loan FHA will approve is $679,650. If you want to live in a low-cost area, your maximum loan will be $279,515.
The FHA was started as a way to stimulate the housing market while protecting lenders from foreclosure losses. As you can see, the department offers a lot of incentives to potential home buyers. Since the loans are guaranteed by the government, these lenders have more creative solutions at their disposal and can help you get a loan when you otherwise wouldn’t qualify. So if you’ve been wanting to a buy a home and meet the above criteria, look up an FHA lender in your area.