What is an FHA Home Loan?The Federal Housing Administration, or FHA, is part of the U.S. Department of Housing and Urban Development and insures home loans for borrowers with low credit scores or needing a lower down payment than conventional loans. Because the government insures these loans, they have less stringent qualifications than traditional mortgages. FHA-insured loans are available to borrowers with credit scores as low as 500 with a minimum of a 10% down payment (depending on your lender), and borrowers may be able to qualify for a 3.5% down payment with a credit score of 580 and above (at lenders discretion). The FHA does not directly issue the loans. There is an approved national network of FHA lenders who process the borrower’s application and complete the underwriting to determine whether or not the loan is approved?
What is the FHA?The Federal Housing Administration (FHA) is a government agency established as a part of the Housing Act of 1934. The Federal Housing Administration (FHA) aims to promote homeownership and provide affordable housing options. The purpose of the FHA is to help people who may not otherwise qualify for a conventional mortgage obtain financing. So it is no surprise that FHA loans are a popular choice for first-time homebuyers or those whose credit scores are less than perfect. All of this is made possible by FHA mortgage insurance which protects lenders if a property owner defaults. In this case, the FHA pays a claim to the lender for the unpaid principal balance. In 2021, over 1.1 million borrowers took out FHA loans—that's more than 10% of all mortgages! According to the Mortgage Bankers Association, almost 20% of first-time homebuyers also use FHA loans.
What is the difference between an FHA loan and a conventional loan?
- FHA has lower down payment requirements from 3.5% to 10%, depending on credit scores.
- A conventional lender will require (in most cases) a 20% down payment.
- FHA credit score requirements starting at a minimum score of 500 allow more people to qualify. Of course, the FHA lender may or may not process a loan at such a low score.
- Conventional lenders require a credit score minimum of 680, with 700+ being much better for securing favorable loan terms.
- The FHA is very lenient regarding the source of the down payment and closing costs. Gifts from family or charities are allowed.
- Convention lenders are much less receptive to monetary gifts. Generally, they will require a seasoning period (holding) of the money which could be as long as a year.
What types of FHA loans are there?The purpose of the FHA is to provide different loan options to assist first-time homebuyers and existing homeowners. There are five loan programs available:
Basic Home Mortgage Loan 203(B)
- The borrower must meet standard FHA credit qualifications.
- The borrower is eligible for approximately 96.5% financing.
- The borrower is able to finance the upfront mortgage insurance premium into the mortgage.
- The borrower will also be responsible for paying an annual premium.
- Eligible properties are one-to-four unit structures.
Rehab Mortgage Loan 203(k)
- The cost of the rehabilitation must be at least $5,000
- The total value of the property must still fall within the FHA mortgage limit for the area.
- The value of the property is determined by either (1) the value of the property before rehabilitation plus the cost of rehabilitation, or (2) 110 percent of the appraised value of the property after rehabilitation, whichever is less.
Construction to Permanent (CP) LoanRefers to the construction of a dwelling on land owned or being purchased by the Borrower. The CP program combines the features of a construction loan with that of a traditional long-term permanent residential Mortgage using a single mortgage closing prior to the start of construction.
Energy-Efficient Mortgage (EEM) Loan
- The FHA Energy Efficient Mortgage covers upgrades for new and existing homes and is now available in all 50 states.
- Loan limits may be exceeded
- No re-qualifying
- No additional down payment
- Improvements are made after closing.
- The appraised value is based on the home prior to upgrades (appraisal does not need to reflect value with improvements)
Title 1 Property Improvement LoansProperty Improvement loans may be used to finance alterations, repairs and improvements for;
- A house, including a manufactured house, which has been occupied at least 90 days
- A non-residential purpose
- To finance the construction of a new exclusively nonresidential structure. NOTE: Improvements must substantially protect or improve the basic livability or utility of the property.
What are FHA loan limits?FHA loan limits are the maximum allowed loan amount for Federal Housing Administration loans. The loans are federally insured mortgages designed for middle and working-class Americans. Because the loans are insured, lenders provide excellent rates for first-time homeowners and those with bruised credit history. The FHA sets limits on mortgage amounts by county, meaning that some areas with higher real estate prices will have higher FHA loan limits. The maximum FHA loan amount you can borrow will depend on where you live. It is up to the lender to determine a maximum loan amount based on the guidelines set by the Federal Housing Administration (FHA).
The FHA Loan Limits For 2022The 2022 FHA loan limit for a single-family home in most parts of the country is $420,680. But some U.S. counties have higher FHA loan maximum than others. For example, in some high-cost regions like Los Angeles, California, the limit is $970,800 for a one-unit property. The FHA loan limits are adjusted based on how the housing market changes. In 2021, FHA loan limits were $356,362 for most areas, and in high-cost areas, a maximum of $822,375. FHA loans have a maximum loan-to-value (LTV) ratio of 96.5%. Therefore you can borrow up to 96.5% of your home's value if you put down at least 3.5% when purchasing the house or up to about 87% if you previously owned the home for more than one year before refinancing. Of course, if your credit scores are 579 or below, your down payment requirement is increased to 10% - an excellent incentive to make a concerted effort to improve your credit scores. The purpose of the loan limit is to ensure that borrowers are not taking on more debt than they can afford. In addition, it helps to protect the participating lenders from default. Even though FHA guarantees 80% of the loan, lenders take an extra step to limit their risk. Any borrowers who cannot put down a 20% down payment must purchase private mortgage insurance, further protecting the lender should you default on the loan.
|FHA Loan Type||Most Areas||High-Cost Areas|
|Duplexes (2 units)||$538,650||$1,243,050|
|Triplexes (3 units)||$651,050||$1,502,475|
|Quadplex (4 units)||$809,150||$1,867,275|
What factors affect FHA loan limits?FHA must set single-family house loan limits at 115 percent of area median house prices. FHA calculates forward mortgage limits by Metropolitan Statistical Area and by the county. The FHA loan limits for low-cost areas are called the "floor." Where housing is much more expensive, they set a maximum FHA loan amount referred to as the "ceiling." In most cases, almost anyone who meets the following criteria can qualify for an FHA loan.
- The money for a 3.5% – 10% down payment.
- An acceptable debt-to-income ratio.
- Two years of ongoing employment.
- Your credit score is 700 or above.
- Stable employment and income for a minimum of 3-years.
- You have a down payment of 20% or more.
How to qualify for an FHA Loan?If you decide that an FHA loan is your best option, here are the basic requirements you must meet to qualify. NOTE: Individual lenders may have more stipulations than required by the FHA.
- FICO scores between 500 and 579 require a 10 percent down payment.
- FICO scores of 580+ require a 3.5 percent down payment.
- You must be able to prove a minimum of two years of consistent income with supporting W-2s and paystubs. NOTE: FHA does allow you to include a co-borrower who does not live with you to help meet the income requirement.
- If there are periods of four weeks or more of unemployment, be prepared to explain why.
- The debt-to-income ratio (DTI) should be 43 percent or less of gross monthly income. In addition, your FHA mortgage payment cannot exceed more than 31% of your monthly income.
- You will be required to provide a complete list of debts owed with current account statements.
- The house must meet the standards set by the Department of Housing and Urban Development (HUD). The home must also be your primary residence not a vacation home.
- A licensed appraiser will visit the property to determine its condition and value before the borrower can close on the loan.
- If you defaulted on a federal loan resulting in foreclosure or discharged your debts via a Chapter 7 bankruptcy, you may not qualify until three years have passed.
Credit ScoreFHA underwriting guidelines require a minimum credit score starting at 500. The challenge is finding an FHA-approved lender who will issue a loan with low scores. The majority of lenders want to see a credit score of at least 620.
Down PaymentShould you find a lender who will finance at credit scores between 500-579, you must put down a minimum of 10%. With credit scores from 580 and up, the required down payment drops to just 3.5%. Keep in mind that lenders may have their own requirements resulting in a higher down payment.
Employment HistoryTwo years of consistent income are required. Accepted proof would be pay stubs or W-2s. If you have 30 days or more gaps, you will need to provide a provable explanation.
Debt to Income RatioFHA allows a fairly high debt-to-income ratio (DTI) not to exceed 43% of your gross monthly income.
Getting the Property AppraisedThe house must meet FHA appraisal guidelines, which include such things as; the livability of the home, a sound physical structure, and no contaminated soil or other health hazards.
OccupancyThe purpose of the FHA is to help more people fulfill their dream of homeownership. Therefore, you must live in the house for one year.
Mortgage InsuranceFHA loans have such desirable terms because of the mortgage insurance required for each mortgage. This insurance reimburses the lender in case you default. With this added layer of risk protection, lenders are willing to finance loans for people that could not qualify for conventional financing.
Applying for an FHA LoanHere is a list of the basic requirements.
- A minimum credit score of 500
- Valid ID such as a driver’s license or passport.
- Social Security number.
- Minimum down payment of 10% (3.5% if scores are 580 and above).
- Debt-to-income ratio of 43%
- NO delinquent Tax payments, student loans or past FHA loans.
- House must pass the appraisal
- House must qualify for the floor and ceiling limits for your area.
Pros and Cons of an FHA loan
- Lower credit scores allowed
- Smaller down payment requirements
- Gifting of the down payment is allowed
- Additional loans for rehab and energy improvements.
- Stricter guidelines to pass appraisal
- May have difficulty in finding a lender
- FHA mortgage insurance premiums are permanent
Current FHA Loan Market InsightsRecently, the Federal Reserve has raised the rates it charges banks in a move to hold down inflation. This action had an immediate effect on mortgage rates. Despite this, FHA loans will continue to maintain their desirability for future home buyers.
In review, some additional points to consider
- The property must be your primary residence. Even if it is a 2-4 unit property you would have to occupy one unit.
- Mortgage Insurance Premium (MIP) is a permanent cost of the loan. There is also a one-time fee assessed at the closing of 1.75% of the total loan amount.
- FHA closing costs including the MIP average 3-4% however, this does not include lender or third-party fees. Be sure to review your loan closing estimate and have the lender explain anything you are unsure about.