The Federal Housing Administration (FHA) Loan is one of the most common loans in the United States for first time home buyers. These loans are designed for borrowers who may not get conventional loans or loans that require a larger down payment.
For FHA-insured loans, credit requirements are slightly more flexible than conventional loans. Interest rates are also lower than the rates that an FHA approved lender would typically charge.
Generally, there is no clear frontrunner among most home loan options because each has its own set of conditions, benefits, and drawbacks. It all depends on your specific requirements. However, if you are trying to figure out if FHA loans are the right fit for you, we have highlighted everything you need to know about the FHA loan, along with tips to help you make the right decision for your FHA home financing need.
FHA loans are government-backed loans that have been available since the mid-1930s and were originally designed to assist first-time house buyers with limited funds and poor credit scores in obtaining a mortgage.
The Federal Housing Administration is an agency within the U.S. Department of Housing and Urban Development. It is part of the U.S. government's commitment to giving low- and moderate-income families access to mortgages so they can become homeowners. The FHA insures mortgages on single-family homes, apartments/condos, manfucatured homes, and townhouses built with FHA-approved mortgage insurance.
Because the loans are government-backed, they are available for borrowers with low credit scores and down payments as low as 3.5 percent (savings or investments, grants, donations, and workplace initiatives can all be used to make a down payment). Mortgage lenders (who must meet tight regulations and are limited in the closing expenses they can charge) are more inclined to offer competitive rates.
Even though the FHA insures its mortgages, the organization does not lend you, the future homeowner, money directly. You can obtain an FHA loan from a specific lender the same way a conventional loan is obtained. Here are the quick steps that will help you get started with an FHA loan.
Finding an FHA–approved lender is the first step in securing an FHA home loan. The good news is that almost all banks, mortgage firms, credit unions, and online lenders offer FHA financing.
If you plan to get an FHA loan, it's best to look at several different lenders to see which ones will work best for your situation. For example, some lenders have credit score minimums that are actually higher than FHA's guidelines. Or some lenders have drastically higher rates than others. Here at X2 Mortgage, we have some of the lowest FHA rates available due to our modern business model.
Once you've chosen a lender, you will need to fill out the Uniform Residential Loan Application (otherwise known as the 1003). The loan application includes information about your income, assets, debts, and employment history.
Many lenders enable you to apply online, but some may require you to speak with a loan representative over the phone or email to finish your application.
Before providing rate information and issuing a pre-approval, lenders will generally access your credit. But don't be too concerned about the impact on your credit score. Numerous inquiries from mortgage lenders in a short period of time will most likely not impact you at all. In fact, Shawn Malkou breaks this topic down very well in a YouTube video to learn more.
Once you complete your loan application and your Mortgage Loan Officer reviews it, you will need to provide additional documents such as
- A photocopy of your driver's license or other state-issued identification
- Information on earnings like W2s and paystubs
- Down payment and closing costs proof of funds
- Occasionally tax returns are needed
After submitting all required documents, you will need to wait for the lender to thoroughly review all documentation. Depending on the speed and workload of your lender, this could take anywhere from 24 hours to 2 weeks.
You will need to keep track of when each document was sent to the lender during this period. You should also check in with the lender periodically to make sure that they haven't forgotten anything.
When the lender finishes, they'll touch base with you on what you can qualify for and what the next steps are. This is where things start getting exciting as you're off the races at this point!
Your lender will evaluate your FHA loan eligibility the same way it would any other mortgage application. A lender may look at the following to determine your qualification.
Your credit score plays a vital role in determining whether or not you qualify for an FHA loan. Technically the minimum required score for an FHA loan is 500; however, if you have under a 580, you'll need to put 10% down to qualify. Even at this point, your lender will still need to be able to obtain an Automated Underwriting Approval which can be tricky depending on what's on your credit report. That's why most lenders advertise a minimum credit score of 580 because at this score, you can put the minimum of 3.5% down for your down payment.
So, if you don't have a stellar credit record, you may need to make a higher down payment (10% of the purchase price) or improve your score before applying for an FHA loan. We always recommend at least a 600 credit score if possible.
The amount of skin in the game is another factor that affects your ability to qualify for an FHA loan. The less money you're putting down (or the less equity you have in the home if it's a refinance), the less likely of obtaining an approval. The Loan-To-Value ratio is calculated by taking the loan amount divided by the home's value. So if you had a $100,000 home and wanted a loan of $75,000, then you'd have a 75% Loan-To-Value.
Keep in mind that FHA allows for up to a 96.5% Loan-To-Value ratio which is why it's one of the most popular loan programs for first time homebuyers. This means to qualify, you just need a down payment of 3.5% (or have 3.5% of equity in the home if it's a refinance).
The lower the Loan-To-Value ratio, the less riskier the loan is and the more likely you'd obtain an approval.
Another important factor determining whether you qualify for an FHA loan is your total monthly debt load. If you have high debt, then you will need to cut back on monthly liabilities to ensure that you can afford the monthly payments. FHA is one of the most lenient loan programs when it comes to your Debt-To-Income ratio.
To calculate your Debt-To-Income ratio, add your expected new mortgage payment, plus your average monthly payments (credit cards, auto loans, and student loans), and then divide it by your gross monthly income.
Your total debt-to-income ratio cannot be more than 57% to be able to qualify for an FHA loan. In fact, some lenders require that it be under 55%. Good news is that X2 Mortgage will go all the way up to the max that FHA allows.
Appraisals are required with FHA loans to determine the actual home value and if it meets HUD guidelines. The appraiser will evaluate the home and neighborhood in addition to seeing how well maintained the house is and its condition (it should meet basic safety and livability standards).
It's worth mentioning that all FHA loans will require mortgage insurance. Mortgage insurance is necessary for the life of the loan and the monthly amount that is paid will depend on the down payment / equity you have in the home. The yearly amount can range anywhere from 0.85% of the loan amount to 0.80% and it's paid monthly inside of your normal mortgage payment.
FHA loans come in various forms and can be used for a variety of purposes. The most common types are listed below.
These are the most common types of FHA mortgages as they make up 97% of all currently outstanding FHA mortgages. You'll very rarely even see the option to choose which FHA mortgage to apply for as your lender will apply the proper one.
Majority of these are fixed-rate mortgages and are used for purchasing and refinancing standard homes.
An FHA renovation mortgage is mainly designed to take advantage of the homeowner's equity in their home to finance home improvements. Think of it as a cash-out refinance, except these allow you to finance the renovation all in one mortgage.
On refinances, you'll take how much you owe on the property + the expected costs of the renovation to get your new 203(k) loan amount. When purchasing a home with a 203(k), you'll need to find a property that is being sold for significantly less than market value. That way you have enough equity in the home to include the renovations.
As with any loan, the amount you can borrow increases as your equity in the home grows, allowing you to borrow more for home improvements without taking out a second mortgage.
An energy-efficient mortgage is a mortgage that helps homeowners to reduce their monthly expenses, such as energy bills and/or fees, by using available tax credits.
To qualify for an EEM, the improvements must be cost effective and will be heavily scrutinized by an home energy assessment to ensure it complies with all guidelines.
The FHA Max Loan Limit is the maximum amount of money a home buyer can borrow to purchase a home with an FHA loan. The loan limit varies by county, but the most common limit is $356,362 for single-unit homes. You may, however, have access to increased limits as much as $822,395 in higher counties. You should visit the HUD website to determine the FHA loan limit in your county.
The main difference between an FHA loan and a Conventional loan is how much money you put down when buying a home and what the minimum credit score requirements are. With an FHA loan, you do not have to put down as much money upfront as you would if you were getting a traditional loan.
With an FHA loan, you will still need to put down some cash upfront, but it is usually less than what you need to put down with a conventional loan. You will also need to pay a premium to insure the loan against loss. This premium is called the "mortgage insurance premium" and it's added to your loan balance on closing day.
In general, the cost of an FHA loan is slightly higher than that of a conventional loan. But this extra cost is offset because you won't have to put down as much money upfront.
Another thing to keep in mind is that an FHA loan is only available through FHA-approved lenders. In contrast, Conventional loans are available from a range of banks, credit unions, and other mortgage lenders as they are not insured by the government.
You may be eligible for both, but there here are a few reasons why you might choose to take out an FHA loan instead of a conventional loan:
- Lower Down Payment Requirements: An FHA loan requires a smaller down payment than a conventional loan does. So, if you are looking to buy a home, you could save thousands of dollars by taking out an FHA loan.
- No Private Mortgage Insurance: Unlike a conventional loan, an FHA loan doesn't require PMI (it does require normal mortgage insurance).
- Lower Credit Score Requirements: If you have bad credit, an FHA loan may be the best option for you. Since FHA loans have looser guidelines, you can apply for one even if your credit is on the poor side of things.
- Low-Interest Rates: The federal government backs FHA loans, so they carry lower rates than conventional loans.
- Flexible Terms: The terms of an FHA loan are flexible. For example, you can typically refinance your FHA loan at any time and sometimes you can qualify for an FHA Streamline refinance which is a major bonus.
- More Homeownership Opportunities: With an FHA loan, you can borrow more money than you could with a conventional loan. This makes it easier for you to afford a larger home.
- Mortgage Insurance is Required For Life of Loan: The only way to remove the mortgage insurance on an FHA loan is to refinance into a conventional loan when you have 20% or more equity in the home.
- Lower Loan Limits: Every year, the FHA sets FHA loan limitations by county. This may limit the number of homes you may buy with an FHA loan, especially in high-cost areas. In most cases, FHA lending restrictions are 65%-70% of conforming loan limits specific regions.
- Primary Residence: An FHA loan can only be utilized to buy a home you intend to live in as your primary residence.
- Only 1 FHA Loan Allowed at One Time: You cannot have more than one active FHA loan in your name. You must sell or refinance your current FHA loan to obtain a new one. In some extenuating circumstances, this rule doesn't apply.
- Housing Regulations are Slightly Stricter: All homes purchased with FHA-backed loans must be structurally strong and secure and fulfill essential health and safety criteria. A finicky appraiser could make it tough to get an FHA loan for a fixer-upper.
FHA loans have no income restrictions. The amount you can request to borrow, however, is limited.
DACA recipients are eligible for FHA loans. This recent eligibility policy in January 2021 will provide stability and a safety net for low-income DACA recipients by allowing them to access the new opportunities that come with owning a home.
FHA mortgage insurance is required of borrowers. This insurance is often to protect the lender from a loss if you default on the loan. The borrower must pay two mortgage insurance charges on all FHA loans: 1.75 percent of the loan amount is delivered as an upfront mortgage insurance fee when the borrower receives the loan. Then anywhere from 0.85 to 0.80 percent of the loan amount is paid yearly inside of your normal mortgage payment.
Assumability is available on all FHA-insured mortgages. Assumability limits were largely absent in mortgages issued before December 1, 1986, but they were present in those issued after that date. The lender may request a creditworthiness check of the assumption, depending on the loan origination date.
Closing costs on an FHA loan are similar to those on a conventional loan. These costs normally range between 2% and 4% of the overall cost of your home. Your charges will be decided by various factors, including the loan amount, the state of the property, and lender fees. Typically, an FHA loan will not have any extra costs vs another loan program.
While an FHA loan may appear to be an excellent solution, it is not for everyone. That's why it's incredibly important to reach out to an experienced Mortgage Loan Officer so that they can weigh the pros and cons with you on which loan program is right for you.
Keep in mind that FHA loans are really an incredible option for aspiring homeowners who don't have a sizable down payment. They were never designed to assist buyers at the high end of the market. Rather, the FHA lending program was created to help low and moderate income borrowers with home purchases.
Overall at X2 Mortgage, we're big fans of them!