If you’re in the market to buy your first home, you may not even realize how many mortgage options are out there. The FHA (Federal Housing Administration) provides mortgage insurance -i.e. “backing” - on loans made by FHA-approved lenders. For many first-time buyers, this is the way to go.
The FHA insures or “backs” these loans on single-family and multi-family homes across the United States and U.S. territories. In fact, the FHA is the largest insurer of residential mortgages in the world. They have insured tens of millions of properties since the FHA’s creation in 1934.
To help you figure out of an FHA loan is a good option for you, we’ve compiled the ultimate guide to getting an FHA loan. Read on for all the details!
What is an FHA loan?
An FHA loan is a government-backed mortgage. This means it is insured by the Federal Housing Administration. FHA home loans require lower minimum credit scores and lower down-payments than most conventional loans. This makes them an especially popular option for first-time homebuyers.
In fact, according to FHA’s 2020 Annual Report, more than 83 percent of all FHA loans were for first-time homebuyers.
However, while the government insures/backs these loans, they are actually offered by private mortgage lenders that have been approved by the FHA. And to be eligible for an FHA loan, you’ll need to meet the borrower requirements, which include a credit score of at least 500 and a down payment of 3.5% to 10%.
When a mortgage is FHA-insured it means that in the event of a foreclosure, the FHA will step in and cover part or all of the lender’s financial losses. Thus, it is because of this added protection that these loans come with low-interest rates and lower down payment requirements.
What is the FHA?
The Federal Housing Administration, better known as the FHA, has been part of the U.S. Department of Housing and Urban Development (HUD) since 1965. But the FHA actually began much earlier, as a component of the New Deal.
In addition to a stock market crash and other financial dips, the Great Depression involved a burst housing market bubble. By early 1933, due to the economic crisis, almost half of all American homeowners had defaulted on their mortgages. Therefore, the FHA was created as part of the National Housing Act of 1934 to stem the tide of foreclosures and help make homeownership more affordable.
The FHA established the 20% down payment as a new norm by insuring mortgages for up to 80% of a home's value. Previously, homeowners had been limited to borrowing 50% to 60% of a home’s value. Today, the FHA insures loans for about 8 million single-family homes.
How Does Getting an FHA Loan Differ from a Conventional Loan?
It's easier to qualify for an FHA loan than for a conventional loan. A conventional loan is a mortgage that isn't insured or guaranteed by the federal government. However, since FHA loans are government-backed, they allow for lower credit scores than conventional loans and, in some cases, lower monthly mortgage insurance payments.
FHA rules are also more liberal regarding gifts of down payment money from family, employers, or charitable organizations. This is yet another reason, why many first-time and younger buyers opt for this type of loan. However, FHA loans may involve additional closing costs that aren't required by conventional loans.
Types of FHA Loans
FHA loans aren’t one size fits all. Even within the umbrella of the FHA loan, there are variations. In broad terms, FHA loans come in fixed-rate or adjustable-rate options. A fixed-rate loan offers a consistent interest rate for the life of the loan. Alternatively, an adjustable-rate mortgage has an interest rate that can fluctuate.
There are also FHA mortgage programs for specific purposes. For example, 203(b) loans. These are what are most typically considered “FHA loans” commonly speaking. FHA 203(b) loans are broadly used to either purchase or refinance a home and require down payments as low as 3.5%.
Another FHA loan is the 203(k) loan, also called a “203(k) Rehabilitation mortgages.” These loans are designed for both buyers and existing homeowners, allowing them to finance eligible home repairs and improvements.
EEM and HECM loans are also types of FHA loans. Energy Efficient Mortgages (EEMs) help homeowners finance home improvements that reduce energy use on the property. EEM loans can be used to purchase a home and improve it immediately. Alternatively, these loans can be used to improve a home you already own.
Meanwhile, Home Equity Conversion Mortgages (HECMs) are more commonly known as reverse mortgages. These mortgages are specifically intended for homeowners over the age of 62, allowing them to turn their home’s equity into a form of income.
Who Qualifies for Getting an FHA Loan?
There are some basic requirements borrowers must meet to qualify for an FHA loan. Keep in mind that a particular lender may also have its own set of guidelines in addition to these.
Here are the general requirements for getting an FHA loan:
- The property being financed must be owner-occupied.
- FHA loans are available for 1-4 unit houses, including single-family residences, town-homes, condominiums, and even manufactured homes.
- A 3.5% (of purchase price) minimum downpayment is required. The downpayment cash can be gifted from parents, children, siblings, or other close relatives.
- An impound account (also known as an escrow account) is required on all FHA loans. As part of this required account, payments for property taxes and home insurance are broken down into monthly payments. They are paid to the lender along with mortgage payments. The lender then makes a payment directly to the county or your home insurance company when it’s due, typically once a year for insurance and twice a year for property taxes.
- Two years of employment history is required. However, if you went to school immediately before starting your employment, the school years can be counted towards the requirement as long as your job is in the same field as your education.
- You must have enough income to meet the maximum debt to income ratio requirement of 43%. In some cases, that ratio can be allowed to be as high as 50%.
- Upfront mortgage insurance (UFMIP) of 1.75% and annual mortgage insurance of 0.45% – 1.05% are required on all FHA loans.
FHA Loan Requirements
Above, we briefly touched on the FHA's minimum requirements. However, some lenders may have additional stipulations. To make sure you get the best mortgage rate and loan terms, even with an FHA loan, we recommend you shop for more than one FHA-approved lender and compare offers.
For example, the FHA offers 30 years fixed, 15 years fixed, and 5 year ARM loans. And while FHA rules allow for much lower credit scores, most lenders require a minimum of 620 Fico scores.
Texas United Mortgage only requires a score of 580, though you can still qualify with a score as low a 500. Let’s dive in more deeply into some of the FHA requirements so you can better understand the process and preparation involved.
Credit score
The very minimum credit score for an FHA loan, as set by the government, is 500. If your score falls on the lower end, i.e. between 500 and 579, you can still qualify for an FHA loan, but you'll need to make a larger down payment. Again, these are the bare minimum FHA guidelines; individual lenders can opt to require a higher minimum credit score.
In light of the COVID-19 pandemic, some FHA lenders have raised the minimum requirements for credit scores. However, the FHA has not changed its requirements.
Many lenders currently ask for a credit score of at least 620, which can be prohibitive for many buyers. That’s why it’s important to find a lending company that will work to support you and your needs, wherever you are.
Look to lenders like Texas United Mortgage, who specialize in FHA loans. Such specialized lenders are usually able to offer loans based on minimum credit scores that are closer to FHA guidelines. These lenders may also offer manual underwriting. This is helpful for buyers without much credit history or with a history of bankruptcy.
Down payment funds
If you have a credit score of 580 or higher, you may qualify for the lowest downpayment option - just 3.5% of the purchase price. However, if you have a credit score that's between 500 and 579, you should plan to put down up to 10% of the purchase price.
However, there is good news! As mentioned earlier, this cash doesn't all have to come from your savings. You can use gift money for your FHA down payment, but you will need some documentation to back it. The donor (person gifting you the funds) must provide a letter with their contact information, their relationship to you, the amount of the gift, and a statement that the funds are a gift and you are not expected to repay any amount.
You can also look into state and local down payment assistance programs for first-time homebuyers. Through such a program you may be able to find low- or no-interest loans or even grants, that can help you pull together a down payment.
Debt-to-income ratio
While there are no income minimums for FHA loans, the FHA dies require a debt-to-income ratio (DTI). This ratio must amount to less than 50. This means that your total monthly debt payments can't be more than 50% of your pretax income. This includes debts that you aren't actively paying, such as student loans in forbearance.
For student loans in deferment, your FHA loan underwriter will include 1% of the loan's total as the monthly payment amount. For other types of loans that you aren't currently repaying, underwriters will use 5% of the loan's total to calculate your DTI.
Property approval
The property you will be buying with the FHA loan, whether a house, condo, manufactured home, or multifamily home, must meet minimum property requirements as set by the FHA.
The FHA requires an appraisal that's separate and different from a home inspection. Since the FHA is backing the loan with government funds, they want to be sure the home is a good investment. Thus it must meet basic safety and livability standards to be eligible for an FHA loan.
For an FHA 203(k) renovation loan, the property may undergo two separate appraisals. The first appraisal is an "as is appraisal” to assess the home’s current state. The home may also need an "after improved appraisal” estimating the value again once upgrades and construction are completed.
Mortgage insurance
FHA mortgage insurance is built into every loan. When you get an FHA mortgage, you'll make an upfront mortgage insurance payment, plus monthly payments thereafter.
If you start with a down payment of less than 10%, you'll continue to pay mortgage insurance for the life of the loan. Those with 10% down payments will pay FHA mortgage insurance for 11 years.
This mortgage insurance requirement is one of the cons of an FHA loan versus conventional however it is typically such a low rate (0.45% to 1.05% of the loan amount) that it is still much more attainable than a conventional loan.
What are FHA Loan Limits?
No matter which type of FHA loan you're seeking, there will be limits on the mortgage amount. FHA loan limits for 2021 range from $356,362 to $822,375.This means that all counties in the country will have this as their loan limit.
Because there are variations in housing markets across the country, the FHA also classified several counties as “high-cost.” That means the loan limits in those counties are higher than $331,760. The upper limit for FHA loans in the highest-cost counties, such as San Francisco, California, is $822,375.
In low-cost counties such as Lucas County, Ohio, the upper limit is $356,362. However, some counties have housing prices that fall somewhere in between, so the FHA loan limits for those counties are mid-range, as well. For example, Denver County, Colorado is considered a mid-range market. Thus the 2021 FHA loan limit there is $596,850. You can visit HUD's website to find the FHA loan limit in your county.
Steps to Getting an FHA Loan
Not all mortgage lenders offer FHA loans, so the first step is to find one who does! At Texas United Mortgage, we specialize in the ins and outs of FHA loans. Once you’ve shopped around and selected a lender, here are your next steps:
Pre-Approval
The mortgage pre-approval process varies depending on the lender or platform you use. It typically involves filling out some basic information. When you get a mortgage preapproval from more than one lender, you can compare rates as well as all the fees and conditions each unique lender will apply.
Application
Once you start applying for your loan you’ll really be in the thick of it! You will fill out the lender’s loan application and submit to a credit check. This process is more detailed than the pre-approval step.
Documentation
Start gathering your documents early. You will need to provide financial documentation including your recent pay stubs, W-2s, tax returns, bank account statements, and more. Your loan officer will tell you the exact documents you’ll need to provide and make sure you include complete documents.
Appraisal
This step comes once you’ve found the purchase property and have completed all the other documents. The appraisal ensures your home is worth the amount of money you’re looking to borrow for it. The appraiser will also review details specific to the FHA requirements, to ensure that the property meets FHA construction guidelines.
Last Steps
Keep in touch with your loan officer throughout the process. As your mortgage moves through the process and goes to underwriting, your loan officer might need additional paperwork or information. A good loan officer will check in with you to ensure everything is in order.
Once the loan has been processed, it will be time to attend your closing appointment! This includes paying your closing costs and down payment (typically through a check or wiring bank funds), signing lots and lots of documents, as well as getting your keys.
Takeaways
FHA loans' requirements surrounding credit scores, debt-to-income ratios, and down payments are more flexible than conventional loans' stipulations. This means you can own a home even if your finances aren't pristine. There are no income limits, and one of the biggest benefits of FHA loans is that the interest rate charged on the mortgage is the same no matter what your credit score is.
If you think getting an FHA loan is the best way for you to purchase a home, don’t hesitate to reach out! We’d be happy to work with you to achieve your home-buying goals. Our experienced team will make your Texas home-buying experience smooth and productive. Get started today!
