What Is An FHA Loan?
FHA loans are backed by the Federal Housing Administration, an agency under the jurisdiction of the Department of Housing and Urban Development. FHA loans are insured by the FHA, which simply means that this organization protects your lender against loss if you default on your loan.
FHA loans are available with low down payment options and lower minimum credit score limits, but you’ll also have to pay mortgage insurance.
The option of a low down payment and more lenient credit requirements can make FHA loans particularly attractive for first-time home buyers, although you don’t have to be a first-time home buyer in order to qualify. Here are some benefits of FHA loans:
- Credit score requirements are lower compared to other loans.
- Your lender can accept a lower down payment.
- You could still qualify for an FHA loan if you have a bankruptcy or other financial issues in your history.
FHA Loan Requirements
There are certain requirements borrowers must meet to qualify for an FHA loan, including:
- The home you consider must be appraised by an FHA-approved appraiser.
- You can only get a new FHA loan if the home you consider will be your primary residence, which means that it can’t be an investment property or second home.
- You must occupy the property within 60 days of closing.
- An inspection must occur, and the inspection must report whether the property meets minimum property standards.
There are a few more specific conditions to qualify, including a down payment amount, mortgage insurance, credit score, loan limits and income requirements.
FHA Loan Down Payments
Your down payment is a percentage of the purchase price of a home, and is the upfront amount you put down for that home. The minimum down payment you’re able to make on an FHA loan is directly linked to your credit score. Your credit score is a number ranging from 300 to 850 that’s used to indicate your creditworthiness.
An FHA loan requires a minimum 3.5% down payment for credit scores of 580 and higher. Triangle Lending Group requires a minimum credit score of 580 for FHA loans.
Note that cash down payments can be made with gift assistance for an FHA loan, but they must be well-documented to ensure that the gift assistance is in fact a gift and not a loan in disguise.
FHA Mortgage Insurance
You have to pay a mortgage insurance premium (MIP) for an FHA loan. Mortgage insurance is put into place to insure your FHA lender against losses if you default on your loan.
In most cases, you pay mortgage insurance for the life of an FHA loan (unless you made a down payment of at least 10%, in which case, MIP would be on the loan for 11 years). FHA loan mortgage insurance is assessed in a couple of different ways. First, an upfront mortgage premium is charged, which normally amounts to 1.75% of your base loan amount.
FHA borrowers also pay an annual mortgage insurance premium, which is based on the term (length) of your mortgage, your loan-to-value (LTV) ratio, your total mortgage amount and the size of your down payment. Annual MIP payments run approximately 0.45% – 1.05% of the base loan amount.
FHA Loans And Credit Score
There are a lot of factors that determine your credit score, including:
- The type of credit you have (whether you have credit cards, loans, etc.)
- Credit utilization, which is simply how much credit you use
- Whether you pay your bills on time
- The amount you owe on your credit cards
- How much new and recent credit you’ve taken on
If you have a higher score, you might be able to qualify with a higher debt-to-income ratio, or DTI. DTI refers to the percentage of your monthly gross income that goes toward paying debts. Your DTI is your total monthly debt payments divided by your monthly gross income (your monthly income before taxes). This figure is expressed as a percentage.
To determine your own DTI ratio, divide your debts (student loans, car loan, etc.) by your monthly gross income. For example, if your debts, which include your student loans and car loan, reach $2,000 per month and your income is $8,000 per month, your DTI is 25%.
The lower your DTI, the better off you’ll be. If you do happen to have a higher DTI, you could still qualify for an FHA loan if you have a higher credit score.
The FHA states that your monthly mortgage payment should be no more than 31% of your monthly gross income, and that your DTI should not exceed 43% of monthly gross income in certain circumstances if your loan is being manually underwritten. As noted above, if you have a higher credit score, you may be able to qualify with a higher DTI.
FHA Loan Limits
There’s a maximum limit to what you can borrow for an FHA loan, and how much you can borrow depends on the county in which your potential home is located.
According to the Department of Housing and Urban Development, the maximum FHA lending amount for high-cost areas (such as large metropolitan areas) is up to $970,800 for 2022. This is also the limit for Alaska and Hawaii at Rocket Mortgage®. The policies of lenders regarding Alaska and Hawaii do differ in terms of loan limits. In lower-cost areas, the FHA limit can dip as low as $420,680. Loan limits are set based on county property values. These are the limits for one-unit properties. If you have multiple units, limits may be higher.
You can look up the FHA mortgage limits for one or more areas on the FHA mortgage limits page. The page also includes a median sale price value for each area. Those are the median price estimates used for loan limit determination, according to HUD.
FHA Interest Rates
FHA interest rates can be competitive compared to conventional mortgages. This is because the government backing decreases the risk you pose and allows lenders to offer you a lower rate in return. The rate depends on several factors, including the prevailing interest rates, your income, credit score, the amount you plan to borrow, your down payment amount, DTI ratio and more.
FHA Income Requirements
Your eligibility for an FHA loan doesn’t hinge on a particular income amount, but you must prove that you have a steady employment history. Your income must be verifiable by sharing pay stubs, W-2s, federal tax returns and bank statements with your lender. Your lender may ask for other examples of verification as well.
Is An FHA Loan Right For You?
If you’re still debating the pros and cons of an FHA loan compared to a conventional loan, you should know that a conventional loan is not government-backed. Conventional loans are offered through Fannie Mae or Freddie Mac, which are government-sponsored enterprises that provide mortgage funds to lenders.
They have more stringent requirements, so keep in mind that you’ll need a higher credit score and a lower DTI to qualify. FHA loans, on the other hand, are nonconforming loans, meaning they don’t satisfy Fannie Mae or Freddie Mac’s requirements for purchase.
Regardless of whether you choose a conventional or FHA loan, there are a few other costs of which you’ll need to be aware. You’ll have to pay closing costs, which are the fees associated with processing and securing your loan. These can vary depending on the price of the house and the type of mortgage, but you should budget 2.5% – 5% of your home’s value.
The Bottom Line
If you’re in the market for a loan with lenient credit, lower down payment and low-to-moderate income requirements, an FHA loan might be right for you. Check your options online with Triangle Lending Group
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