FHA Mortgage Loans
The Federal Housing Administration (FHA), which is part of HUD, is the largest insurer of residential mortgages in the world. FHA loans have been helping people become homeowners since 1934.
The money for an FHA mortgage is not given to borrowers by the FHA; rather, borrowers receive the funds from an FHA-approved lender, and the FHA guarantees the loan. On one hand, this means that different lending institutions might offer you a very similar mortgage (or might turn you down), since the FHA’s loan guidelines don't change based on whom you borrow the money from. On the other hand, the FHA offers lenders flexibility in setting their own standards for determining loan eligibility, and many lenders’ minimum requirements are higher than those set by the FHA. As a result, one institution may give you an FHA loan while another may not.
Benefits Of An FHA Loan
The reason why FHA loans are so popular is that borrowers that use them are able to take advantage of benefits and protections unavailable with most traditional mortgage loans. Loans through the FHA are insured by the agency, so lenders are more lenient. Here are a few benefits you can enjoy with an FHA loan:
Easier to Qualify
While most loans exclude applicants with questionable credit history and low credit scores, the FHA makes loans available with lower requirements so it's easier for you to qualify.
Competitive Interest Rates
You've heard the horror stories of subprime borrowers who couldn't keep up with their mortgage interest rates. Well, FHA loans usually offer lower interest rates to help homeowners afford housing payments.
In addition to lower interest rates, you can also enjoy lower costs on other fees like closing costs, mortgage insurance, and other costs.
The Major Components That Determine Borrower Eligibility:
Credit Score Requirements
The FHA has a minimum credit score requirement of 500 for its loans, which is very low. Anything below 620 is considered subprime. That being said, borrowers with poor scores may be disqualified based on the activities that created those low scores, such as not paying bills on time. Also, lenders typically require a higher minimum credit score.
The FHA usually requires two lines of credit for qualifying applicants. If you don't have a sufficient credit history, you can try to qualify for a substitute form. Instead of your credit report, the lender will look at other payment history records, such as utility bills and rent payments.
Credit And Down Payment
FHA loans provide great assistance to home buyers by offering mortgage loans with lower down payments. While this is a benefit for many people, recent changes in policy may have put the loans just out of reach for some would-be homeowners with questionable credit history.
For those interested in applying for an FHA loan, applicants are now required to have a minimum FICO score of 580 to qualify for the low down payment advantage, which is currently at around 3.5 percent.
If your credit score is below 580, however, you aren't necessarily excluded from FHA loan eligibility. Applicants with lower credit scores will have to pay a 10 percent down payment if they want to qualify for a loan. They will also have to find a lender who will approve them with the lower credit score.
Gift funds may be contributed to the down payment if they come from an acceptable source (which must be verified), such as a relative or employer. If the gift was given in the distant past, generally three months or more, it will not need to be verified or even mentioned in the application. The reason the FHA wants documentation for gifts close to the time of purchase is to ensure that the money isn't from a new loan, which would throw off the borrower's previously approved debt-to-income ratio.
So if you're planning to buy a house, and your credit score doesn't meet the minimum score of 580, you should weigh the advantages and disadvantages of putting down a larger down payment or using those funds to try and improve your credit score first.
Credit issues like a previous foreclosure, short sale or bankruptcy will not disqualify a borrower, as long as enough time has passed (usually one to three years for a foreclosure or short sale and one to two years for bankruptcy). The borrower must also have established a documented ability to manage his/her finances since the negative event. If a borrower is delinquent on their federal student loans or income taxes, then they won’t qualify for the loan.
Income and Employment
Only stable and documented income (called "effective income") can be considered for a borrower's mortgage eligibility. In general, lenders like to see two years of steady employment in the same line of work prior to the mortgage application, with no more than a one-month gap in employment. The job must be expected to continue for at least three years after obtaining the loan.
Part-time employment does not count unless it has been uninterrupted for the last two years. A full-time contract position that will end shortly also may not count, nor will the current salary of someone expecting to retire shortly. (Carrying a mortgage in retirement might negatively affect your finances.)
However, lenders look positively upon borrowers who have changed jobs in order to move up in their fields and increase their incomes. Also, there are allowances for those who work seasonally or have taken an extended leave of absence from the workforce for reasons such as to raise kids or attend school.
Those who are self-employed will need two years of successful self-employment history, documented by tax returns and a current year-to-date balance sheet and profit and loss statements. Applicants who have been self-employed for fewer than two years but more than one year can be eligible if they have a solid work and income history for the two years preceding self-employment and the self-employment is in the same or a related occupation.
The FHA lets borrowers have a maximum debt-to-income ratio of 50% if they have what is called “strong compensating factors,” such as at least three months of cash reserves or a history over the last 1–2 years of making housing payments greater than or equal to the proposed monthly mortgage payments. This means that the total of your debt obligations must not exceed 50% of your gross effective income. These obligations include:
• Credit cards
• Student loans
• Car payments
So if you and your spouse together make $6,000 a month before taxes, your house payment plus your other monthly debt payments would need to be under $3,000. If you have a credit score of less than 580, your debt-to-income ratio must be 43% or lower. Also, as with credit scores, lenders can and often do require lower debt-to-income ratios than the FHA does.
Maximum Mortgage Amount
The maximum mortgage a borrower can receive, assuming he or she has the required income, is the lesser of:
• The statutory limit for the geographic area where the home is located.
• The maximum loan-to-value (LTV) ratio for a specific property.
Limits are indexed to Freddie Mac conforming loan limits and change as often as once a year on January 1 of each year.
FHA loans allow the seller to contribute up to 6% of the loan amount toward the buyer's closing costs, compared with 3% for conventional loans. This feature of FHA loans makes it easier for cash-strapped buyers – or buyers who would simply prefer to hang on to their cash so they can invest it elsewhere or use it to remodel – to purchase a home.
FHA loans require mortgage insurance because of their low down payments. Up-front mortgage insurance is due at the time the loan is taken out. This amount is equal to 1.75% of the loan amount and is typically rolled into the mortgage so the buyer doesn't have to come up with extra cash to close. This premium does not decrease the total loan a borrower is eligible for, but rolling it into the mortgage does increase the monthly payment slightly. The monthly payment will also include a monthly mortgage-insurance premium, which costs 0.85% of the loan amount on an annual basis if you’re putting 3.5% down on a 30-year loan. This premium is divided by 12 and added to your monthly payment. You’ll pay these premiums for the life of the loan, which makes FHA loans significantly more expensive than conventional loans, where you can cancel PMI when you have 20% equity. In addition, the FHA’s monthly premium is often more expensive than private mortgage insurance (PMI) on a non-FHA loan.
FHA Inspection And Appraisal Requirements
Even if you qualify for an FHA mortgage, that doesn't mean you'll be able to purchase the exact home you want. The FHA requires all the mortgages it insures to be backed by homes of a particular caliber. Essentially, the home must be habitable, with running water, toilets, a stove and the other elements necessary to live in a safe and sanitary manner. Extreme fixer-uppers, while they can be a bargain, are not likely to qualify for FHA financing because of this requirement.
Also, if the property does not appraise at or above the purchase price, it cannot be purchased with an FHA loan unless the purchaser/borrower can come up with enough cash to make up the difference between the appraised value and the sale price.
Property Types Eligible for FHA Mortgages
In general, a property financed with an FHA loan must be the borrower's principal residence and must be owner-occupied. Detached and semi-detached houses, townhouses, mobile homes, factory-built housing, row houses and condos within FHA-approved condo projects are all eligible for FHA financing. (This loan program cannot be used for investment or rental properties.)
The FHA loan underwriting process offers a lot of flexibility in evaluating borrowers' ability to repay a mortgage. If your situation is not described above, that doesn't mean you won't be eligible for an FHA mortgage. This mortgage program looks at the borrower's big-picture situation, and financial strengths in some areas may compensate for weaknesses in others. To find out if you qualify for FHA financing, talk to an FHA-approved lender.