FHA Loans: Are They Right For You?
Are you ready to buy a home and looking for a loan with lenient credit and low-to-moderate income requirements? Conventional, VA, USDA, jumbo and FHA loans are all possible loan types that might be a match for you.
VA, USDA and FHA loans are backed by the U.S. government and might be your best fit based on your credit and income needs. Right now, we’ll focus on FHA loans to help you decide whether this type of loan is the best fit for your situation.
What Is An FHA Loan?
FHA loans are backed by the Federal Housing Administration, which is an agency under the jurisdiction of Housing and Urban Development (HUD). FHA loans are insured by the FHA, which simply means that the FHA 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.
If you’re a first-time home buyer or you haven’t owned a home in at least three years, you could qualify for an FHA loan through an FHA-approved lender. 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.
- Closing costs can be rolled into your loan.
FHA Loan Requirements
Note that there are certain requirements you have to 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 for an FHA loan, and those include the down payment amount, mortgage insurance, credit score, loan limits and income requirements. We’ll explore all of these factors in more depth below.
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 that ranges from 300 – 850 and is used to indicate your creditworthiness.
An FHA loan requires a minimum 3.5% down payment for credit scores of 580 and higher. If you can make a 10% down payment, your credit score can be in the 500 – 579 range. A mortgage calculator can help you estimate your monthly payments, and you can see how your down payment amount affects them.
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 lender against losses in the event that you default on your loan.
In most cases, you pay mortgage insurance for the life of an FHA loan. FHA loan mortgage insurance is assessed a couple of different ways. First, an upfront mortgage premium (UFMIP) is charged, which normally amounts to 1.75% of your base loan amount.
You also pay an annual mortgage insurance premium which is based on the term (length) of your mortgage, your loan-to-value ratio (LTV), your total mortgage amount and the size of your down payment. Annual MIP payments run approximately 0.45% to 1.05% of the base loan amount.
FHA Loans And Credit Score
There are a lot of factors that determine your credit score, and chief among them are the following:
- 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
The minimum FICO® Score is 580 for an FHA mortgage. If you have a higher score, you might be able to qualify with a higher debt-to-income ratio (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 or can make a larger down payment.
The FHA has 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.
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 (HUD), the maximum FHA lending amount for high-cost areas (such as large metropolitan areas) is up to $726,525 for 2019. In lower-cost areas, the FHA limit can dip to $314,827.
The FHA mortgage limits page allows you to look up the FHA mortgage limits for one or more areas. The page also includes a median sale price value for each area. According to HUD, those are the median price estimates used for loan limit determination.
FHA Interest Rates
FHA interest rates can be competitive in comparison to conventional mortgages. This is because the government backing of the loan decreases the risk you pose and allows lenders to offer you a lower rate in return. The rate depends on a number of 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 income doesn’t have to meet certain requirements to qualify for an FHA loan, but you must prove that you have a steady employment history. Your income must be verifiable, and you can verify your income 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 merits of an FHA loan, and in particular, compared to a conventional loan, know that a conventional loan, unlike an FHA 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.
Regardless of whether you choose a conventional or FHA loan, know that there are a few other costs you’ll need to be aware of. 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 between 3% and 6% of your home’s value.
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. Rocket Mortgage® by Quicken Loans® can help you determine which loan is the bets fit for your situation.
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