With low down payments, low closing costs, and more flexible credit score requirements, it’s no wonder that nearly one in every five home purchases are made using an FHA Loan. FHA loans are famous for their flexibility, but sometimes they come with requirements that both the borrower and the property owner must meet. Here’s how to know if an FHA loan is the right fit for you and your unique homeownership goals.
What is an FHA Loan?
You may have heard of FHA loans, but do you really know where they come from and how they work? To begin, FHA stands for the Federal Housing Administration, a government agency created in 1934 by the U.S. Department of Housing and Urban Development (HUD). The FHA was started by HUD as a resource to increase homeownership in America.
An FHA loan sounds like a loan that comes from the FHA, right? This is not true: The FHA does not issue loans directly to homebuyers. Instead, the FHA insures loans offered by private lenders. If a homebuyer can’t pay for their FHA mortgage, the home will be foreclosed on. If that happens, HUD will pay off the loan to the lender and take ownership of the home. This insurance removes some of the risk for lenders, allowing them to offer lower credit score and down payment requirements, which in turn allows more homebuyers to qualify for home loans.
How to Get an FHA Loan
If you think an FHA loan is a good fit for your needs, it’s time to start taking steps towards securing one. As mentioned, the FHA and HUD don’t actually make the loans, they just insure them: To get an FHA loan, you will need to connect with a lender.
In order to meet your lender’s requirements for an FHA loan, you’ll need to ensure that you have (and understand) the following:
- 620+ credit score with at least a 3.5% down payment
- A home appraisal done by an FHA-approved appraiser
- A 50% maximum debt-to-income (DTI) ratio
- You must occupy the home as your primary residence
Who Can Get an FHA Loan?
Although FHA loans are a relatively well-known type of mortgage, there are often misconceptions around both eligibility and overall criteria. Here are three common types of homebuyers who can benefit from considering an FHA home loan.
First-Time Homebuyers
Many first-time homebuyers use FHA mortgages to make their homeownership dreams a reality. Even after that first home purchase, you can still use an FHA loan — they are not restricted to your first home purchase. But, because FHA loans can only be used for your primary residence, you generally can’t have two FHA loans open at the same time. However, there are several exceptions to this rule, such as a move required for work, or your family outgrowing your current home.
Homebuyers with Poor Credit
Even if you think your credit score is too low for a traditional loan, you still may be eligible for an FHA loan. Buyers with a 500 credit score can get an FHA loan with 10% down, and buyers with a credit score of at least 580 can get an FHA loan with 3.5% down.
Low-Income Buyers
Many low to moderate-income buyers who don’t qualify for a traditional loan or need a lower down payment option are still able to get an FHA loan. This is because the FHA allows lenders to be more flexible with potential buyers’ DTI ratios, even sometimes approving up to a 55% DTI.
FHA Loan Interest Rates
One of the most important elements of your home loan is your interest rate, which will be a large factor in the affordability of your monthly payment. FHA loan rates are similar to traditional loan rates in that they are based on both larger market conditions and the qualifications of the individual buyer. Wondering what your options will be?
View today’s FHA loan rates!
FHA Credit Score Requirements
One benefit that makes FHA loans attractive to buyers is the flexibility with regard to credit score requirements. (An FHA loan can allow for a credit score as low as 580 depending on your lender, a score that would make you ineligible for many other types of loans.) Once you know your credit score, you can see your eligibility for various FHA loan products. Here is the limit for 2019:
Credit Score of 620 and Higher: PennyMac Buyers with a minimum credit score of 620 can
qualify for the low down payment advantage, which is currently 3.5% of the purchase price.
Need to estimate your monthly mortgage payment? Use PennyMac’s FHA home loan calculator to get an estimate today.
2019 FHA Loan Limits
In addition to the limits on your credit score and down payment amounts, there are also limits on the total mortgage amount that can be offered through an FHA loan. The FHA does have lending limits, and these numbers can differ depending on where you buy a home. Loan limits are established by the FHA and can vary by county.
FHA Loan Benefits
In addition to expanded eligibility criteria (that makes them easier to qualify for overall), FHA loans offer many other benefits to borrowers.
Open to Buyers with a History of Bankruptcy and/or Foreclosure: A history of bankruptcy or foreclosure is not necessarily a barrier to qualifying for an FHA loan. There is a two-year waiting period after a bankruptcy, and a three-year waiting period after a foreclosure before you can qualify for an FHA loan.
Gift Money: Struggling to save for your down payment? If you have loved ones who want to help you, FHA loans accept gift money as a source of down payment or other funds. There are some limits and other rules, so be sure to discuss your situation with your lender.
Competitive Interest Rates: FHA loan rates are comparable to conventional mortgage rates.
Credit History and Loan Eligibility: FHA loans can work for many borrowers when traditional loans can’t, due to the fact that they have looser credit score requirements. FHA lenders will look at your complete financial picture, including your ability to pay for things like your rent, utilities, auto, student loans, and more.
Non-Occupying Co-Borrowers are Allowed: If your debt to income ratio is high, a co-borrower (and their income) can help you qualify for a loan you would not otherwise be eligible for, just like a conventional loan. Co-borrowers have ownership interest and are listed on the home’s title. They must sign all loan documents and will be obligated to pay the monthly payments if you ultimately cannot. FHA loans allow you to have a co-borrower who won’t be living with you, such as a family member who lives elsewhere.
What Mortgage Insurance is Required for FHA Loans?
When buyers have little invested in a home (whether via down payment or equity), lenders consider the loan (FHA or conventional) to be a bigger risk. Because of this, they typically require those buyers to pay a monthly fee for mortgage insurance, also known as private mortgage insurance or PMI. This insurance is usually required for any buyer who has a loan for an amount that is more than 80% of their home’s value. For example, if your home is worth $100,000 and you have a mortgage balance of 90,000, you only have 10% in equity. Your loan is therefore 90% of your home’s value and your lender will require mortgage insurance.
For an FHA loan, the details are a little different. FHA loans don’t have the same standards of a conventional loan, rather, they require the following two kinds of mortgage insurance premiums: one paid in full upfront (or financed into the mortgage) and another which is paid as a monthly fee, regardless of how much equity you have.
Upfront Mortgage Insurance Premium (UFMIP)
This fee must be paid at closing (or added to your loan amount) and is currently 1.75% of your loan amount. For example, this would mean an extra $3,500 due at closing for a $200,000 loan.
Annual Mortgage Insurance Premium (MIP)
This additional insurance cost ranges from 0.45% to 1.05% of your loan amount. The yearly cost (based on your loan-to-value ratio and loan length) is divided by 12 and paid as a part of your monthly mortgage payment. On a $200,000 loan, a MIP at 1% will add $167 to your monthly mortgage payment.
Looking to obtain mortgage insurance financing with down payments as low as 3.5%?Learn more here.
Timeline for Paying Back FHA Mortgage Insurance
Mortgage insurance may be an unexpected expense for many first-time homebuyers, but, depending on your loan details. Your mortgage insurance timeline will predominantly depend on your amortization period (the length of your loan) and the loan to value percentage you had on your loan origination date. Here is a chart that can help you figure out what the details will be on your loan.
| Loan Term | Down Payment | Duration |
|---|---|---|
| 15 years or less and loan amount is no more than $625,500 | Less than 10% | Life of loan |
| 15 years or less and loan amount is no more than $625,500 | 10% or higher | 11 years |
| Over 15 years and loan amount is no more than $625,500 | Less than 10% | Life of loan |
| Over 15 years and loan amount is no more than $625,500 | 10% or higher | 11 years |
FHA Loan Requirements for Single-Family and Other Properties
As a buyer, once you have met all of the FHA loan requirements, it’s time to look at the property you want to buy. There are certain requirements that your future home must meet as well. HUD has minimum property requirements to ensure that any home that the FHA insures will be a good investment for both the buyer and the lender. Those requirements ensure that the home must be:
- Safe: Your home must be a healthy, safe place to live
- Sound: The structure of your home must be sound, not significantly damaged
- Secure: The home must be a secure investment for a lender
The requirements above apply to all properties able to be purchased with an FHA loan. If you are not buying a single-family home, there may be additional requirements unique to the type of property you are considering. Here are two of the most common property types that are not single-family homes and the additional requirements for each.
Condominiums
Condominiums can be a great choice for homebuyers in urban areas, or in any area where buyers want the benefits of home ownership without the maintenance that a single-family home can require. You can buy a condo with FHA financing, as long as it is included on the FHA’s approved condominium project list. If the complex you are interested in is not listed, it may still be eligible as long as it meets the requirements listed in FHA’s handbook for condos. Those requirements include:
- The complex is in compliance with state and local laws and regulations
- The complex contains at least two residential units
- No more than 35% of the complex is used for non-residential or commercial purposes
- No more than 10% of the units in the complex are owned by one investor or entity—this can be an issue in small complexes
- The complex’s homeowners association fees (HOA) are in good financial shape: no more than 15% of the total units in the complex are more than 60 days past due on their condo association dues payments, and the HOA is allocating at least 10% of their budget to a reserves account to be used for maintaining the common areas, and the complex has adequate insurance
If you are planning to buy a condo with an FHA loan, make sure that your real estate agent knows this and can help guide you through the process of finding an approved complex that you will love.
Getting an FHA Loan with Student Loan Debt
If you have student loan debt, it will factor into your FHA loan eligibility. Since they are counted as a part of your monthly debt, student loan payments impact your ability to qualify for (and repay) a mortgage. Consider the following three factors when calculating how student loan debt may affect your ability to secure an FHA loan.
The Debt-to-Income Ratio Factor (DTI)
A big part of how lenders determine your loan eligibility amount is by looking at your total monthly bills. By knowing both your income and what other debts you need to pay, they will be able to see how much you can afford to pay on a mortgage.
If your gross income is $3,000 a month, and you have $1,500 a month in debt payment obligations, your DTI is 50%. Many lenders want you to have a DTI ratio of 43% or less.
The 1 Percent Rule
When determining what your monthly bills are, your lender will usually apply the “1 Percent Rule” to your student loan debt. For example, if you have $25,000 in student loan debt, your lender will assume a 1% ($250) monthly payment. This can be a problem, and inaccurate, if you are on an income-based repayment plan or other student loan forgiveness programs that offer you a monthly payment amount of less than 1%. Fortunately, FHA loans allow for higher DTIs than conventional mortgages which can compensate for the higher student loan payment, which can allow a borrower to qualify.
FHA Loan Alternatives
As common as FHA loans are, it’s important to remember that they are not the only option available to most homebuyers. Whether you are trying to avoid the 1 Percent Rule mentioned above, want to buy an ineligible condo, or are looking for very specific loan terms, there are many situations where a conventional mortgage may be a better fit for you than an FHA loan. It’s important to discuss your situation with your lender, and carefully compare all of your choices.
FHA Loan Final Checklist
Once you have found your dream home and have gone through the application and underwriting process for an FHA loan, there are a few final items you will need to have in order to ensure a smooth closing process.
Homeowner’s Insurance Policy: Your homeowner’s insurance will protect one of your biggest investments — your house, its contents, and your loved ones. The cost of this policy will be included in your monthly payment and paid annually by your lender, so make sure your lender has your insurance information before closing.
Identification: At your closing, you will need two forms of identification. One must be government-issued, photo I.D. — your driver’s license or passport are good options. The other must only have your name printed on it, such as a Social Security card, credit card, debit card, or insurance card.
Title Insurance Policy: Title insurance protects you and your lender from any costs or other issues that may come from unknown liens, encumbrances, or other issues with the title or legal ownership of your home.
Closing Funds: Finally, you will need the money you are using for your down payment, and any other closing costs you are paying. Talk to your lender to determine the total amount and the form (cashier’s check, wire transfer, etc.) in which the funds will need to be paid.
Ready to crunch your numbers and get your questions answered? Check out our current FHA Purchase Loan Options.
Finance Your Home Today with an FHA Loan
FHA loans are used by many homebuyers every year. From more flexible qualification requirements to greater flexibility with down payment amounts, FHA insured mortgages can help you buy your first home, your last home, and any in-between. If you’ve found your dream home and are ready to buy, reach out to a PennyMac Loan Officer to get pre-approved for an FHA loan today.