FHA Loan Requirements
The FHA loan program was developed in part to help tackle the issue of mass foreclosures and defaults in the 1930's and to provide mortgage lenders with adequate insurance that would in turn stimulate the housing market. The program was also established to help make loans accessible and affordable for people with bad credit or those who could only afford to make a low down payment.
FHA loans are mortgages insured by the Federal Housing Administration (FHA). They are a popular choice for first time home buyers as they allow down payments of 3.5% for credit scores of 580+. Borrowers, however, are required to pay mortgage insurance premiums, which offers protection to the lender in case a borrower defaults. Because the federal government insures loans for FHA-approved lenders, lenders do not risk loss if a borrower defaults on their mortgage payments. As a result, FHA loans typically have better interest rates.
So, What's the Catch?
Although FHA loans are appealing, they do come with more requirements than a conventional loan.
FHA Loan Requirements
Borrowers who are interested in buying a home with an FHA loan with the low down payment amount of 3.5% must have a minimum FICO score of 580 to qualify. A lower credit score than 580 doesn’t necessarily exclude you from FHA loan eligibility if you have a minimum down payment of 10%. There are other requirements for FHA loans in addition to credit score and certain down payment amount. Here is the complete list of FHA loan requirements, which are set by the Federal Housing Administration:
1) Steady Employment History
Borrowers must be able to demonstrate a steady employment history or have been working for the same employer for the past two years.
2) Social Security Number
Borrowers must have a valid social security number, lawfully reside in the U.S. and be of legal age to sign a mortgage in their respective state at the time of application.
Borrowers must put a minimum down payment of 3.5%, which can be gifted by a family member.
4) Owner-Occupied Residence
New FHA loans are only available for primary residence occupancy. You must live in the home as your primary residence after purchase. FHA loans are designed to encourage home-ownership. The owner-occupancy requirement prevents investors from buying the homes and renting them out.
5) Property Appraisal
Borrowers are required to have a property appraisal from a FHA-approved appraiser. The property must meet certain minimum standards at appraisal. If the home you want to purchase does not meet these standards and a seller will not agree to the required repairs, your only option is to pay for the required repairs at closing (to be held in escrow until the repairs are complete).
6) Front-End Ratio
Borrowers are generally required to have a front-end ratio (mortgage payment plus HOA fees, property taxes, mortgage insurance, homeowners insurance) of less than 31% of their gross income. Sometimes, you may be approved with as high a percentage as 40% but your lender will be required to provide justification as to why they believe the mortgage presents an acceptable risk. The lender must then include any compensating factors used for loan approval.
7) Back-End Ratio
Borrowers are required to have a back-end ratio (mortgage plus all your monthly debt, i.e., credit card payment, car payment, student loans, etc.) of less than 43% of their gross income. Sometimes, you may be approved with as high a percentage as 50% but your lender will be required to provide justification as to why they believe the mortgage presents an acceptable risk. The lender must include any compensating factors used for loan approval.
8) Minimum Credit Score
Borrowers are required to have a minimum credit score of 580 for maximum financing with a minimum down payment of 3.5%. Borrowers are required to have a minimum credit score of 500-579 for maximum loan-to-value (LTV) of 90% with a minimum down payment of 10%. FHA-qualified lenders determine on a case-by-case basis an applicants’ credit worthiness.
Borrowers must be two years out of bankruptcy and have re-established good credit. Some exceptions can be made if there were extenuating circumstances beyond your control that caused the bankruptcy and you have managed your money in a responsible manner.
Borrowers must be three years out of foreclosure and have re-established good credit. Some exceptions can be made if there were extenuating circumstances and you’ve improved your credit. Not being able to sell your home because you had to move to a new area does not qualify as an exception to the three-year foreclosure guideline.
11) Loan Limits
The Federal Housing Administration is the one that sets maximum mortgage limits for FHA loans that vary by state and county. Loan limits range from $275,665 to $721,050 for a 1 living-unit property depending upon where you are buying a home.
FHA loans are a great option for first time homebuyers, people with bad or no credit, or people who have gone through bankruptcy or foreclosure in the past. If you are interested in getting an FHA loan, find out how to get pre-approved.