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FHA Guidelines: The Ultimate Guide

FHA Guidelines

Table of Contents

Are you thinking of applying for an FHA loan but are still wondering if it’s the right type of mortgage for you? No need to worry because we’ve created the only guide you need to understand all about it!

In this guide, we will break down the definition of FHA loans and everything you need to know about them, including mortgage insurance and the requirements you need to meet. Of course, we will also share some top tips when applying for an FHA home loan.

Without further ado, let’s get right into it!

What is an FHA loan?

The Federal Housing Administration, or FHA for short, is a government agency in the US that was founded in 1934 and offers mortgage insurance to pre-approved lenders. So, FHA loans mean a mortgage that is backed by the government and approved by the FHA.

This loan program is created to help borrowers who aren’t able to afford large down payments, have low credit scores, and have difficulties qualifying for traditional mortgage loans.

They usually have lower credit score requirements, which can be useful for those buying their first homes. As a matter of fact, the FHA 2020 Annual Report stated that over 83% of FHA loan originations had been for first-time homebuyers.

How does an FHA mortgage work?

FHA offers mortgages with a fixed interest rate over either 15 or 30 years, and the flexible standards are especially useful for borrowers who may not be able to qualify for traditional home loans.

One thing that makes FHA loans able to have lower requirements is compulsory mortgage insurance. This is important as it protects the lender in case you default on your loan. While insurance is usually only required for those who make less than a 20% down payment, all FHA-backed loans should have insurance.

There is upfront insurance, which means you have to pay 1.75% of your loan amount in the beginning. Don’t worry because this amount can be rolled into your loan later on.

There is also the annual insurance. It’s usually around 0.45 to 1.05% of your loan and has to be paid monthly. Although the exact percentage is determined by your term, loan amount, and the loan-to-value ratio.

After 11 years, if you have financed 90% or less of the value of your home, your mortgage insurance premium will be automatically removed from your monthly payments. But if your initial LTV ratio is over 90%, then you need to pay the insurance for the entirety of your loan period.

Another key detail is that lenders can only charge 5% at most in closing costs, which can be a helpful rule for borrowers. This will ensure that your closing costs are not ludicrously high.

FHA loans benefit

What are some of the benefits of an FHA mortgage?

1. Make a lower down payment

Perhaps the most appealing reason for an FHA loan is the much lower down payment you have to pay. If you have a 580 credit score, then you can get away with only 3.5% in down payment. This makes it so much easier for people with limited finances and doesn’t have much cash in hand. Although if your credit score is lower than that (even as low as 500), you may have to make a 10% down payment on your loan.

2. Lower credit score requirement

Another great advantage that attracts many homebuyers is the low credit score requirement. The typical minimum for other types of home mortgages is 620, which may be out of reach for some people. The good news is that with an FHA loan, all you need is 580 to safely qualify for a mortgage! In some cases, you can even have lower credit scores in exchange for a higher down payment.

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3. Buy your first home faster

The whole aim of an FHA loan is that it makes buying a home easier and more affordable for everyone, which means you’ll be able to start aggregating your equity faster. In other words, you don’t have to keep paying for rent as you try to save up and boost your credit history. You can be a homeowner much sooner than if you simply rely on conventional loans.

4. FHA 203(k) loan program

This is a program that can be useful for new homeowners as it lets you borrow a loan for various home improvement projects as part of your existing mortgage. It’s basically an FHA construction loan and you can use it to finance repairs, updates, and improvements needed to fix up your primary residence.

5. Qualify quickly after a bankruptcy

Finally, mortgages can be impossible to secure if you have just experienced bankruptcy in recent years. But you can still apply and qualify for an FHA loan pretty soon following the bankruptcy. Although it will still be on your credit report for the next seven years, you can still qualify after at least two years of being discharged from a Chapter 7 bankruptcy, or just a year after a Chapter 13 bankruptcy.

FHA loans drawbacks

Of course, like any other type of mortgage, there are some drawbacks to FHA loans. These include:

1. You have to pay for mortgage insurance

The main disadvantage of an FHA loan is that you can’t avoid paying a mortgage premium. Since you have a lower credit score, there’s a larger risk of you defaulting on your loan. This means that the lender has to protect themselves with insurance.

It’s possible to pay the upfront payment into your closing fee, but the rest of the annual insurance will be divided throughout the year, and you have to pay them along with the monthly payments. If your down payment is below 10%, you also must pay annual premiums for the entirety of your mortgage.

2. There are loan limits

There is a limit on how much your FHA loan can be. This varies according to the city and county you’re in and also depends on the local real estate market. Typically, the range starts from around $270 thousand and can go upwards of $620 thousand in high-priced areas. The limit is also higher for multi-unit homes, so don’t forget to double-check and see if the property you want to purchase falls within this limit.

3. Strict property eligibility requirements

When you are applying for an FHA mortgage, you have to ensure that the property meets some requirements that are usually stricter than conventional loans. The first is that you have to live in the house and make it your primary residence. It also must pass a verified inspection to ensure that they’re safe and secure. If there are any issues such as leakage or bad wiring, then you should fix them before your mortgage can get approved.

4. Some lenders avoid FHA loans

A lot of lenders can be wary of borrowers using an FHA loan as they’re typically much higher risk than conventional mortgages. Some may also assume that the home inspection process is stricter and less flexible. Overall, many lenders prefer to make offers for homeowners who are using other types of mortgages other than FHA.

5. Can’t be used for a second home

The last drawback of an FHA loan is that you can’t use it to purchase a second or holiday home. The property that you are applying for a loan for should be used as your main, primary residence. So, if you’re looking to buy a home for investment, then your best bet is to apply using a different type of home loan.

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FHA mortgage qualification

How do you qualify for an FHA mortgage? From minimum credit score, and down payment, to insurance, these are the latest requirements from the official FHA website:

  • FICO score (>580) = 3.5% down payment
  • FICO score (500-579) = 10% down payment
  • Mortgage Insurance
  • Debt-to-income ratio < 43%
  • The borrower should live in the property full-time
  • Steady income and proof of employment

Let’s break them down further!

Credit score: > 580

If you want to apply for an FHA loan, you need to have a FICO or credit score of 580. With this number, you will be able to get the advantage of just 3.5% in down payment. But if your credit score is lower than that, don’t worry because you can still qualify! The only difference is that you have to make a 10% down payment, so it’s still worth maintaining a good credit history when possible.

Another thing to remember is that the FHA credit requirement also includes factors such as your payment history, past foreclosures, and any bankruptcy you may have experienced.

Down payment: 3.5%

A conventional mortgage may require you to pay as much as 20% as a down payment, which can be understandably a high amount for some. This is where FHA loans can be very accessible! If you hit the minimum credit score needed, you are able to put down as little as 3.5%.

Debt to income ratio: < 43%

Your debt-to-income ratio, or DTI, measures the proportion of your monthly gross income compared to your monthly debt payments. This is an important ratio that will help you determine whether you’re able to afford certain homes. The 2022 FHA loan requirements state that a maximum of 43% is recommended if you want to qualify for it.

Insurance premium

A lot of conventional loans don’t need you to pay for a Mortgage Insurance Premium (MIP) unless you make a down payment that is less than 20%. However, an FHA mortgage insurance is a must, and you have to pay for the premium regardless of how much down payment you make. This is in exchange for the more flexible requirements on the other aspects.

Different types of FHA loans

These are some common FHA loan types:

  • FHA 203(k) loan: You can use this to renovate and buy a home with just one mortgage, or refinance an existing mortgage to add the cost of your home improvement. Two types of the 203(k) include the limited loan for a total of $35,000 or less and the standard loan which can cost anywhere above $5,000.
  • Graduated Payment Mortgage: Also known as the 245(a) loan, this is for those of you whose income is set to increase over time. You can start out your loan by paying a smaller monthly payment and increase them by several different rates, from 2 to 7.5% annually over 5 or 10 years.
  • Energy-efficient mortgage (EEM): This mortgage type lets you buy certified, energy-efficient homes or fit old homes with energy-efficient features and systems.
  • Home equity conversion mortgage (HECM): Designed for homeowners aged 62 and older, the HECM allows you to withdraw some equity if you already own a significant portion of it.
  • FHA condominium loan: This loan type can be a bit more complex but can be great if you’re planning to buy a condominium.
  • FHA jumbo loan: If the home you want to purchase exceeds the limits imposed by Fannie Mae and Freddie Mac, you can try applying for a jumbo loan. Note that it’s harder to qualify because you’ll need a great credit score and make a larger down payment.
  • Cash-out refinances: Yes, it’s possible to tap your home equity with an FHA cash-out refinance. You will need documents such as your income and asset verification, and proof of employment.
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Applying for an FHA loan

You can apply for an FHA loan in a variety of ways, including banks or approved lenders. Lenders are allowed to set their own interest rates as long as they meet the FHA’s standard.

The first step is to calculate how much you are able to afford for a house. You should take into account things like your income (current and projected), expenses, current savings, and the area you want to live in. This is an important but often overlooked part of any mortgage application, including for an FHA loan.

You may also find online mortgage calculators to be useful for this.

Once you know how much you can afford to spend on a home, it is time to collect all the necessary documents and paperwork. Submitting them on time and in an organized manner can really speed up your approval process and also make your lender’s job so much easier!

This includes documents like your tax returns, salary slips, driver’s license, savings accounts, assets documentation, and proof of employment.

Last but not least, it is always important to compare multiple lenders before accepting a deal. This will help you get your best offer and secure the best rates and terms. Which lender can give you the lowest interest rate? Or the lowest down payment? These are just some questions to keep in mind when you’re shopping around!

FAQs on FHA mortgage loan

How much is the insurance for an FHA loan?

The upfront fee for your insurance is 1.75% of the total amount, which you have to pay as part of the closing cost. Meanwhile, the monthly fee of your insurance depends on the property value.

Can I get rid of my FHA mortgage insurance?

The short answer is that you can’t, not really. Your FHA insurance will last for the length of your loan or 11 years. The only way you can stop paying for insurance is if you refinance using a non-FHA-backed loan.

What is the maximum loan amount for an FHA loan?

The exact limit for an FHA loan depends on where your property is, your own financial situation, and whether it is a single-unit or multi-unit home. The latest figure for 2022 is $420,680 in a cheaper city or up to $2,800,900 in a high-cost area.

How do I apply for an FHA loan?

It’s quite simple! You can apply for a pre-approval to the bank or your chosen lender, who will then respond within around one day.

Should you get an FHA loan?

You probably should get an FHA loan if you don’t have a lot of money in hand for a large down payment and an acceptable credit score. While the 3.5% minimum down payment is an attractive offer, remember that not everyone will benefit from an FHA loan.

If your credit score is exceptional, then it might be worth applying for a conventional loan. This is because you won’t have to pay for the insurance premium and can save some money in the long run. Likewise, if you have some cash for down payment but not the best credit, then a conventional loan is still worth a shot.

FHA guidelines summary

When it comes down to it, FHA loans can be a fantastic alternative for potential homebuyers with a lower credit score or little cash for the down payment. If this is your first time buying a property, then it may be worth considering too!

Although don’t forget that you may end up paying more in monthly payments and insurance over time. So, it’s still important to think about your personal financial situation to know the best mortgage option for you!