Saving up for a large down payment on a residential home can be a financial challenge that prevents first-time homebuyers with minimal savings from ever becoming homeowners. Fortunately, government-backed Federal Housing Administration (FHA) loans can help potential homebuyers who want a home but struggle to save or source a large down payment. In 2018, more than 80% of FHA loans made were to first-time homebuyers, according to the U.S. Department of Housing and Urban Development.This guide will cover the advantages and disadvantages of using an FHA loan to purchase a home, how homebuyers can begin the process of researching and getting approved for these loans, and how you may be able to utilize and FHA loan for refinance purposes.
What is an FHA Loan?An FHA loan is a home mortgage insured by the government – specifically, by the Federal Housing Administration. The term “FHA loan” is actually somewhat of a misnomer because the FHA doesn’t actually lend money to would-be homeowners. Rather, it ensures the loans made by private lenders. So while we’ll use the term “FHA loan” for simplicity, an “FHA-backed or insured loan” is more accurate.An FHA loan aims to put homeownership within reach for many Americans who wouldn’t otherwise qualify for a conventional, non-FHA-backed mortgage. You may be able to get an FHA loan with a lower credit score, lower down payment, and a higher debt-to-income ratio than you could have for a conventional mortgage.
Types of FHA LoansFHA mortgage loans come in several different configurations depending on your age, assets, income, current home equity, needs, and circumstances.
Fixed-Rate Purchase Loan.Also known as a 203b mortgage loan, this is the most popular type of FHA purchase loan. Terms can vary, but 15 and 30 years are the most common. Interest rates tend to be lower than comparable conventional mortgages. 203b mortgage loans can be used on one to four-family residential homes.
Adjustable-Rate Purchase Loan (ARM).Under the Section 251 Adjustable Rate Mortgage Program, the FHA insures ARMs whose interest rates can rise by no more than one percentage point per year and no more than five percentage points over the full term. Borrowers receive notice of pending rate increases at least 25 days prior to the increase.
Condominium Loans.Known as Section 234c loans, FHA-insured condominium loans are 30-year fixed-rate products that finance the purchase of individual condominium units within developments larger than four units. There’s no strict occupancy requirement, so borrowers can use FHA-backed condo loans to earn rental income. However, in any given development, at least 80% of FHA-insured loans must be made to owner-occupants.
Secure Refinance Loan.FHA Secure Refinance loans are designed to help borrowers with conventional mortgage loans refinance into fixed-rate, FHA-backed mortgages. Delinquency is not necessarily disqualifying, though it must result from higher monthly payments on a conventional ARM. Non-delinquent borrowers can refinance any type of conventional loan. Standard qualification requirements apply, including steady income, acceptable credit rating, and reasonable debt-to-income ratios.
FHA Streamline Refinance Loan.An FHA Streamline is a refinance option for homeowners with existing FHA mortgages. This program is “streamlined” because it doesn’t have many of the income and appraisal requirements that are included with standard refinance programs. As a result, the streamlined program provides homeowners with a quick, simple way to make their mortgage more affordable.The FHA guidelines state that a streamline refinance must provide a benefit to the borrower by either lowering the interest rate or converting the loan from an adjustable-rate mortgage (ARM) to a fixed-rate. The program also allows for higher loan-to-value ratios than many refinance programs, so borrowers who have little or no equity in their home are still eligible.
FHA Loan Requirements
FHA loan down paymentWith the FHA, the minimum down payment depends on your credit score. With a credit score of 580 or higher, the minimum down payment is 3.5%. With a score of 500 to 579, the minimum down payment is 10%.
FHA debt-to-income requirementsLenders pay attention to your debt-to-income ratio, regardless of the type of mortgage you get. The debt-to-income ratio, known as DTI, measures the percentage of your pretax income that you spend on monthly debt payments, including mortgage, credit cards, student loans, and other obligations. You can use a debt-to-income ratio calculator to figure out where you stand.The FHA requires a debt-to-income ratio of 50% or less, according to Brian Sullivan, public affairs specialist for the U.S. Department of Housing and Urban Development, which runs the FHA.
FHA loan income requirementsThere is no minimum or maximum salary you can earn that will qualify you for or prohibit you from getting an FHA-insured mortgage. However, you must:Have at least two established credit accounts. Examples: a credit card and a car loan.Not have delinquent federal debt or judgments tax-related or otherwise or debt associated with past FHA-insured mortgages.Account for cash gifts that help with the down payment. These gifts must be verified in writing, signed and dated by the donor.
Checklist of Required FHA Loan DocumentsBlank checklist with space for ticks on pad on office desk. Checklist for office worker, manager, businessman, chief on dark wooden background top view. Individual mortgage lenders have different paperwork requirements. After all, they are different companies with different business models and procedures. But when it comes to FHA loans, there are certain documents borrowers must provide regardless of which mortgage company they are working with.According to the Department of Housing and Urban Development (HUD), the government agency that manages this program: “The mortgage loan application package must contain all documentation that supports the lender’s decision to approve the loan.” This includes a wide variety of documents relating to the borrower’s financial situation, as well as those pertaining to the property being purchased.
Common FHA documents include, but are not limited to, the following:
- Loan Application
- Form HUD-92900-A
- SSN Verification
- Credit Report
- Verification of Employment
- Tax Returns
- Sales Contract
- FHA Amendatory Clause
- Real Estate Certification
- Appraisal Report