I wasn’t expecting to buy a home. My husband and I were in debt pay-down mode, aggressively tackling credit card debt. I assumed a house was at least two or three years in the future.
However, an opportunity arose to buy a great four-bedroom with a big backyard, and my husband wanted to jump on it. I was wringing my hands. I hadn’t been working on saving up for a down payment. Where would we get the money?
After consulting with a mortgage broker about our options, we arrived at a solution that worked for us: An FHA loan. If you meet the FHA loan requirements, you have a chance to get a home with a smaller down payment — and you might even have easier-to-meet credit qualifications.
What is an FHA loan?
The Federal Housing Administration (FHA) is an agency within the Department of Housing and Urban Development (HUD) that insures loans made by approved lenders. The government doesn’t make the loans. Instead, financial institutions provide the capital for your home purchase, and the government guarantees the loan.
Because the government assumes some of the risk involved with making the mortgage, lenders can offer better terms to borrowers.
“The credit guidelines for FHA loans are generally more lenient,” said Matt Hackett, the operations manager at Equity Now, a direct mortgage lender. For example, Hackett notes, you’re usually allowed to carry a higher debt load, “and they require a smaller down payment than a typical conventional loan.”
FHA loan requirements
However, just because some of the qualifications are easier to meet, it doesn’t mean there are no restrictions. Kevin Miller, the director of growth at real estate website Open Listings, pointed out that homes and buyers have to meet specific standards to take advantage of an FHA loan. Here’s a rundown of the current requirements.
First of all, it’s important to realize that you can’t just get a mortgage for any amount. Limits are set each year, based on your ZIP code and the number of units on the property. Some areas, including Alaska, Guam, Hawaii, and the U.S. Virgin Islands, have larger limits because the average cost of a home is higher in those areas, according to Miller.
The FHA provides a handy calculator that can help you determine the FHA loan limit in your area, depending on the year.
You must have a credit score of at least 500 to qualify for an FHA loan. However, in the end, companies still get to set their own credit qualifications, said Seth Phillips, who heads up SP3 Realty, a company specializing in down payment assistance.
After looking at the data, Phillips said, it is clear that many lenders still prefer consumers that have FICO credit scores of at least 620. “We work with only two companies that offer products under a 560 FICO score.”
In addition to having a credit score of at least 500 to even think about applying for an FHA loan, you need to be at least two years out of bankruptcy and at least three years out of foreclosure. “Exceptions are available, but only in cases of mitigating circumstances and improved credit,” said Miller.
Your debt-to-income ratio shows how much you owe in payments each month compared to your monthly income. FHA loan requirements also include debt-to-income limits:
- Your mortgage payment should be less than 31 percent of your monthly gross income, although it’s possible to be approved for up to 40 percent of your monthly gross income.
- Your total debt-to-income ratio should not exceed 43 percent of your gross monthly income, although you can be approved for up to 50 percent.
When deciding how much house you can afford, these limits can help you avoid getting in too far over your head.
If your FICO credit score is at least a 580, you only need to provide 3.5 percent of the home’s purchase price as a down payment. If your score is below 580, the down payment requirement jumps to 10 percent.
Your home will be reviewed by an FHA-approved appraiser to make sure that the home meets health and safety standards. Peeling paint, loose handrails, and other safety or health issues have to be resolved before the home sale can go through.
You have to be especially careful if you buy a home that needs repairs, Miller said. “If the home you’re buying fails to meet specific minimum appraisal standards, and a seller refuses to agree to required repairs, the borrower’s sole option is paying for repairs at closing.”
It’s also worth noting that the appraiser won’t perform an actual home inspection and the FHA doesn’t require an additional buyer-financed home inspection. While the FHA encourages separate home inspections, they aren’t necessary to complete the sale of the home.
“The main thing to watch out for is that FHA charges mortgage insurance, both upfront and monthly,” said Hackett. “It can sometimes be less expensive to use conventional financing.” This is especially true if you have a higher down payment.
Currently, the upfront premium for an FHA mortgage is 1.75 percent of the loan amount. The annual premium, which is split up into monthly payments, depends on the size of your loan, your down payment, and the length of your mortgage.
For example, if you have a 30-year loan with a down payment of less than 5 percent, your annual premium will be 0.85 percent of the loan amount. On the other hand, a 15-year loan with a 10 percent down payment comes with an annual premium of 0.45 percent.
Hackett also pointed out that there are more conventional mortgages that come with low down payment options, such as the HomePossible and HomeReady mortgages. He also recommended that veterans look into VA loans as a potential alternative to FHA loans. These mortgages might have lower insurance premiums, depending on your situation, costing you less over time.
How to get an FHA home loan
If you meet the FHA loan requirements, then it’s time to apply for a loan. For the most part, said Hackett, you go through the same process with an FHA mortgage application as you would with any other home loan.
The main difference is that you need to start with an FHA-approved lender. You can go to the HUD website and use the lender search.
Once you find a lender, your loan officer or broker will help you make sure you meet the eligibility requirements for the FHA program. Next, it’s a matter of meeting regular mortgage application qualifications, including:
- Providing identifying information, like your Social Security number, full name, birthdate, and address.
- Showing proof of a steady income with paystubs and tax returns.
- Submitting to a credit check.
- Offering information about your assets, including bank, investment, and retirement statements.
- Revealing all the debt obligations you have.
Just as you would with any other loan, shop around for your best terms and interest rate. There are plenty of FHA lenders, including online mortgage originators like Quicken Loans.
Getting an FHA mortgage with poor credit
As mentioned earlier, it’s possible to get an FHA home loan even if you have poor credit. However, you still have to find someone willing to lend to you. Plus, you still need to come up with that 10 percent down payment, instead of the 3.5 percent down payment for those with credit scores of at least 580.
Companies that offer low FICO products all have manual underwriting, in which a loan officer personally reviews your case rather than just plugging your information into a formula to see if it makes the grade, Phillips said.
“They actually take the time to understand the prospective borrower’s complete story,” he said.
This can mean more work for you, however. Steven A. Bogan, the regional managing director at Glendenning Mortgage Corporation, said that often a statement or letter describing your situation is needed.
“With any record of delinquency, it is important to distinguish the root cause,” he said. “If due to unforeseeable circumstances such as illness or job loss, an underwriter might be more sympathetic.”
On top of that, Bogan continued, it’s vital to realize that delinquency on federal student loans will prevent you from getting an FHA loan. Normally, it’s possible to buy a home with student loans, but if you have missed payments, the story changes. “Getting these accounts brought current or paid in full should be a priority for a buyer,” he said.
Also, understand that just because you can get the loan, it doesn’t mean that it’s going to be inexpensive. Bogan said that borrowers with poor credit will pay higher interest rates. If your score is below 620, he recommended rethinking a mortgage until you improve your credit.
“You might be able to get an FHA loan, but it will cost you big,” Bogan said. “Being able to re-establish a timely payment history on [your] obligations, keeping utilization of credit card debt low, and time are the best cures for low credit scores.”
Is an FHA loan right for you?
Even if you meet all the FHA loan requirements, it’s a good idea to think about your options when it comes to a mortgage. If you only have enough for a small down payment, and you aren’t sure if your credit situation will hold up to conventional standards, an FHA mortgage can work.
However, there are other options available, especially if you qualify for conventional products such as the HomeReady loan. A good mortgage broker can help you review different loan programs and choose one that best fits your needs and circumstances.