Whether you’re taking out a new home loan or refinancing an existing one, you have a variety of mortgage loan products available to you — from conventional loans to those offered by the VA, DHA, and USDA. Because they are fully backed by the Federal Housing Administration, FHA loans have more lenient standards that appeal to many borrowers.
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Because they allow more approval leeway as detailed below, FHA loans appeal to a variety of borrowers. The most obvious of these are first-time homebuyers, but repeat buyers with less-than-excellent credit histories can also be approved for FHA loans.
According to FHA loan requirements, “even borrowers who have suffered from bankruptcy or foreclosures may qualify for an FHA-backed mortgage.” It should be noted, however, that a borrower in this situation must show that they’ve re-established good credit over an extended period of time.
An FHA loan application is not limited to first-time homebuyers.
When applying for an FHA loan, you need to show proof of your identity and your social security number to meet federal customer identification regulations.
In addition, an FHA-approved lender must verify that you have a steady income, which you have maintained over an extended period of time. In order to prove that, you’ll need to supply original pay stubs, W-2 forms, or valid tax returns.
Before you apply for an FHA loan, gather up all necessary verifying documentation, such as your driver’s license, social security card, and pay stubs.
In most cases, you need a credit score of at least 680 to be approved for a conventional loan. While that minimum amount represents a flexible range up to the perfect credit score of 850, it’s still not enough for some consumers who wish to own their home.
With an FHA loan, it’s possible to obtain a mortgage with a credit score above a 580.
How can the FHA accept lower credit scores for its loan programs? FHA-approved lenders rely on other factors to establish creditworthiness. This includes the FHA requirement to review your past credit history and to verify the following items:
According to the FHA, the optimal credit score for loan approval is 580 or above.
With most FHA loan options, you can use a down payment as low as 3.5% of the purchase price. If you want to purchase a home for $250,000, you could put down as little as $8,750.
FHA loans also appeal to first-time homebuyers and others with minimal savings because they allow you to use gifts to help you come up with your down payment as long as they meet FHA acceptability standards.
First, any gifts must be free and clear (not a loan). Second, gifts must be documented as part of the loan approval process. Finally, gifts can only come from the following:
FHA rules require a minimum 3.5% down payment if your credit score is at least 580 or a minimum 10% down payment if your score is between 500 and 579.
No matter what type of loan you apply for — FHA loans included, your debt-to-income (DTI) ratio is used to determine how much mortgage you can afford. It’s a simple calculation that looks at two aspects of your financial situation:
To calculate your DTI ratio, you divide your total monthly debt payments by your total monthly gross income and multiply the result by 100.
Whereas most conventional loan programs require a DTI ratio of no more than 36%, the FHA considers a DTI ratio up to 43% acceptable. Although in some cases, a DTI ratio of up to 50% may be approved by an FHA lender.
For the best results, your DTI ratio needs to be below 43% in order to qualify for an FHA loan.
Even though an FHA-approved lender may allow a higher DTI ratio than is needed for a conventional loan, you still need a proven record of paying your bills on time in order to be approved. In most cases, this means evidence of at least 12 consecutive months with no late payments.
This standard definitely applies to any accounts related to a current mortgage or lease, installment loan or credit card because late payments are reported to the major credit bureaus. You should also be diligent about paying utility, medical, and other recurring or one-time bills whose delinquent balances could be sent to a collection agency and end up on your credit report.
Make sure you’re paying all your bills on time for at least one year before applying for an FHA loan.
There are limits to how much you can borrow with an FHA loan. Each year, the FHA publishes its Nationwide Mortgage Limits, which are delineated for low-cost and high-cost areas. The 2020 FHA loan limits are as follows for a single family unit:
New York City, San Francisco and Washington, D.C. are deemed high-cost areas by the FHA. Most other areas fall somewhere between the lower limit of $331,760 and the upper limit of $765,600.
When you take out a conventional mortgage, you are typically only required to pay private mortgage insurance (PMI) if you put down less than 20% of the purchase price of your new home. Once the principal balance on your loan goes below 80% of your home’s original value, your PMI can be cancelled.
FHA loans work differently in that they all require PMI regardless of your down payment amount. You pay an upfront premium at closing and an annual premium thereafter that is divided into 12 equal payments.
All FHA loans require an upfront and an annual mortgage insurance premium (MIP).
You can only take out an FHA mortgage on an owner-occupied home (your primary residence). An FHA loan can’t be used for the following property types:
In addition to property type limitations, the FHA has some other specific property standard requirements. First and foremost, an appraisal must be performed on the property to assess its market value, as well as the structural safety and soundness of the home’s roof, electrical and HVAC systems, water heater and other appliances, bathrooms and plumbing, and more.
The appraiser must also check for asbestos and make sure there is adequate access to the property.
FHA mortgages are available for a home you plan to occupy within 60 days of closing and live in as your primary residence.
One final important thing to remember: Although the FHA insures mortgages under its loan programs, it does not actually lend money to borrowers. FHA-approved lenders, which can be banks, credit unions, and even online lenders, accept and underwrite borrower applications for such loans based on FHA guidelines. These financial institutions then fund the mortgages upon approval.
As a result, individual lenders are allowed to impose their own requirements on borrowers that may be stricter than those of the FHA.
It’s important to ask an FHA-approved lender about their specific requirements and how they may differ from FHA minimum standards for approval.
If you’re in the market for a new home, but are struggling to meet down payment or credit score requirements, an FHA loan is a flexible alternative. Although there are certain FHA restrictions on the loan amount, property type and mortgage insurance, borrowers generally find it easier to get approved for an FHA loan and pay less in closing costs.
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