FHA loans provide first-time homebuyers as well as experienced homebuyers the opportunity to secure financing without the restrictions that are placed on conforming lending. The requirements that need to be met for an FHA loan are much more lenient than any other type of loan due to the mortgage insurance that is provided by the FHA. This means that if you were to default on your loan, the FHA would guarantee the bank supplying the funds that they would still receive the leftover outstanding principal balance. FHA loan requirements come with their own quirks, but for the most part, many people that were turned down for a conforming loan are able to obtain approval on an FHA loan.
FHA loans are available on a variety of properties, each with differing maximum loan amounts. The area you plan to purchase a house in as well as the type will determine the maximum amount of loan that can be offered. Of course, your personal details including your employment history, income, current debts, and credit score will play a role in how much of a loan you are able to obtain along with the value of the property itself.
The FHA loan requirements regarding credit are a bit different from any other loan. They do not have a minimum credit score, per se. They look at your overall credit history and even take into account any “bad” times you may have had that caused your credit to dip. If your credit history is completely blemished for the past two years with no signs of recovery, then it might be more difficult to obtain an FHA loan, but if you show recovery that has lasted for a period of at least 12 months, any bad situation can typically be worked through.
The one hard and fast rule that the FHA does have is in regards to your credit score and the down payment required. If your credit score is below 580, the down payment requirement increases from 3.5% to 10%. This is an FHA rule and there is nothing any lender can do about it, no matter how much your finances may have improved over the last few months to a year. If your credit score is below 580 and you do not have 10% to put down, you can continue to work on improving your credit score by paying your bills on time, watching the amount of credit you have outstanding when compared to your credit line, and avoiding opening new credit lines. Eventually your credit score will increase with these positive steps and you will be able to get your score above 580, allowing just a 3.5% down payment on the purchase of a home.
FHA loan requirements do give lenders the ability to work with negative situations that include bankruptcies, foreclosures, collections, and late payments. Bankruptcies have a hard and fast rule that you must be 2 years out from the day that your bankruptcy was discharged. If you have a Chapter 13 bankruptcy and are making payments on it, you will have to submit proof of the timely payments as well as approval from the trustee overseeing your case. Foreclosures have a longer waiting period of 3 years, but lenders are sometimes able to work around that timeframe if there were special circumstances involved in the reason for your foreclosure. Late payments and collections do not have a specified time period that must pass in order to be eligible; instead, they just need to be rectified and a letter of explanation for the late payments and/or collections will typically be required. The lender will look at each case on an individual basis to determine if a loan should be offered.
Debt Ratio Requirements
Debt ratios are an important component of the FHA loan requirements as well. They are not as strict as those requirements of the conforming loan, but there are maximum limits imposed in order to ensure that no one is provided a loan that they cannot afford. In order to obtain your debt ratio, the lender will figure out your gross monthly income based on the documents you provide, whether your paystubs and W-2s or your income tax forms, depending on the type of income you receive. Once your income has been determined, the lender will determine your total mortgage payment, which is your principal, interest, mortgage insurance, taxes, and home owners insurance. This total is divided by your gross monthly income to come up with the front end debt ratio. This number should be below 31% in order to qualify.
The back end ratio is then determined by figuring out your total monthly debt as it is reported on your credit report. This includes items such as credit card minimum payments, installment loan payments, student loan payments, and any personal loans you have outstanding. The amount of these debts is added to your total mortgage payment from above and divided by your gross monthly income to come up with the back-end ratio. This ratio should be less than 43% in order to qualify for an FHA loan.
As the FHA is known for being forgiving in certain situations, they do allow debt ratios to go a little higher than the above maximums if there are compensating factors to make up for the higher debt ratio. Typically compensating factors include a great credit score, steady employment, or the receipt of bonuses or commission throughout the year that is in addition to the gross monthly income used to qualify you for the loan. Every case is determined on its own and is up to the individual lender’s discretion if they want to take the chance.
Down Payments Required
The standard FHA loan requirements state that a minimum of 3.5% of the purchase price of the home needs to be put down in order to obtain an FHA loan. As stated above, however, this only pertains to those borrowers with a debt ratio over 580. If your credit score is below this threshold, you will be required to put down at least 10% of the purchase price of the home. The good news is that the funds do not have to come from you in order to qualify. Gifts from friends, family members, government grants, and your employer can count towards the down payment requirement, enabling you to get into the home you desire. If you are receiving a gift, however, the lender needs to determine that it is a gift and not a loan. This means that there cannot be any requirements for the funds to be paid back at any point in the future. The money for the down payment CANNOT come from the seller, builder, or any real estate professional involved in the sale.
Loan Size Requirements
The FHA loan requirements in terms of the loan size depend on several factors:
- The area the home is located
- The purchase price of the home (to determine the LTV)
- Your credit score
- Your debt ratios
The loan sizes are varied by region based on the average price of housing in the area. FHA loans are meant for borrowers with low to average income that would otherwise be unable to obtain conforming financing. These borrowers are maximized at a certain loan amount size in their area for their own good in order to ensure that they do not get in over their head. The national conforming loan limit of $417,000 is used as the gauge to determine the maximum loan amount in each area.
In low cost areas, the lowest the maximum will reach is $271,050. These are the areas where the average cost of a home is less than 65% of the national conforming limit. This is figured by determining the number of homes that are less than 65% of $417,000. If 115% of those homes are within that range, the maximum loan amount is $271,050.
In high cost areas, the process works in much the same way, however, the average cost of the homes must be 150% more than the national conforming loan limit. If 115% of the homes are 150% more than $417,000, then the maximum loan amount in those areas will be $625,500.
These examples are the two extremes for the high and low cost areas; the remaining areas will lie somewhere in between those two numbers based on the cost of the homes in the area. The FHA breaks down the regions by county, so finding out what the maximum FHA loan amount is for your county is suggested in order to ensure that you are looking within a reasonable price range for a home.
Mortgage Insurance Requirements
FHA loans come with mortgage insurance; there is no working around it. You will pay an Upfront Mortgage Insurance premium as well as annual mortgage insurance.
- Upfront Mortgage Insurance – The upfront insurance, as the name suggests, is paid at the time that you close on the loan. This insurance is 1.75% of the loan amount that you are borrowing. The figure gets worked into your closing costs. For example, if your loan was the maximum in low cost areas of $271,050, your Upfront Mortgage Insurance would be $4,743.
- Annual Mortgage Insurance – The insurance you pay per month is called Annual Mortgage Insurance. It equals out to 0.85% of the loan amount and is divided amongst your 12 monthly payments for the year. On the above, $271,050 example, you would pay $192 per month on top of the principal, interest, taxes, and homeowners insurance that you pay.
The annual mortgage insurance premium typically lasts for the life of the loan unless you put 10% down on the home when you purchase it. If this were the case, you would only have to pay the annual mortgage insurance for a period of 11 years, at which point the MIP would be cancelled.
Closing Cost Requirements
The FHA closely monitors the closing costs that are applied to a loan. The typical closing costs that would see on an FHA loan pertain to an FHA loan. These costs include:
- Credit report costs
- Document costs
- Underwriting fees
- Title fees
- Appraisal fees
- Inspection fees
- Attorney fees
- Origination fees
The difference between the FHA loan requirements and conforming loan requirements is the ability to get help with the closing costs. You can receive up to 6% of the loan mount from family, friends, or even the seller. This 6% is usually adequate enough to cover all of the closing costs involved in the closing of the FHA loan.