FHA Purchase: The Bottom Line

What Is an FHA Loan?

FHA loans are mortgages insured by the government through the Federal Housing Administration (FHA). The FHA is an agency of the U.S Department of Housing and Urban Development (HUD) that was created in 1934 to not only aid in home financing, but to also improve housing standards. Because FHA loans are government backed, they pose less risk to lenders allowing them to offer better terms with less stringent criteria. For example, when compared to conventional loans, FHA loans not only have a lower credit score requirement of 580 but also have a higher DTI cap of 57%, which makes them a particularly popular product among first-time homebuyers. FHA loans can also be structured in a number of ways that allow for a variety of uses, but can only be issued by FHA-approved lenders.

Notable FHA Loan products

1. Fixed-rate FHA loans - Arguably the most popular FHA loan product is the fixed-rate FHA loan. The fixed-rate FHA loan is probably the best option for those who want to maintain a consistent interest rate throughout the life of their mortgage.  The fixed-rate loan comes in both a 30 year and 15 year version, with the 30 year being the most common because it offers the lowest payment.

2. Adjustable-rate FHA loans – The second most popular FHA product is the adjustable-rate mortgage (ARM). The FHA ARM is a product in which the interest rate adjusts periodically based on a pre-determined index. ARM loans generally begin with a lower interest rate than fixed-rate loans, which in turn make ARM’s the best choice for those who want the lowest interest rate available. There is a second type of ARM loan that incorporates notable characteristics from both the fixed-rate mortgage and adjustable-rate mortgage, called the hybrid ARM. A hybrid ARM’s initial rate will be fixed over a predetermined period before adjusting over time for the remainder of the loan. Both ARM’s and hybrid ARM’s are great choices for those who expect a raise, or plan on selling in their near future

3. FHA 203(k) loans – For those considering to purchase a home but would like to renovate it as well can use the FHA 203(k) loan. The 203(k) loan, aka the 203(k) rehab loan, allows for a borrower to purchase or refinance a home that may need some renovating by rolling all the funds necessary into one loan. This means borrowers can now pay for the costs of renovations over time along with their mortgage, so long as the cost of repairs exceeds $5,000 and are done by licensed professionals.

Note: These are just a few of the many FHA loan products available and is therefore not a complete list.

What are the criteria for an FHA Loan?

Down Payment: Regardless of what FHA loan product is chosen, all FHA loans require a minimum down payment of 3.5%.

Mortgage Insurance Premium: All FHA loans require you to pay a mortgage insurance premium (MIP). MIP is used to protect lenders and minimize losses from any defaulted loans. MIP is one of the reasons why lenders are able to offer FHA loans with much more lenient criteria than other forms of loans.

Generally speaking, mortgage insurance will be paid throughout the entirety of the loan unless a down payment of 10% or greater is made, which would then mean that MIP would only remain on the loan for 11 years. MIP is assessed in two ways, one being an upfront premium which is 1.75% of the loan amount, and the second being an annual premium that is between 0.45% and 1.05% of the loan amount. The upfront premium is due at closing while the annual premium is divided by 12 and reflected in each monthly payment along with the principal and interest.

Credit score: All FHA loans have a minimum credit score of 580 to be eligible for an FHA loan.

Debt-to-income ratio: FHA loans will generally require that the debt-to-income ratio (DTI) be 43%, unless there are compensating factors which would then allow a max DTI of 57%. Compensating factors include documented cash reserves, residual income, and or a minimal increase in housing payment. DTI can be roughly calculated by adding up all monthly debts, like credit card payments or student/auto loans, and then dividing that amount by the gross monthly income.

Loan size: FHA loan limits depend on two factors which are the number of units (1-4 units), and the area the property is in. In places considered “low cost areas” your loan limits will range from $420,680 to $809,150, where in places considered “high cost areas” your loan limits will range from $970,800 up to $1,867,275. Lastly, there are a few “special exception” areas where your loan limits start at $1,456,200 and top out at $2,800,900.

Other Requirements

• An FHA-approved appraiser must appraise the home being purchased.
• Only primary residences are eligible, so secondary residences or investment properties are ineligible.
• You have 60 days after closing to occupy the property.
• An inspector must conduct an inspection of the home and report that the house in question meets minimum standards.

How do I get an FHA Loan?

Applying for an FHA loan starts by finding an FHA-approved lender. Once an FHA-approved lender is found, the rest of the application process is pretty straight forward. Applications can be done in person or online at most lending institutions. Regardless of how your application is submitted, you will have to at least meet the minimum credit score requirement of 580 to move forward. Once it is established that you meet the credit score requirement, then your odds of approval will be determined by several other factors like your DTI, amount of down payment, and financial ability to repay the loan. Your ability to repay the loan doesn't necessarily depend on a specific income amount, but you must be able to show consistent employment history. Any income claimed has to be documented through pay stubs, bank statements, tax returns and W-2s. Please keep in mind each lender is different and may require additional documentation.

Why should I get an FHA Loan?

Because FHA loans are government backed, and provide some sort of lender protection, they allow for more lenient criteria. FHA loans also require a low down payment amount like 3.5%, and offer competitive interest rates. FHA loans are a great option for first time home-buyers that don’t have a lot of funds on hand, have lower credit scores, or higher DTI ratios and would rather buy now than wait for their situation to improve.

FHA Loan: The Bottom Line

Ultimately, the FHA loan is a great product with forgiving criteria like its higher DTI cap, low down payment amount, and low credit score requirement. Now, because of its lenient criteria, the FHA loan process does incur some additional steps in comparison to its conventional counterpart, like needing an FHA appraiser and also requiring the use of a home inspector. It is important to note, that regardless of your down payment amount there will always be mortgage insurance that in most cases will remain on the loan throughout its entirety. Despite being a federally insured mortgage with some additional steps, the FHA loan is a versatile mortgage that can be used in a number of ways making homeownership more accessible to a wider range of buyers. 

Considering going FHA? Here’s the bottom line on the FHA Loan – What it is, how to get one, why should you get one, along with its most notable products, common criteria and an expert analysis from our experienced team.