FHA Loan Requirements

FHA Loan Requirements

Do you think of FHA loans as a first-time homebuyer’s loan? You’re not far from the truth as that’s the reputation it’s built over the years, but it’s also a great loan for anyone that doesn’t qualify for conventional (standard) financing.

The low FHA minimum down payment requirements, flexible credit score guidelines, and high debt ratio allowances make it a forgiving loan for anyone, especially in today’s economy. If you have little money to put down on a home or your credit has seen better days, you may want to explore the options the FHA loan provides.

FHA Qualifying Requirements

So what do you need to qualify for an FHA loan? You’ll likely be pleased with the flexible guidelines:

• Minimum 580 credit score
• Maximum 31% housing ratio (not as important as total debt ratio)
• Maximum 43% total debt ratio (but can be as high as 57% in certain cases)
• Minimum 3.5% down payment (with at least a 580 credit score)
• No recent bankruptcies or foreclosures

FHA Minimum Credit Scores

First, let’s talk about FHA minimum credit scores as this is where the program really shines. All you need is 580 for maximum financing – that’s just about 100 points less than what conventional loans require. Some credit bureaus classify 580 credit score ‘fair’ if that gives you any indication.

But, you may even qualify for an FHA loan if you have a credit score as low as 500. The down payment requirement changes, but this gives even those with poor credit a chance to become a homeowner

FHA Max Debt-to-Income Ratios

The FHA looks closely at your debt ratios or the comparison of your monthly expenses to your gross monthly income (income before taxes). They break it down into two categories:

• Housing ratio – This compares your mortgage payment (principal, interest, taxes, and insurance) to your gross monthly income. Your housing payment should take up less than 31% of your income.
• Total debt ratio – This compares your ‘total’ debts to your gross monthly income. Total debts include credit card payments (minimum payments), car payments, student loans, and other installment loans. It doesn’t include things like groceries, utilities, and insurance.

In some cases, you can have a total debt ratio as high as 57%. It depends on your ‘other’ qualifying factors such as your credit score, down payment, and employment stability. This is just another example of FHA loan’s flexibility.

How Debt To Income Ratio (DTI) works:

Monthly Gross Income	$5,000
Proposed mortgage monthly payment	$1,000
Housing Ratio Calculation: ($1,000 / $5,000 ) x 100	20% Housing DTI Ratio

Monthly gross income	$5,000
Proposed mortgage monthly payment	$1,000
Total monthly expenses reporting on credit (car payment, credit card payments, etc..)	$800
Total Ratio Calculation: (($1,000 + 800) / $5,000 ) x 100	36% Total DTI Ratio

FHA Minimum Down Payment

Everyone wants to know how much they have to put down on a home, right? It’s often the reason potential homebuyers don’t buy a home because they don’t have a large enough down payment. Fortunately, the FHA minimum down payment is low and flexible.

If you have at least a 580 credit score (or higher), you can put down as little as 3.5% on the home. For example, if you bought a $200,000 home, you’d need just $7,000 down on the home.

If you have a credit score between 500 – 579, you’ll need a 10% down payment. While this is higher than the traditional FHA minimum down payment, it’s still low compared to your other options.

FHA Employment Requirements

The FHA doesn’t require you to make a specific income or even be at your job for a specific length of time. While they would prefer a 2-year job history, it’s not a deal-breaker if you don’t have it.

What they like to see is consistency. For example, if you changed jobs last year, they’ll look at your job history over the last two years and compare it. Did you change jobs and stay within the same industry? If so, it shows consistency and the likelihood that you’ll succeed/continue in the job.

If you changed industries, the lender may look for other qualifying factors. For example, if you went from teaching to working as a website designer, the two careers aren’t related. But, if you show the proof of your training/education to succeed as a website designer, the lender may accept the new job as adequate as long as your new income helps you meet the FHA max debt-to-income ratio guidelines.

Other FHA Loan Requirements

In addition to your credit, debt-to-income ratio, employment, and down payment, the FHA requires a few other factors:

• You must prove you’ll live in the home full-time as your primary residence. FHA loans are only for owner-occupied properties. They aren’t for investment homes, vacation homes, or second homes.
• You must have at least two trade lines on your credit report to prove your creditworthiness. If you don’t, you may qualify with alternative trade lines, such as insurance payments or utility payments. You must be able to prove timely payments for at least the last 12 months, depending on the lender’s requirements.
• If you filed for Chapter 7 bankruptcy, it must be at least 2 years from the discharge date before you can apply for an FHA loan.
• If you filed for Chapter 13 bankruptcy, you must make at least 12 payments on your Chapter 13 repayment plan and have your trustee’s approval to get a new FHA loan.
• If you lost your home in a foreclosure, you must wait 3 years before you can apply for a new FHA loan.

Proving your Funds for the FHA Minimum Down Payment

You must prove to the lender that the money you’re using for your FHA down payment is your money. In other words, the money must be ‘seasoned’ or in your account for at least 2 months. This way lenders can determine if the money is yours or if it’s borrowed money.

You aren’t allowed to use borrowed funds for the down payment. All funds you use must be your own, whether earned or liquidated from an investment, such as selling a car, boat, or house. If you do have a large influx of cash because you sold an investment, for example, you must supply adequate proof of the sale so the lender knows the money belongs to you.

FHA Gift Funds

Fortunately, the FHA does allow the use of gift funds to make your FHA minimum down payment. If you have a credit score of at least 580, you are able to receive 100% of your down payment as gift funds. This means a family member, employer, or charity can supply your entire down payment.

If you have a credit score between 500 – 579, you must supply 3.5% of the down payment, but the remaining 6.5% can be a gift.

In order for gift funds to count, you must use the following guidelines:

• The donor must provide a gift letter that states the amount of the gift, the reason (to buy a house), the address of the house, and include a statement that this is a gift and no repayment is expected.
• The donor must provide proof of the funds’ origination to ensure that the money isn’t a loan hidden in someone else’s name.
• The donor (or you) must provide proof of your relationship as only family members (blood or marriage), employers, and charities can help with the down payment funds.

FHA Documents Needed

In order to get an FHA loan, you’ll need to supply the proper documents, they include:

• Paystubs that cover the last 30 days of employment
• W-2s from the last 2 years
• Tax returns from the last 2 years if you are self-employed or work on commission
• 2 months of bank statements (all pages)
• Proof of your identity
• Sales contract for the home purchase (if applicable)

FHA Property Requirements

Many people fear the FHA property requirements, but they aren’t as bad as you think. As long as the home is safe, sanitary, and sound, it should pass the FHA appraisal.

Granted, the appraisal process does require the appraiser to ensure the home meets the FHA Minimum Property Requirements, but if the home is in decent condition, it should pass.

The appraiser looks for things like holes in the wall, plumbing that doesn’t work, or problems with the electrical system, just to name a few.

FHA Loan Limits

The FHA sets floor and ceiling loan amounts. In 2020, the FHA floor loan amount or the minimum loan amount limit is $331,760. This means the highest loan amount available in low-cost areas is $331,760.

The FHA loan amount ceiling is $765,600; this means the maximum loan amount in high-cost areas is $765,600.

Most counties fall in between the floor and ceiling. The loan limits vary by county based on the average price of the homes in the area.

FHA PMI Requirements

All FHA loans require mortgage insurance. FHA loans have two types of FHA mortgage insurance requirements. The first is the upfront mortgage insurance. Most borrowers pay an upfront mortgage insurance fee of 1.75% of the loan amount. On a $200,000 loan, you’d pay $3,500. You can either pay the amount in cash at the closing in addition to your down payment or you may be able to roll it into the loan amount.

FHA borrowers also pay annual FHA mortgage insurance. You pay this for the life of the loan if you take out a 30-year loan. Unlike conventional loan PMI that you can have canceled after you owe less than 80% of the home’s value, FHA mortgage insurance lasts for the duration of the loan.

In 2020, FHA borrowers pay 0.85% of the outstanding loan amount. On the same $200,000 loan, you’d pay $1,700 per year, which breaks down to $142 per month. The amount of the FHA mortgage insurance decreases each year as you pay down the principal balance.

Types of FHA Loans

Most people automatically assume an FHA loan has a fixed interest rate and most FHA loans do, but they do offer an ARM loan option too.

• Fixed-rate – The fixed-rate loan has the same interest rate for the life of the loan. You don’t have to worry about the amount of your payment changing unless your escrow payment (real estate taxes and homeowners’ insurance) payment changes.
• Adjustable-rate – The rate on an ARM loan changes annually after the initial fixed period. The initial fixed period lasts for a predetermined time, typically 3, 5, or 7 years depending on the program you choose. After that time, the rate changes once a year on a predetermined date. It changes based on the chosen index and margin determined by the lender.

FHA loans offer a great opportunity to buy a home even if you have a low credit score or little money to put down. It’s one of the most flexible and affordable loans available today.

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