Many people looking for an affordable mortgage — especially buyers who might not have a lot of savings for a down payment, or have debt or a lower credit score — find themselves researching FHA loans. Indeed, MarketWatch Picks profiled one such first-time homebuyer, who was priced out of New York City, but used an FHA loan to buy a $340,000 home in Savannah with just 3.5% down.
She’s not alone: The Federal Housing Administration (FHA) has insured more than 40 million home loans since 1934. But what are the FHA loan requirements, what are the FHA loan limits, and what else do you need to know about FHA loans?
What is an FHA loan?
Federal Housing Administration (FHA) loans are government-insured (though not government-issued) loans that enable home buyers and homeowners with less-than-ideal credit and smaller down payments to purchase a home, refinance their existing mortgage or renovate a home.
FHA loan requirements
Broadly speaking, an FHA loan requires a down payment of at least 3.5%, a credit score of at least 580, a debt-to-income ratio no higher than 50%, FHA mortgage insurance and an FHA appraisal. Wood says, “FHA appraisals are less scary than they sound. Issues that arise are often easily remedied, like not having a handrail next to steps.”
Who is an FHA loan for?
FHA loans are traditionally used by first-time buyers or buyers who have been out of the housing market for a while. “Because FHA loans require as little as 3.5% down, they’re a good option for buyers who aren’t cashing out of another house,” says Bankrate.com analyst Jeff Ostrowski
But you don’t have to be a first-time homebuyer to get an FHA loan: As long as you have a minimum down payment of 3.5%, a credit score of 580 or higher, a debt-to-income ratio of 50% or less and you’re purchasing a home as your primary residence, not an investment property or vacation home, you may benefit from an FHA loan. They’re appealing because you can sometimes get an FHA loan even if you have debt, financial issues and even with a bankruptcy on your record. In fact, you can apply for an FHA loan 2 years after the date of discharge on a Chapter 7 bankruptcy and 12 months after a Chapter 13 discharge as long as you’ve made at least 12 on-time bankruptcy payments and have written permission from the bankruptcy court to enter into a new mortgage transaction, according to Rocket Mortgage.
FHA loan interest rate
According to Bankrate data for the week ending July 22, the national average 30-year FHA mortgage rate is 5.58% and the average 30-year FHA refinance rate is 5.55%.
FHA loan down payment
The minimum down payment you can make on an FHA loan is 3.5% or 10%, depending on your credit score. “With a down payment this low, a borrower has to pay FHA mortgage insurance for the life of the loan and the only way out of it is to sell the home or refinance to a different loan type,” says Wood. If a borrower makes a down payment of 10% or more on an FHA loan, FHA mortgage insurance only lasts for 11 years.
FHA loan insurance
FHA borrowers pay FHA mortgage insurance, which is different from private mortgage insurance. (Most lenders require PMI for conventional borrowers who put down less than 20%; it can be canceled once the buyer has sufficient equity.) “With an FHA loan, the borrower makes a large upfront mortgage insurance payment at closing, then pays monthly FHA mortgage insurance, which can’t be canceled. The upfront mortgage insurance premium is 1.75% of the total loan amount, which can be rolled into the cost of the loan,” says Wood.
Mortgage insurance payments last the life of the loan if your FHA down payment is below 10%, with a down payment of 10% or more, borrowers will pay FHA mortgage insurance for 11 years.
Credit score for FHA loan
The Federal Housing Administration sets minimum credit scores for FHA loans at 500 to 579 for borrowers making a 10% down payment, while a credit score of 580 or higher allows you to make a down payment as low as 3.5%. “Though these are the FHA’s guidelines, lenders can, and often do, opt to set their own credit score minimums which can be higher, ” says Wood.
Income requirement for FHA loan
FHA loans aren’t income-based, though the Department of Housing and Urban Development’s (HUD) intention is for these loans to offer lower-income people a shot at homeownership.
FHA loan limits
FHA loan limits change each year and vary depending where you live. In high cost areas, loan limits are higher. “For 2022, FHA loan limits for single-unit properties range from $420,680 to $970,800,” says Wood.
For perspective, Nicole Rueth, SVP and producing branch manager of The Rueth Ream at Fairway Independent Mortgage Corporation says, “Denver, Colorado’s FHA loan limit is $684,250 but Weld, Colorado’s is $483,000 and Yuma, Colorado’s is $420,680.”
How does an FHA loan compare to other loans?
FHA loans are intended to help Americans become homeowners, so these loans generally have more relaxed lending standards, such as lower credit score and downpayment requirements than conventional loans. What’s more, with an FHA loan, a borrower can potentially pay their entire down payment using monies gifted to them. “That can be a tremendous help for buyers who are able to handle a monthly mortgage payment but have trouble setting aside money for a down payment,” says Kate Wood, home expert at NerdWallet.
That said, lenders aren’t required to follow the guidelines laid out by the Federal Housing Administration. While on paper, borrowers could have a credit score as low as 500 and qualify for an FHA loan with at least 10% down, in practice, Wood says it’s hard to find lenders who will accept such a low score.
Another discerning factor is that FHA loans are backed by the Federal Housing Administration, which gives lenders some reassurance. “Normally, lenders don’t want to take on borrowers viewed as higher risk because they don’t want to deal with the possibility of foreclosure. With FHA loans, lenders don’t take the risk, the FHA does, providing a backstop for lenders in case the borrower defaults,” says Wood.
While FHA loans can make accommodations for lower credit scores and higher debt-to-income ratios, appraisals are one area where FHA loans are notably more strict than conventional loans. “An FHA appraisal is separate from a lender’s regular appraisal, which is focused on determining the home’s value. It’s also separate from the home inspection. FHA appraisals focus on whether the home meets FHA standards for safety and livability,” says Wood.
One key difference is that FHA loans can only be used for a primary residence, whereas conventional loans can be used to purchase a rental or vacation home in addition to a primary residence, says certified financial planner Kevin Barr, the director of financial planning at Facet Wealth.
Types of FHA loans
As the name suggests, these types of loans are used to purchase homes. “For most buyers, a straightforward FHA purchase mortgage will probably be what will work best for them,” says Jacob Channel, senior economist at LendingTree. Wood adds, “FHA loans can be used to purchase single-family homes, two- to four-unit dwellings so long as the buyer occupies at least one unit, condos and some manufactured homes.”
These allow borrowers to get a new loan on their home with different rates and terms than their previous loan. “They’re good for current homeowners who think that they can qualify for a lower rate as well as for homeowners who want to change the length of time that their loan roasts,” says Channel. “Closing costs for the refinance may be able to be wrapped into the loan making it easier on the borrower. One consideration is that a cash out cannot be taken with this type of refinance,” says Barr.
Streamlined refinances can allow borrowers to get a lower rate and in turn, a lower monthly payment without needing to do a lot of paperwork. “They typically don’t require a full credit check as long as a borrower has made their mortgage payments on time for the past year and there is no requirement for income verification,” says Channel. These refinances don’t require a new appraisal but, this type of refinance is unlikely to be a great option for someone who is struggling to make their payments and is behind on their current mortgage.
With a cash-out refinance, a borrower can get a new loan worth more than their old one and pocket the difference as cash. Borrowers can also change their rate and their loan term when they get a cash-out refinance. “This type of refinance can be beneficial to those who’ve built a lot of equity into their homes and need extra cash for a new purchase,” says Channel.
With this mortgage insurance, borrowers can finance an additional amount up to $35,000 on top of their mortgage that they can use to pay for renovations and improvements on the home they’re planning on buying. “These loans can be good for people thinking about buying a fixer-upper, but because they’re for a larger amount of money, they’re likely going to cost borrowers more each month than a typical FHA purchase mortgage would,” says Channel.
A limited or streamline 203(k) only allows for up to $35,000 in repairs and bars certain types of renovations. The standard 203(k) has a minimum of $5,000 and allows for structural repairs which aren’t covered by the limited 203(k); with a standard 203(k), a HUD consultant has to oversee the renovations. “These loans require a lot of paperwork so it’s smart to work with a contractor who has experience dealing with HUD,” says Wood. And remember, renovations that the FHA considers to be luxuries, like putting in a swimming pool, can’t be financed with a 203(k).
How to know if an FHA loan is right for you
Look at your full financial picture and weigh all the facts. An FHA loan may allow for a lower credit score and a higher amount of debt, and the ability to make a down payment using gift money can also be beneficial. But FHA loans may have higher interest rates than conventional loans and come with FHA mortgage insurance, which can beef up the cost. “If you’re close to hitting the qualifications for a conventional loan, it may cost you less in the long run to work on your finances, pay down debts and build your credit so that you’re a better qualified candidate once you’re ready to get a mortgage. Even if you’re considering using an FHA loan because you want to use a 203(k), there are conventional options that also allow you to roll the cost of renovations into your home loan, like Freddie Mac CHOICERenovation and Fannie Mae HomeStyle renovation loans,” says Wood.
Shop around and compare the rate and terms you’re offered on a conventional loan with those you’re offered on an FHA loan. “Then take into consideration other costs like FHA required insurance before you make a decision,” says Channel. Remember, even if an FHA loan is easier to qualify for, it may end up being more expensive over the long term, particularly if you’re able to put 20% down.
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