Tuesday, June 25, 2024

How to Qualify for a Federal Housing Administration (FHA) Loan

Guide to FHA Eligibility Criteria

Facilitating homeownership for individuals who might not meet the criteria for a Conventional Loan, the Federal Housing Administration (FHA) Loan is specifically tailored for low to moderate-income applicants and first-time home buyers. It extends accessibility to individuals with lower credit scores, allowing individuals with less-than-perfect financial histories to achieve homeownership.

In this guide, we will explore the ins and outs of FHA loans, providing you with valuable information to make informed decisions on your journey to homeownership.

How to Qualify for an FHA Loan

To qualify for an FHA loan, borrowers must meet certain basic criteria, including having a valid Social Security number and legal residency in the U.S.

Dana Hendrix from DSLD Mortgage outlined the specific eligibility criteria for an FHA loan for us below.

  1. Demonstrate Stable Employment and Income: Lenders require potential borrowers to have a stable employment history and income. You must demonstrate your income with pay stubs, W-2s, and tax returns. While there are no specific income limits, it’s essential to have sufficient income to maintain acceptable debt-to-income (DTI) ratios. Importantly, having a higher income will not impact your eligibility for a FHA loan.
  2. Credit History and Bankruptcy: While FHA loans are more forgiving of lower credit scores, a FICO® score of 500 or higher is needed.  Additionally, you must have no bankruptcy history within the last two years.
  3. Debt: Your debt-to-income (DTI) ratio is determined by dividing your total monthly debt payments by your gross income. Generally, your mortgage payments and other monthly debt payments should not exceed 43% of your monthly income.
  4. Payment History: Lenders evaluate more than just your credit score throughout the credit check process — a strong emphasis is on a positive credit history. It’s crucial to note that late payments could potentially disqualify you from loan eligibility.
  5. Foreclosure History: A prerequisite for loan eligibility is the absence of a foreclosure history within the preceding three years. However, in certain situations, borrowers can still be considered for a loan if they provide evidence that their foreclosure resulted from extenuating circumstances.
  6. Down Payment: A minimum down payment of 3.5% of the purchase price is required for a FICO® score of 580 or over. This increases to a minimum 10% down payment for a FICO® score between 579 and 500. The down payment required may vary depending on your  FICO® score and the lender.
  7. Primary Residence: FHA loans are only available for the borrower’s primary residence and can not be used for investment properties or second homes.

FHA Appraisal

The home must comply with the guidelines established by the U.S. Department of Housing and Urban Development (HUD). An appraiser approved by HUD will have to evaluate the property to determine its current market value and confirm its adherence to minimum property standards.

The appraiser might identify areas requiring correction or additional inspection. If necessary, they will label it as “as-repaired,” indicating that the home’s value and eligibility to meet Minimum Property Requirements are contingent on addressing the specified repairs.

Certain conditions are fixable and can be readily resolved with repairs, leading to conditional approval. However, if substantial repairs are needed, the property may not be eligible to purchase through an FHA loan.

FHA Private Mortgage Insurance (PMI)

Understanding FHA private mortgage insurance (PMI)  fees is essential for borrowers. Considered a closing cost, PMI insurance is a crucial component separate from the down payment.

Closing costs encompass various upfront fees incurred during the home closing process, covering expenses like attorney fees, inspection costs, and appraisal fees. Notably, FHA loans permit lenders and third parties to contribute up to 6% of these closing costs.

Borrowers should be aware of two FHA Private Mortgage Insurance (PMI) fees:

Upfront Mortgage Insurance Premium (UFMIP): Equal to 1.75% of the total loan amount, this premium can be financed into the loan or paid upfront in cash when the borrower secures the loan.

Annual Mortgage Insurance Premium (MIP): Ranging from 0.15% to 0.75% of the total loan amount, this premium varies based on factors such as the loan term (15 or 30 years), loan amount, and down payment. The annual premium is divided over 12 months, necessitating monthly payments. Importantly, these payments may be mandatory for the entire term of the loan.

Three Drawbacks of FHA Loans

FHA loans come with many benefits. However, they also have a number of potential drawbacks, including the following:

1. FHA Appraisal Requirments and Restrictions: You cannot purchase a property requiring substantial repairs. This limits the property options and how much you can increase your home’s value. Consider a conventional home loan if you prefer to buy a property that needs work.
2. Private Mortgage Insurance (PMI): With a conventional loan, if you can make a down payment of 20% or more, you can avoid paying for PMI. This could save you a substantial amount of money over the life of your loan.
3. House Value Restrictions: The FHA loan program limits the amount you can spend on a property, depending on the state. More information can be found online through the FHA Mortgage Limits Search.

FHA Loan Take Away

An FHA loan is generally the better option if you cannot make a large down payment and do not have a high credit score. In some cases, the FHA loan program can be beneficial even if you have a high credit score or can make a large down payment, as you may still benefit from lower interest rates than with a conventional loan.

Your lender should take time to discuss all of your loan options with you and explain the benefits and drawbacks based on your circumstances.

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