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What to Know About FHA Loan Requirements

November 2, 2017

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U.S. homebuyers have a number of financial tools at their disposal today when it comes to smoothing out the notoriously expensive and complicated process of purchasing a home. One of the oldest and most well-known is a publicly funded program from the Federal Housing Administration, popularly known as the FHA loan. For qualifying homebuyers who can find the right house, FHA loans are mortgages backed by the FHA that can allow for home purchases with low down payments and closing costs. That makes them particularly attractive to many first-time buyers or anyone who has difficulty qualifying for a conventional mortgage.

While FHA loans are not directly financed by the FHA, they do involve a number of strict requirements that buyers and their potential new homes must pass. It’s essential to understand these rules to decide whether or not FHA is right for you.

The basics

The main selling points of the FHA loan program are its low down payment requirements, competitive interest rates and more lenient credit requirements compared to conventional mortgages.

  • FHA buyers may purchase a home with a down payment as low as 3.5 percent of the loan’s value.
  • Interest rates on FHA loans are still around 4 percent on average.
  • Buyers need a FICO credit score of at least 580 to qualify for the lowest down payment.

According to experts who spoke with Nerdwallet, these main points make FHA loans a generally good option for low- to middle-income borrowers, families and seniors. But gaining approval for an FHA loan also requires its own rigorous application process.

Important FHA credit requirements

Like most lenders, FHA buyers will need to be approved for their loan based on a set of credit and financial requirements:

  • Borrowers will need to provide a valid Social Security number or proof of lawful U.S. residency.
  • Borrowers must have proof of a steady income for at least the last two years.
  • The borrower’s front-end ratio (the cost of the monthly mortgage payment plus mortgage insurance, taxes and other fees) should usually be less than 31 percent of their gross income, although it may be as high as 40 percent in some cases.
  • The borrower’s back-end ratio (mortgage costs in addition to spending on other debt from credit cards, student loans, etc) cannot exceed 43 percent of their gross income in most cases, but may be approved as high as 50 percent.
  • For those with FICO scores between 500 and 580, borrowers will need to make a minimum 10 percent down payment.

The FHA also imposes limits on exactly what sort of house you can buy with an FHA-sponsored loan:

  • The borrower must live in the property as their primary residence.
  • Limits on FHA loan value vary depending on location. In general, the loan limit is equal to 115 percent of the county’s median home price.
  • The property to be purchased must be appraised by an approved appraiser in most cases. The appraiser will assess the home’s fair market value as well as criteria for safety and security mandated by the U.S. Department of Housing and Urban Development.

Mortgage insurance

One other important difference between FHA loans and conventional mortgages is how they handle mortgage insurance. In most situations where borrowers put less than 20 percent down on a home purchase, they need to pay additional private mortgage insurance fees at some point in the life of their loan, which drives up monthly payments. 

In the case of FHA loans, borrowers need to pay two kinds of mortgage insurance:

  • Upfront mortgage insurance may be paid as a lump sum at closing or rolled into monthly costs. Regardless of credit score, FHA borrowers will pay 1.75 percent of their loan value for this insurance premium.
  • Annual mortgage insurance premiums are tacked onto monthly payments, and vary depending on the terms of the mortgage. This premium ranges from 0.45 percent to 1.05 percent of the loan’s value.

Borrowers may need to pay mortgage insurance premiums for only up to 11 years, or they might extend over the entire life of the loan depending on the terms of the mortgage. 

These are just the most essential facts most borrowers need to know about FHA loans, but they do not cover every consideration that each buyer needs to make. Work with an FHA-approved lender like New Penn Financial to understand all the details of the program and whether it’s right for you given your financial situation and specific housing needs.

With this knowledge in mind, you’ll be in a better position to get a great deal on a new home using this popular program.

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