Anyone in the process of buying a home will inevitably deal with a vast array of options when it comes to funding. That’s because lenders offer several home loans, but all of them have certain requirements and conditions to meet for eligibility.
One of the most popular options if you’re buying a home is the use of an FHA loan, created during the Great Depression as a way to bolster homeownership. Now, in the 21st century, FHA loans have been heralded as one of the many relief options during the coronavirus pandemic and other economic downturns as buyers face tremendous struggles of affordability.
While the FHA (or Federal Housing Administration) does not provide the loan itself, it does provide lenders with a backing of the loan, offering assurance it will be repaid with government assistance if the loan falls into default. With this guarantee, lenders make such loans more readily available.
What is an FHA Loan?
Many would-be homebuyers browsing listings right now have only a vague idea of what they can afford and how they can afford it. Many of them are first-time homebuyers with low-to-moderate income and meager savings set aside to use as a down payment. That’s where an FHA loan can help, requiring a lower credit score and a smaller down payment to secure a mortgage.
The FHA, which is part of HUD (or the U.S. Department of Housing and Urban Development) has been backing loans since 1934. You might hear an FHA loan referred to as an “FHA-insured loan.” That’s because it still comes from an FHA-approved lender, such as a bank or credit union.
You can find an FHA lender through the HUD website or by talking to a mortgage advisor or mortgage broker.
FHA Loan Requirements
There are a litany of requirements to get an FHA loan, but there are two in particular that borrowers are often most interested in — the credit score requirement and the minimum down payment.
In 2020, borrowers interested in obtaining an FHA loan with the lowest down payment possible at just 3.5% must have a minimum credit score of 580. While buyers won’t be denied FHA eligibility with a lower score, they would need to come up with the cash for a 10% down payment in that scenario.
Some other key requirements set by the FHA include:
- Proof that potential borrowers have steady employment and/or have worked at the same job for a minimum of one to two years.
- Original pay stubs and tax returns showing verifiable income.
- The expectation that borrowers will use the loan only for a primary residence.
- Proof that any borrower is at least two years post-bankruptcy and three years from any foreclosure.
Remember, there are going to be different FHA mortgage requirements outlined for every buyer depending on his or her circumstances. There are no special considerations and you’ll be denied outright if you don’t legally reside in the United States, have a valid Social Security Number, or if you’re under the legal age to sign a mortgage in your state.
A rough guideline says your mortgage payment cannot be more than 35% of your total income before taxes. Additionally, buyers securing an FHA loan are responsible for paying both an upfront insurance premium and monthly mortgage insurance on the property until it has at least 20% equity (or 20% of the overall value paid off).
Benefits of FHA Loans
FHA loans are incredibly flexible in their structuring and are perfect for those with less-than-perfect credit or limited savings. Beyond those obvious benefits, there are some other things to like about FHA loans, including the allowance of both fixed and variable rates. Additionally:
- FHA loans allow gift funds for the down payment and for borrower-paid closing costs and fees at settlement. All gifts must be from acceptable sources and be documented and verified.
- The FHA offers not just a singular ‘loan’ but a variety of loan options. These are products designed to meet the specific needs of buyers, including those looking for a rehab mortgage or to finance the construction of a new home. Additionally, borrowers can seek home improvement loans or so-called energy-efficient mortgages.
- FHA loans aren’t limited to first-time buyers or those with poor credit. They are an option for many homebuyers.
- If you need to sell your house later on, you can transfer your FHA loan to the buyer.
- The FHA also has various programs to help homebuyers, including financial help for seniors, and state and local government programs designed to help buy, maintain, and keep a home.
Choosing an FHA Lender
As a homebuyer seeking an FHA loan, you’ll want to speak with an FHA lender who can talk to you about FHA loan products. Luckily, these folks are easy to find and probably work in your neighborhood. A simple search can be done on the HUD website to find lenders using various selection criteria.
To find the best lender, you’ll need to shop around and talk rates, terms, fees, and more. Just be wary that rates and terms from direct lenders can (and will) vary widely. You may talk to one lender on a Monday and qualify for a loan, then talk to a different lender on Wednesday and be offered completely different rates and terms. That means you can ultimately end up with a more expensive loan.
If you’re a first-time buyer, you should also understand that you don’t have to work with a direct lender. There are options including using a mortgage broker, which you should think of as a matchmaker between you (the borrower) and the lender. Brokers are paid after closing by either the lender or the borrower and typically charge a small percentage of the full loan amount for their services.
It’s worth it to investigate all your options before you sign off with a mortgage lender. Some upfront homework and research on your end could net you big savings and a hassle-free transaction.
Once you’ve found the home you want to purchase and are ready to apply for your FHA loan, you’ll need to go through the standard application and underwriting process. Your lender will inform you of the need to get an appraisal for the home (so you don’t violate the FHA’s loan-to-value limits). You’ll also need to show proof of income, undergo a credit check, and provide proof you can afford the down payment.
The Bottom Line
An FHA loan might sound like the best option available to many would-be homebuyers, but it has some limitations. It can’t fix a bad credit score, nor will it make allowances for one. It can’t forgive or eliminate a down payment, and there’s no way around the requirement to hold mortgage insurance on an FHA loan.
Any homebuyer shopping ‘up’ and looking at homes priced on the higher end won’t get an FHA loan, nor should they consider one (after all, maximum loan amounts vary by location and might be capped as low as $331,760 for most of the country). But anyone who knows they fit into a bracket of a ‘low-to-moderate-income’ buyer and has limited cash for a down payment should look into what an FHA loan can offer.
- CNBC, Coronavirus mortgage bailouts suddenly swell as homeowners face new struggles. Accessed at https://www.cnbc.com/2020/06/26/coronavirus-mortgage-bailouts-suddenly-swell-as-homeowners-struggle.html
- Encyclopedia.com, Housing: 1929-1941. Accessed at https://www.encyclopedia.com/education/news-and-education-magazines/housing-1929-1941
- HUD, Let FHA Loans help you. Accessed at https://www.hud.gov/buying/loans
- HUD, Acceptable Sources of Borrower Funds. Accessed at https://www.hud.gov/sites/documents/4155-1_5_SECB.PDF
- NerdWallet, FHA Mortgage Insurance. Accessed at https://www.nerdwallet.com/article/mortgages/fha-mortgage-insurance
- Bankrate, Six Steps to Finding the Best Mortgage Lender. Accessed at https://www.bankrate.com/mortgages/finding-the-best-mortgage-lender/
- Housing Wire, FHA Loan Limits Increasing for Almost all of U.S. in 2020. Accessed at https://www.housingwire.com/articles/fha-loan-limits-increasing-for-almost-all-of-us-in-2020/