FHA Loan Requirements and How to Apply

FHA Loan provides a good option for low income home buyers who want to obtain mortgage loan but don’t have much money to pay for down payment.  The reason is that, FHA Loan does not only offer low down payment, the loans are insured by the Federal housing Administration. Prospective borrowers should understand that Federal housing Administration does not grant FHA Loans. What it does is to guarantee the payment of the loans made to homeowners through the approved lenders.  In this regard, borrowers will be required to pay Mortgage Insurance premium on their FHA Loan. This is what makes the loans to be less risky to lenders and this encourages them to be willing to grant the loans to borrowers under less stringent conditions.

Some people think that FHA loans are just for first time home buyers. This is a myth. The truth is that, you can actually use the loan to finance your second or third home. The only restriction is that you can only have one FHA loan at a time. The low down payment contributes to what makes FHA Loan attractive to newly married couples and other people who may not have much money stacked up in their savings account for down payment, especially those who are just graduating from University. Also, those people with bad credit in the past as a result of bankruptcy and foreclosure can still be eligible for FHA Loans. FHA Loan has really made it possible for a lot of Americans who ordinarily would not have been able to buy a home to become homeowners today. If you are considering applying for FHA loan, below are some vital facts you need to know about the loan.

Read Also: VA Loans: Eligibility Requirements and Essential Features

Features of FHA Loans

  • Required credit score: Minimum credit score required for FHA loans is not as high as the credit scores required for conventional mortgage loans. FHA requires that you have FICO score of at least 580 to be eligible for maximum financing and you will only need to make just 3.5% down payment. However, you might still be eligible for FHA loan if your FICO score is within the range of 500 and 579. But this will require that you make 10% down payment.
  • Low down payment: Just as explained above, the down payment required from borrowers under FHA loan program can be as low as 3.5% provided they have FICO score of at least 580. But for borrowers with FICO score within the range of 500 and 579, they will be required to make 10% down payment. This may seem high but it is still considerably low when you compare it with 20% down payment under conventional mortgage loans.
  • Closing costs: Though FHA loans are considered cheap; it still involves payment of closing costs. The closing costs you should expect include origination fee, attorney fees, cost of title insurance and title examination, property survey, appraisal and inspection fees, deposit verification fees, credit reports, test and certification fees, home inspection fee, transfer stamps, recording fees, taxes and document preparation fee if you engage a third party.
  • FHA approved Lenders: Federal Housing Administration does not give loans. If you want to borrow FHA loans, you will need to go through the FHA approved lenders. They are scattered all around U.S. Therefore, you will always find approved lenders that are close to you.
  • Loan Limits: There are limits to how much loans that FHA will insure. The FHA loan limit that will apply to you depends on your county, the prevailing conventional loan limit and other factors such as the type of your home, whether single family, duplex, triplex or four-plex. The FHA lending limits are reviewed every year. Therefore, what is obtainable today may not be obtainable next year. If you want to know the FHA loan limit that will be applicable to you, it is not enough to know the general FHA loan limits for a particular state, it is important that you are specific about your county. You may realise that there might be one or two counties that will have FHA loan limits that are different from other counties within the same state. For instance, the FHA loan limits in 2017 for most counties in Alabama are $275,655 for Single, $352,950 for Duplex, $426,625 for Tri-plex and $530,150 for Four-plex respectively. But Hale, Pickens and Tuscaloosa counties have FHA loan limits of $331,200 for Single, $424,000 for Duplex, $512,500 for Tri-plex and $636,900 for Four-plex respectively while Russell County has FHA loan limits of $289,800 for Single, $371,000 for Duplex, $448,450 for Tri-plex and $557,300 for Four-plex respectively
  • Appropriate documentation: Before you apply for the FHA loan at all, it is advisable that you have all your documents ready. Just for a guide, you will need to provide your lender the following information.
    • All addresses where you have lived in the past two years.
    • Your employers’ name and addresses for the last two years, plus the amount of your gross monthly salary
    • W2s for the last two years: Definitely, your W2s will contain your gross and net salary and all applicable taxes. Essentially, your W2s will be used to verify the income you disclose on your FHA Loan application.
    • Income tax forms submitted in the past two years: You should note that even though you have a copy of your income tax forms, lenders may not rely on that. Borrowers will be expected to sign a release authorising the lender to request their tax returns on their behalf so that they can receive the required tax information directly from IRS.
    • DD Form 214 (This is only applicable to veterans to show that they have been officially discharged from the Armed Forces. For veterans who are recently discharged but don’t have their DD Form 214, they can apply for a copy from their final outprocessing base or request for electronic copy from the Department of Defence. Veterans that want to request for their DD Form 214 can as well place a call to the records office or the orderly room.
  • Property Appraisal: The property requires appraisal from professional appraiser as approved by the FHA. You cannot decide on who to appraise the property by yourself. It has to be approved by the FHA.
  • Mortgage Insurance Premium (MIP): There are two types of Mortgage Insurance Premium (MIP) you will need to pay. The first one is called Upfront Mortgage Insurance Premium which is 1.75% of the loan amount and it is paid at closing of the loan. The second one is Annual Mortgage Insurance Premium. The premium is paid on a monthly basis as part of the loan repayment. The annual insurance is determined by the loan amount, the length of the loan and the ratio of your loan to the value of the home. Below is the table showing the MIP rates for FHA Loans for the year 2017
Loan Term Loan Amount LTV Annual MIP
> 15 years ≤$625,500 ≤95% 0.80%
> 15 years ≤$625,500 >95% 0.85%
> 15 years >$625,500 ≤95% 1.00%
> 15 years >$625,500 >95% 1.05%
≤ 15 years ≤$625,500 ≤90% 0.45%
≤ 15 years ≤$625,500 >90% 0.70%
≤ 15 years >$625,500 ≤78% 0.45%
≤ 15 years >$625,500 >78%, ≤90% 0.70%
≤ 15 years >$625,500 >90% 0.95%

From the table above, you must have noticed that the longer the loan term, the higher the MIP rates. Also, it applies that the higher the loan to value, the higher the applicable MIP rates. This means that if you really want to keep your MIP rates low, you can do this by either lowering your loan term, loan to value or both. Borrowers should understand the need for Mortgage Insurance Premium (MIP). Apart from the fact that it helps FHA protect the lenders from possible losses that may arise as a result of defaults by the borrowers, it also helps the borrowers assess the FHA loans at lower rates. FHA does not finance the loans from taxpayers’ money. Its operations are financed by the revenue generated in the form of insurance premium.

How Long it takes to pay NHF Mortgage Insurance Premium (MIP)?

If your loan is among the loans with FHA case numbers assigned on or after June 3, 2013, you will be required to pay Mortgage Insurance Premium (MIP). How long you will pay the Annual Mortgage Insurance Premium is a function of the amortization term and your LTV ratio. The table below summarizes how long you will need to pay the Mortgage Insurance Premium on your loan.

Loan Term LTV ratio Duration
≤ 15 years ≤90% 11 years
≤ 15 years >90% Loan term
> 15 years ≤90% 11 years
> 15 years >90% Loan term

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FHA Loan Requirements

Below are FHA Loan requirements you will be expected to meet if you want to apply for the loan.

  • Must be of a legal age: FHA does not specify a particular age as a requirement for FHA loans. Legal age here can mean the required age as may be applicable in the state where the loans will be granted. However, it is pertinent that the borrower should be an adult.
  • Employment stability: .FHA does not require that borrowers should specific income level. However, for you to be eligible for FHA loan you must have a steady job and must be in the same job or company for at least past two years. There should be a proof of stable or increased income from the job. In this regard, your lender may ask you’re your account number.
  • For self-employed, you will need at least two years of successful self-employment history. You are required to support your self-employment history with the current year to date financial statements (income statement and balance sheet) of your business. If you are less than two years but more than one year in self-employment, you may still qualify for FHA loan provided you had steady job and income in the two years preceding the self-employment. Such previous job and your current self-employment should be in the same or related industry.
  • Must be resident in the U.S with valid Social Security Number: FHA Loans are strictly for people who are resident in the U.S. Not only that, you must have your valid Social Security Number.
  • The home must be primary residence: You cannot use FHA loan to finance investment property, vacation home or a guest house. The home has to be owner occupied. In case of co-borrowers, at least one of the borrowers must live in the home at the time of closing.
  • Front End Ratio: This ratio is the sum of property monthly expenses, that is, (comprising mortgage insurance, homeowner insurance, property taxes, mortgage payment and HOE fees) expressed as a percentage of your gross monthly income. This can also be referred to as mortgage to income ratio. For the purpose of FHA Loan eligibility, your front end ratio must be less than 31% of your gross income. Lenders may still accept front end ratio of 40%.

How to calculate front end ratio

It will be assumed that your property mortgage expenses amount to $2,500 while your gross monthly income is $9,000. In order to calculate your front end ratio, you will divide $2,500 by $9,000 and multiply the reason by 100. This is calculated below:

Front end ratio  = $2,500/$9,000 x 100 = 27.78%.

  • Back end ratio: This is the ratio that indicates how much you are paying monthly towards your debts in relation to your gross monthly income. Monthly debts comprise mortgage loan, auto loans, student loans, alimony and credit card payments etc. Monthly mortgage loan payment will include the monthly principal, monthly interest payment, monthly property taxes and monthly insurance premium. In order to calculate your back end ratio, you will divide all your monthly debt payment by your gross monthly income. This is usually expressed in percentage.

How to calculate back end ratio

For example, let’s assume that you are requesting for FHA Loan of $424,000 with a monthly repayment of $2,200 (covering principal and interest), monthly property tax of $400, monthly insurance premium of $90, monthly student loan payment of $300 and monthly auto loan payment of $500. While your monthly income is $8,000. You will calculate your back end ratio as follows:

($2,200 + $400 + $90 + $300 + $500)/$8,000 = $3,490/$8,000 = 43.63%

The benchmark set for FHA Loans is that, for a borrower to be eligible, his back end ratio must be less than 43% of his gross income. However, lenders may still accept front end ratio of 50%. High back end ratio means that the borrower is using significant part of his income to finance debts. Such person may be profiled as high risk borrower who may not be able to pay back his mortgage if approved.

Read Also: Significance of Debt to Equity Ratio

  • Minimum credit score: A lot of borrowers usually misunderstand the minimum credit requirements they should meet to be eligible for FHA loans. Some of them wrongfully believe that if they don’t meet up to 580 FICO credit score that they are not eligible. This is not what the FHA loan requirements say. People who have FICO credit score below 580 can still be eligible. The difference is that, for any borrower to be eligible for 3.5% down payment, the person must have FICO score of 580 minimum. People with FICO score between 500 and 579 are still eligible for FHA Loans but instead of 3.5% down payment, they will be required to make at least 10% down payment.

However, FHA loan requirements may not actually reflect lenders standards. Lenders may need to assess the creditworthiness of individual borrowers based on their record of payments and their patterns of credit use. As a result of the difference in lenders’ standards, it is always better for borrower to shop around so they can find the one that offers loans on the terms that suit will them. Some lenders can even consider people with lower credit score if the borrower can compensate his credit deficiency with larger down payment. On the other hand, a borrower with sufficient cash reverse may be able to convince lenders about his ability to repay. If you want to get the best deal on your FHA mortgage loan, you may need to look beyond mortgage companies. You can equally get your FHA loans from banks, thrift and credit unions.

In a situation whereby you are unable to find a lender that is willing to grant you the loan as a result of bad credit; you may wait for say one year more and use the period to repair or improve your credit. Making prompt payments on your card without any default can help you improve your credit score. Also, you need to stop maxing out your credit if you have been doing this. Keeping your credit utilization ratio below 30% will help improve your credit score. If you are the type that uses credit card heavily, you may need to be paying your card balance twice in a month.

Other FHA Loan Requirements

Besides the FHA Loan requirements listed above, the following are the other requirements you must meet:

  • Minimum 2 years out of bankruptcy: If you have been bankrupt, it must not be within the last two years. Also, you must be able to demonstrate that you have re-established your good credit. It can be beneficial if you can prove that the bankruptcy was as a result of one time financial difficulty and convince the lender that you now have stable income.
  • Minimum 3 years out of foreclosure: Any foreclosure within the last three years may make you illegible for FHA loans. But if it happens in the time that is more than three years ago, and you have re-established your good credit, foreclosure may no longer be a barrier.
  • The property must meet the minimum standard. If the property needs some repairs, it has to be carried out by the seller. But if the seller is unwilling to carry out the repair, you can pay for this as part of the closing costs. However you will need to keep the money for the repair in escrow account until the repairs are completed.

If you are not sure if you meet all the FHA loan requirements, it is actually advisable that you attend Consumer Credit Counselling program where you can be advised on the required income to debt ratio. You can also be advised on how you can maintain satisfactory payments. It is even possible that there are errors in your credit report; a good counsellor can guide you on how to ensure that the errors are corrected.  A little improvement in your credit rating as a result of correction in your credit reports can make a big difference as to whether your application for FHA loan will be granted or denied. It is always better if borrowers can make their credit rating the best it can be before applying for FHA Loans.

Are you eligible for FHA Loan?

Having gone through the FHA loan requirements listed above, if you still don’t know whether you are eligible, I will tell you that you may not be eligible under the following conditions:

  • If you can’t make the minimum down payment: FHA loans are not a VA loans which don’t not require any down payment. Even though you meet all other requirements, you will not be able to obtain FHA Loan if you can’t meet up with the 3.5% down payment. However, you have option. You can ask somebody to help you pay the down payment but the money should be a gift. That is, it should not be a loan to you that the person will be expecting you to pay back.
  • Your credit is less than 500: The minimum FICO score is 500. Therefore, if your FICO score is less than 500, you may need to first improve your credit before applying for the loan.
  • You are delinquent on federal student loans.
  • You are delinquent on income taxes.

Read Also: Current Mortgage Rates and How to Get Low Rates

How to Apply for FHA Loan

Most importantly, before you start talking about applying for the loan, you need to meet the all FHA loan requirements first.  In summary, let me highlight the procedures you may need to go through if you want to obtain FHA Loans.

Decide on the type of home:  You should bear in mind that the type of the home you want to buy and the location of the property will determine the value of the home. You should be aware of the FHA loan limits that are applicable to your county. If the value of the home is more than the FHA loan limits, it may not qualify for financing. Besides, you need to work with the amount you can afford to pay. You should have a budget and ensure you stay within it. It is one thing to borrow, it is another thing to be able to repay. You can use FHA mortgage Calculator to estimate how much you can borrow.

Choose a lender: You need to search for lenders that are near you. It should not be difficult for you to locate approved FHA mortgage lenders as there are many banks, thrifts and mortgage companies that offer conventional mortgages which also offer FHA loans. Shopping around can help you get a good mortgage deal. You can also take advantage of the online database of the approved lenders maintained by Department of Housing and Urban Development (HUD) to find FHA Loan lenders in your area. You can limit your search to your city or county. If you already have established relationship with a bank in your area, that may be your first point of call. But you need to be sure that they are an approved FHA loans lender.  Lenders that are BBB members may be more reliable.

Apply for your loan: Having located an approved lender that is okay for you, you can then apply for your FHA loan. You will be able to get the application document from your lender. You will need to make the required documents available. Beside the documents mentioned above, some lenders will ask that you provide your gross monthly salary, bank account information, other loans information, current income statement and balance sheet of your business if you are a business owner etc.

Have the property appraised:  It is a requirement by Federal Housing Administration that before any property can be financed, it has to be appraised by an approved appraiser. This is to determine the value of the property and also to ensure that the property meets the health and safety standards

Provide a down payment: You will need to made a down payment of 3.5% of the home sale value if your FICO score is up to 580. But if your FICO score is less than 580 but up to 500, you will be required to make 10% down payment. You need to have this amount readily available because without it, the loan will not be released to you.

Read Also: Reverse Mortgage: What is a reverse mortgage?

Sign the closing documents: Before you sign the loan closing papers, you should endeavour to read through and understand the contents. If anything is not clear to you, you should endeavour to ask the lender. This can save you future stress. Also, you will need to pay your closing costs such as origination costs, appraisal fees and attorney fee etc.

Advantages of FHA Loans over Conventional Loans

You may want to know if FHA Mortgage Loans are any better than conventional loans. It depends on the perspective at which you are looking at the two loans. However, for clarification, I will like to highlight both the advantages and disadvantages of FHA loans as compared to conventional mortgage loans.

Advantages of FHA Mortgage Loan

  • Low Mortgage rate: The interest rates on FHA Loans are generally low. This is because the loans are federally insured. This makes the loans to be less risky to lenders thereby resulting to lower interest rate.
  • Low FICO Score requirements: One can get FHA mortgage loan with a FICO Score as low as 500. This may be impossible under conventional loans. If at all you succeed in getting conventional mortgage loan with that FICO Score, you may need to pay for the increased credit risk by way of higher interest rate.
  • Low Down Payment: FHA loans accommodate low income individuals as borrowers don’t need to pay large amount as down payment. If you have up to FICO Score of 580, you can pay as little as 3.5% down payments. But if your FICO Score is within the range of 500 and 579, you will be required to make 10% down payment. Still, this is still far better than requirement by private lenders under conventional mortgage loans. With FHA mortgage loan, someone can even pay your down payment on your behalf in case you don’t have the money. The only condition is that, the money must be a gift and not a loan that you will need to refund.
  • No Prepayment Penalty: If you are able to pay your FHA loan before your loan term, you will not be asked to pay prepayment penalty.
  • Qualification is easy: Individuals with bankruptcy and foreclosure history can still qualify for FHA mortgage loans if they have been able to re-establish their credit. Also they must have been out of the bankruptcy or foreclosure for a certain number of years as explained under FHA Loan requirements.
  • Higher Debt to Income ratio: FHA loan requirements are more lenient when it comes to debt to income ratio of the borrowers.
  • Cheaper Closing Costs: FHA lenders are not allowed to charge closing costs that are above a particular level. This makes it cheaper than the conventional mortgage loans. Also, seller can even pay up to six per cent of the closing costs. There are even many FHA approved lenders to choose from. If you shop around, you will be able to get your FHA loan at good rates.
  • FHA Loans are assumable: Homeowners can transfer the terms of their outstanding FHA mortgage loan to a new buyer.

Disadvantages of FHA Loans

FHA mortgage loans are not without their disadvantages. Below are few of the disadvantages of FHA loans:

  • Mortgage Insurance Premium (MIP): Borrowers need to pay both Upfront Mortgage Insurance Premium and Annual Mortgage Insurance Premium. This adds to the costs of the FHA mortgage loans.
  • Lower loan limits: There are FHA loan limits set for each county. These limits may not be sufficient to the value of the home you intend to buy.
  • Paperwork: The FHA loan requirements involve a lot of paperwork ranging from proof of Social Security Number, W-2 forms, original pay stubs and valid tax returns. This can discourage people who are not prepared for such level of documentations.
  • Restriction on usage: FHA mortgage loans can only be used to finance owner occupied home. This means you can’t use FHA loans to finance rental property, guest house or vacation house. Also, you can’t have two FHA loans at a time.

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