FHA Loan Guide
If you're looking to buy a home or refinance your mortgage, you've probably heard of the FHA Loan. It's one of the most popular loan types. The Federal Housing Administration insures this type of loan. The agency's mortgage insurance program protects lenders from the risk of default.
If you want to learn more about the loan, including its types and the eligibility requirements, here is a detailed look.
Understanding FHA Loans
To understand FHA Loans, you'll first need to understand what was happening during the Great Depression of 1929-1939. See, during this period, the worldwide economy was in tatters, and so was the housing market. It was characterized by ridiculously high foreclosure and default rates. Therefore lenders would agree to cover only half of the purchase price and treat borrowers to balloon payments and unfavorable terms.
Safe to say, many Americans' dreams of owning a home quickly became the stuff of pipes. In fact, only 10% of homes were owned by their residents.
So, what did the government do to help?
The government created the Federal Housing Administration in 1934 to stimulate the housing market. Its main purpose was to insure mortgages for lenders, thereby lowering the lender's risk and making it easier for borrowers to be approved for mortgages.
In 1965, the agency was absorbed into the Department of Housing and Urban Development (HUD). According to information from the Federal Reserve Bank of St. Louis, the percentage of homeowners in the United States has continuously risen since the FHA's formation, peaking at 69.2 percent in 2004. As of Q2 2021, it stood at 65.4%.
How Do FHA Loans Work?
The FHA home loan program is designed for borrowers who don't have stellar credit scores, enough down payment money, and aren't eligible for conventional mortgages. You can get funding for up to 96.5 percent of a home's value if you qualify. However, mortgage insurance will be required.
Payments for MIPs go to the FHA, and if you default on your loan, your lender notifies the agency, which then pays off your loan balance. Because the FHA shoulders the risk of default, lenders can offer borrowers larger loan amounts.
Types of FHA Loans
The FHA offers several loan programs. Here's the breakdown:
Traditional mortgage - for the financing of primary residence
Home Equity Conversion Mortgage (HECM) - a reverse mortgage for seniors aged 62+ to use to convert their equity stake in their properties into cash but still keep the property's title
FHA 203(k) Improvement Loan - includes extra cash for repairs and renovations costs
FHA Energy Efficient Mortgage - includes additional cash to help you make modifications that will reduce your utility bills
- Section 245(a) Loan - The introductory monthly payments are lower and slowly increase as your income rises over time, shortening the life of the loan
What Types of Properties Can You Get an FHA Loan For?
The following types of property can be purchased with an FHA-insured mortgage:
- Single-family houses
- Multifamily housing
- Residential care homes
What Are the Qualification Criteria for FHA Loans?
When evaluating a customer for an FHA mortgage, lenders are most concerned with the following:
Work history and payment-history records
To issue an FHA loan, most lenders require a credit score of at least 580. But even with credit scores below 580, you can still qualify for these loans if the lender chooses to consider your employment history from the previous two years and payment history such as rent and utility payments instead of credit score.
However, remember that lower credit scores and down payments generally mean higher interest rates.
Even if you can only afford 3.5% of the purchase price, you can be approved for an FHA loan as long as your credit score is 580 or more. For credit scores between 500 and 579, you will need down payments upwards of 10%. You can use gift funds from friends, employers, or family to cover downpayment as long as you prove there's no debt obligation.
The following mortgage insurance payments are required of FHA borrowers.
- A one-time MIP of 1.75 percent of the loan sum
- a yearly MIP of 0.45 percent to 1.05 percent of the loan sum, levied monthly
Do FHA Loans Have Income Limits?
There are no income limits when it comes to FHA loans. Still, lenders will want to verify that you can afford your regular mortgage payments, so get ready with documentation to support your income.
The following incomes are considered:
- Social Security income
- Investment income
- W2 wages
- gig work income
- Freelance income
- Supplemental Security Income
- Social Security Disability Insurance
Depending on the region where you live, there are limits on how much you can borrow.
What Are the Employment Requirements for FHA Loans?
A loan application for an FHA mortgage will require a valid social security number, two years of employment history, and proof that you are of legal age.
If you have been with the same employer for more than two years, the financial institution may request a copy of your latest pay stub to confirm your income.
If you're self-employed, you'll need to provide the business and personal tax returns for the past two years. Additionally, lenders may demand profit and loss statements (P&L), current balance sheet, and other financial documents.
For individuals who've been freelancing for only a year now and therefore have no tax returns for the previous two years, you must provide stellar employment and earning history from two years before self-employment. You must also be freelancing in the same field or related occupation as your previous employment.
If you've just graduated and begun your career, you may use your degree program to stand in for work history to apply for an FHA loan. Provided you have a stable income and a stable job, you can still qualify for a mortgage even with student loan debt.
Pros of FHA Loans
- Don't require high credit scores conventional loans.
- Don't require a low debt-to-income ratio as conventional loans
- You can buy a two- to a four-unit property with as little as 3.5% upfront payment
- This loan program is not limited only to those buying homes for the first time
- Various loan programs with lenient eligibility requirements
- No income limits
Cons of FHA Loans
- You'll need mortgage insurance
- There's a cap on the maximum amount you can borrow depending on various factors
- FHA loans are for primary residences only
- Mortgage insurance payments last throughout the loan's life
- No matter your equity stake in the property, you still have to pay mortgage insurance
- The mortgage loan will be more expensive in the long run
What Are FHA Loan Limits?
FHA loan limits vary depending on the number of housing units and country area. Places like Hawaii and Alaska are higher-cost areas. Here's the breakdown:
One housing unit - you can borrow up to $356,362 in most parts of the country and up to $822,375 in higher-cost areas
Two units - the maximum is $456,275 in most parts of the country and up to $1,053,000 in higher-cost areas
Three units - you can borrow up to $551,500 in most parts of the country and up to $1,272,750 in higher-cost areas
- Four units - the maximum is $685,400 in most parts of the country and up to $1,581,750in higher-cost areas
FHA loans are for individuals who can't qualify for conventional loans. They require lower credit scores and downpayment, but you will have to get insurance and pay premiums throughout the life of your loan. The disadvantage is the loan will cost you more money in the long run. Still, you can always start with an FHA loan, and as soon as your equity stake in the home reaches 20 %, and your credit score is healthy again, pay some money upfront to refinance and shift to a conventional loan.
Talk to your loan officer or real estate agent for more advice on FHA loans.