The Federal Housing Administration (FHA) Purchase Loan Program has become the home loan of choice for people looking for a low down payment as well as lower fees, rates, and credit requirements.
How does the FHA make this possible? By insuring mortgage loans that meet FHA requirements, they are able to reduce the risk of these loans to the lenders issuing them. Assured that the government will back up the loan if the borrower defaults, lenders are able to issue loans to more Americans. It’s a win-win: lenders are shielded from risk, and Americans who previously could not have purchased a home are able to become homeowners.
Benefits of the FHA Home Loan Program
- Credit requirements are more attainable. It doesn’t take a perfect credit score to qualify for an FHA purchase loan. Even after a foreclosure, short sale, or bankruptcy, you can still qualify for an FHA purchase loan after just one year, if you meet FHA requirements.
- Down payments are lower. Compared to down payments on conventional loans, which can require a down payment of 15-20%, FHA Purchase Loan down payments are almost unbelievably low at 3.5%. And they even allow you to use gift funds from family members, an employer, or a charity to make that down payment.
- Interest rates are more competitive. Even with the extra insurance premium that comes with FHA Purchase Loans, their interest rates are still on par with general rates in the market.
- They adjust for hardships. The FHA offers a slew of programs for people whose hopes of owning a home have been dashed by financial hardships. They even have programs to aid those who encounter a hardship after they’ve purchased a home with an FHA loan.
About the FHA
Established in 1934 at the height of the Great Depression to save the U.S. housing market, the FHA was created by the federal government as part of the National Housing Act of 1934. At the time, as during the recent housing crisis, housing foreclosures were out of control and the banking system was on the rocks. To reverse these trends, the FHA was empowered to make homeownership a financial reality again by ensuring loans and keeping interest rates and costs low.
Since that time, the FHA has provided insurance for over 34 million FHA purchase loans. Today, their insured loans make up a huge chunk (30%) of the housing market.
FHA Eligibility Requirements
What does it take to be eligible for an FHA Purchase Loan? Here are the biggest eligibility requirements:
- No bankruptcy or foreclosure within the past 12 months
- At least two years of steady employment/income
- A credit score of 530 or more (640 is preferred)
- The home you are buying must be your primary residence
Also worth noting here is the fact that, if you're applying with a co-signer, both you and your co-signer must meet these requirements.
FHA-Approved Appraisal Required
As with many kinds of home loans, FHA Purchase Loans require an appraisal of the property before the loan can be approved. This appraisal provides a few benefits, such as making sure that the home is actually worth its listing price and if there are any physical issues or defects that need to be repaired before purchasing the home.
With the usual maximum LTV on an FHA purchase loan set at 96.5%, borrowers are expected to provide the remaining 3.5% for a down payment. However, in the event that the property appraisal reveals that the property is worth less than the sale price, the borrower must also make up that difference in their down payment.
Debt-to-Income Ratio Requirements
Lenders use your debt-to-income ratio (DTI) to determine how much of a monthly mortgage payment you can realistically take on. There are two ways the DTI ratio is calculated.
First, front-end DTI is calculated as the percentage of your monthly income that goes to paying off home loan debt. For example, if you earned $3,000 in income per month, the FHA would approve you for a maximum front-end DTI of 30%—or a maximum $900 monthly mortgage payment.
Second, back-end DTI is calculated by adding up all of your monthly debt payments—any debt that will not be paid off in the next 10 months—and dividing that sum by your monthly income. The maximum back-end DTI allowed by the FHA is 43%. So, for example, if your monthly income was $3,000, the FHA would allow you to carry no more than $1,290 in total monthly debt payments, including payments for your new mortgage.
Like most home lenders, FHA-approved lenders want proof that you have had steady employment. They verify this by looking at your most recent pay stubs, tax return forms, and W-2 forms from the last two years. In the event that you haven’t been at your current job for two years, your lender will likely require more documentation from you to prove that you’ve had steady employment elsewhere. If you’ve been self-employed, you will have to provide a profit and loss statement and other documentation to prove that you have been gainfully employed with steady income for two years or more.
Eligible Property Types
- Manufactured homes (mobile homes)
- Single-family houses
- 2 to 4-unit residences (when one unit is owner-occupied)
It’s important to note that FHA Purchase Loans are required to be used only for owner-occupied properties. This disqualifies investment properties and second homes. The only exception to this rule is if the first home is not already a primary residence and doesn't have an FHA loan.
The Benefits of a Low Down Payment
Especially for those buyers who may not have enough cash on hand for the 15-20% down payments required on conventional loans, the 3.5% minimum down payment required on FHA loans can be a lifesaver.
Imagine if you wanted to get a loan for a $300,000 home. A conventional loan could demand a down payment as high as $60,000, out of reach of many prospective homebuyers. In contrast, an FHA Purchase Loan would require a down payment as small as $10,500.
Are you interested in an FHA Loan? To see if you qualify, contact a Mortgage Advisor today.