How to Qualify for an FHA Loan
10.21.2022 | Category: Mortgage Basics
A Federal Housing Administration (FHA) Loan is a government-backed mortgage loan sponsored by the U.S. Department of Housing and Urban Development (HUD). This backing from the government significantly reduces the risks of these loans to the lender, allowing them to be more lenient in their borrowing criteria while having significantly lower down payments and closing costs than conventional loans.
The FHA loan program is designed to make homeownership more accessible for low to moderate-income families, making it particularly popular among first-time homebuyers. Thanks to the backing provided by the government, FHA loans have become more accessible and affordable to everyone, from those with less-than-perfect credit scores and no savings or equity from previous sales to borrowers with good credit and strong financials.
How Does an FHA Loan Work?
FHA loans exist because of strong financial backing from the government, particularly the Federal Housing Administration and the Department of Housing and Urban Development (HUD). However, they do not make direct loans to applicants. Instead, private third-party lenders like Mutual of Omaha Mortgage finance the loan while the government offers an insurance guarantee.
The insurance guarantee offered by the federal government acts as a guarantee that protects them in case of customer default. At the same time, it acts as an incentive for private lenders to open up the loan and make it more accessible by offering better terms.
On top of mortgage payments, the FHA also requires mortgage insurance payments when the down payments made are less than 20% of the total mortgage value. All FHA loans require borrowers to pay two mortgage insurance premiums:
Upfront Insurance Premium: 1.75% of the total loan amount, to be paid immediately upon securing the loan. But it can also be rolled into the financed amount.
Annual Insurance Premium: 0.45% to 1.05% of the total loan amount, depending on the terms selected, the amount of the loan itself, and the initial loan-to-value ratio (LTV). This premium amount is divided by 12 and paid monthly.
Types of FHA Loans
The FHA offers several types of mortgage loans to help potential homeowners and buyers realize their ownership goals. These include:
Fixed-Rate FHA Loan: Within a fixed-rate FHA loan, borrowers can choose between available terms that also come with low down payment advantages. While generally accessible with a minimum credit score of 500, higher credit scores can be more beneficial to give room for higher savings and lower interest rates.
Adjustable-Rate FHA Loan: An FHA Adjustable-Rate Mortgage (ARM) comes with interest rates that are fixed for a period of time, then adjust annually throughout the remaining loan term. While interest rates may increase depending on current market conditions, most potential homebuyers are drawn to ARM because of its significantly lower interest rates.
Section 245(a) Graduated Payment Mortgage: Monthly payments on a graduated-payment mortgage can increase throughout the life of the loan. These plans are designed to pay the principal debt much faster by making a higher payment each month.
FHA Energy Efficient Mortgage (EEM): EEM mortgages are commonly used for home improvements that improve the home’s energy efficiency, such as updating widows or buying solar panels.
FHA Mobile Home Loan: FHA loan financing may be available for purchasing mobile homes, although they are viewed as personal property and come with higher insurance rates.
FHA Condo Loans: FHA loans can cover the purchase of condo units. However, given the rules and regulations enforced by condo associations on property sales and improvements, not all condo units may apply. The best way to determine a unit’s eligibility is to check out the FHA’s list of approved developments.
FHA 203(k): FHA 203(k) loans offer potential homebuyers added flexibility with their purchase options by providing additional funds for home repairs and renovations into the mortgage. Under the 203(k), homebuyers can choose to purchase fixer-uppers and access additional funds, which is up to 110% of the home’s post-renovation appraised value.
FHA Reverse Mortgage (HECM Program): Under the home equity conversion mortgage (HECM) Program, homeowners aged 62 and beyond can exchange the equity they’ve built up in their homes for monthly cash disbursements and increase their monthly cash flow.
How to Qualify for an FHA Loan
Although an FHA loan is made more accessible than conventional mortgage loans, you will still need to meet certain requirements before qualifying. Here’s how to qualify for an FHA loan:
Minimum Credit Score
Your credit score can significantly impact the minimum down payment you can make on your FHA loan. However, in order to qualify, you must have a FICO score of at least 500, which allows you to secure the loan with a 10% down payment. Meanwhile, at a minimum FICO score of 580, you can secure an FHA loan with a down payment of as little as 3.5%.
History of Honoring Debts
Your work and bill payment history for bills like utilities and rent will also matter in your FHA mortgage application. Generally speaking, any recent foreclosures or declarations of bankruptcy within the last two to three years can be problematic. However, exceptions can be made when there is evidence of an effort to re-establish good credit.
Proof of Steady Employment
Although proof of income is typically not a requirement for securing an FHA loan, your ability to repay must still be verified to ensure that there is no likelihood of defaulting on the loan. This proof is readily available as evidence of steady employment or solid income history as a self-employed individual. Frequent job changes or gaps in employment should have an explanation and extra documentation.
Low Debt-to-Income Ratios
To avoid potential problems with loan repayment, the following debt-to-income ratios must be satisfied:
Front-End Ratio: Loan payments, mortgage payments, property taxes, homeowners association (HOA) fees, and insurance must be less than 31% of gross income.
Back-End Ratio: Mortgage payments and consumer debts must be less than 43% of gross income.
Eligible Home for Financing
In order to qualify for FHA loan financing, the home must meet the FHA’s eligibility guidelines:
The loan must finance a primary residence to be occupied by the owner.
The owner must wait at least a year before re-selling the property.
An FHA-approved appraiser must handle its appraisal.
The property must satisfy the FHA’s minimum property standards for safety and living conditions.
FHA Loan Limits
The FHA doesn’t place any restriction on how many times you can secure an FHA loan throughout your lifetime. However, because the purpose of these loans is for primary residences only, it means you can’t have more than one at a time.
FHA Loans Can Help You Achieve Your Goals
FHA loans can be a great option for borrowers who are looking for a way to finance their new home purchase but don’t have great credit or a ton of savings on hand for the down payment. If you’re looking for mortgage loans with more lenient requirements, speak to a Mutual of Omaha Mortgage Loan Officer today. We will help you determine your eligibility and look for more favorable rates on your FHA loan. Give us a call at 1-800-24-RATES.