FHA loans are loans that are backed by the Federal Housing Administration. Contrary to what most people believe, they are not funded by the FHA, but rather are guaranteed by them. It is the actual bank or lender that is issuing the loan that is providing the funds. The FHA is strictly providing the insurance for the loans. This insurance serves as a source of funding for banks for loans that are defaulted on after funding. FHA loans originally began in the 1930s as a response to the rash number of foreclosures that were occurring. The FHA insurance was meant to help banks provide funding while stimulating the housing market.
FHA loans, which used to be known as the “first-time homebuyer’s” loan, are a great source of funding for just about anyone today. FHA loans are available for both single family homes as well as multi-unit homes and provides flexible guidelines that make it a good loan for people that do not qualify for a conventional loan for one reason or another.
As with any loan, there are certain FHA loan limits that vary by region. The FHA sets these standards by gauging median home price in any given county compared to the national conforming loan limit. As of right now, the national conforming loan limit is $417,000. This is not the maximum loan amount in most areas, however. Each county is provided its own maximum based on the median home price in the area. As of January 1, 2015, the lowest maximum loan amount that exists in low cost areas was $271,050. This is the limit in areas where the average house price is less than 65% of $417,000. In order to come up with the maximum of that amount, 115% of the homes in that area must be 65% less than the national conforming limit. On the other hand, in high costs areas, such as San Francisco and New York, the maximum loan amount is $625,500. This is only for those areas where 115% of the homes cost more than 150% of the $417,000. Each county will have its own maximum based on the home prices in that area and can change on a yearly basis, depending on the FHA guidelines for that year.
In addition to the maximum loan size for each county, are the requirements that play into what loan amount each individual qualifies for; this will differ for each person. The lender will take into consideration your credit score, amount and type of income, amount of outstanding debt, the value of the home you are purchasing or refinancing, and your history of paying your debt on time. Each of these factors combine together to create your risk profile and each lender can differ in what they allow and do not allow, so shopping around can sometimes get you a higher loan amount if that is what you need. In addition to your particular qualifications, however, is the type of home you are purchasing and/or refinancing. Single family, duplex, three unit, and four unit properties each have their own maximum loan amount in each county which will also play a role in your loan size.
As a first step in the FHA process, the lender will pull your credit. This is their first look into how you handle your financial responsibilities. Each lender has their own requirements regarding what they deem acceptable and which situations they will not accept. Things like missed payments, late payments, foreclosures, bankruptcies, and collections all play a role in your loan approval. One thing that every lender has in common is the requirement to have a minimum credit score of 580. If the credit score is below that amount, it does not mean that you are automatically ineligible, it just means that you will be required to put a higher down payment down on the loan, whereas the people with the credit score above 580 are only required to put down 3.5% of the purchase price of the home.
There are certain situations that can occur within your credit report that will require special circumstances in order for you to obtain an FHA loan including:
- No credit – If you do not have at least two credit lines, you will not have sufficient credit to use a credit report for approval purposes. In these cases, the lender may accept alternative forms of a credit history such as a 12-month history of your insurance payments, rent payment, or even utility payments.
- Late Payments – A period of late payments does not automatically disqualify you for an FHA loan. The underwriter will look at the whole picture to decide what is right for your situation. If your late payments are isolated within a certain time period and you have a valid explanation for the late payments, such as a job loss or illness, the late payments can often be overlooked as long as everything is on time as of the time of the loan application.
- Chapter 7 Bankruptcy – There must be 2 years between the date that the Chapter 7 bankruptcy was discharged and the date of the loan application. It is important to note that the discharge date differs from the date that the bankruptcy was filed, so be sure to count the time correctly for your loan purposes.
- Chapter 13 Bankruptcy – If you are still making payments on your Chapter 13 bankruptcy, the payments need to be timely and have occurred for the last 12 months at a minimum. The trustee of the bankruptcy case will also have to approve the loan before it can go through underwriting.
- Foreclosure – A foreclosure has to be at least 3 years behind you in order for you to be eligible for an FHA loan. There are exceptions to this rule, which apply only to special circumstances. This is up to the lender’s discretion and will require a letter of explanation as well as proof of the situation. In addition, good credit must have been established in order for the lender to consider a foreclosure within the last 3 years.
- Collections –Typically collections are not an issue for FHA loan approval unless they are a federal debt. Any type of federal collection renders a loan application declined. The only way they would be considered is if you were on a payment plan that is current and without any late payments.
Every loan has debt ratio requirements in order to ensure that the new loan does not put you in over your head financially. The FHA guidelines are a little more relaxed than the guidelines for any other loan in terms of the debt ratio. The FHA sets the maximum debt ratios at 31% on the front end and 43% on the back end, each of which are broken down as follows:
- Front End Debt Ratio – Any payments in conjunction with your mortgage are in the front end ratio. This includes principal, interest, taxes, insurance, mortgage insurance, and association dues.
- Back End Debt Ratio – The total mortgage payment from above combined with any recurring monthly charges, such as car payments, credit card payments, student loans, or personal loans.
Each of these totals are divided by your gross monthly income, whether just for you or for you and your spouse if you are including him/her on the loan. If the ratios are higher than the maximum, you might need an exception for the loan, which some lenders will provide and others will not, but you can shop around to find a lender that will accept your ratios.
All FHA loans have mortgage insurance; in fact, they have two types of mortgage insurance – Up Front Mortgage Insurance and Annual Mortgage Insurance. The Upfront Mortgage Insurance, as the name suggests, is paid at the onset of the loan. It is a set amount of 1.75% of the loan amount. For example, if your loan was $200,000, you would owe $3,500 at closing for the Upfront Mortgage Insurance. This is in addition to any closing costs as well as the down payment you are placing on the home. After the Upfront Mortgage Insurance is paid, you will owe an annual mortgage insurance premium which is paid on a monthly basis. This amount is 0.85% of the loan amount and is divided up into 12 payments. On the same $200,000 example, the annual mortgage insurance premium would be $1700, which translates into $141.67 per month. Once you hit 78% LTV, the mortgage insurance premium is cancelled.
Down Payment Requirements
FHA guidelines require a 3.5% down payment on any loan that the borrower has a credit score above 580. Of course, you are welcome to put more down on the home if you would like, but the minimum is 3.5%. If your credit score is below 580, however, you will have to put 10% down on the home in order to get an FHA loan. Down payment money can come from your own money as well as be a gift from a family member or a grant from the government.
Closing costs are a part of any loan, including the FHA loan. The one stipulation that sets this loan apart from others is the ability to receive the closing cost money from the seller or a family member; you do not have to pay the fees yourself. There are certain fees that are allowed under the FHA guidelines, including:
- Appraisal costs
- Credit report costs
- Origination fee
- Fees for an attorney
- Title insurance fees
- Survey fees
- Home inspection fees
- Preparation of document fees
The amount that either the seller or a family member is allowed to contribute is maxed out at 6% of the loan amount in order to avoid the payments to be considered coercion or forcing the borrower to take the loan and purchase the home.