What is a Federal Housing Administration (FHA) Loan?

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A Federal Housing Administration (FHA) loan is a mortgage that is insured by FHA and issued by an FHA-approved lender. FHA loans are designed for low-to-moderate-income borrowers. You can borrow up to 96.5% of the value of a home with a FHA loan. This means you'll need to make a down payment of 3.5%. You'll need a credit score of at least 580 or higher to qualify depending on individual investor/lender requirements. With FHA loans, your down payment can come from savings, a financial gift from a family member, or a grant for down-payment assistance or a specific down-payment assistance program in second lien position. Because of their many benefits, FHA loans are popular with first-time homebuyers.

Key Points:

  • FHA loans require a lower minimum down payment and a lower credit score than many conventional loans.
  • As a general rule of thumb, the lower your credit score and down payment, the higher the interest rate you'll pay on your mortgage.
  • The FHA loan program is not intended to be used for investment or rental properties.
  • In order to secure the guarantee of the FHA, borrowers that qualify for an FHA loan are also required to purchase mortgage insurance.
  • FHA loans require a two year employment history. The employment does not have to be with the same employer, but it does typically need to be in the same type of business/occupation.
  • If you're self-employed, you will need two years of successful self-employment history. This can be documented by tax returns and a current year-to-date balance sheet and profit and loss statement. If you've been self-employed for less than two years but more than one year, you may still be eligible if you have a solid work and income history for the two years preceding self-employment (and the self-employment is in the same or a related business/occupation).
  • At least two years must have passed since the borrower experienced a bankruptcy event and/or including the bankruptcy discharge date.
  • You must be at least three years removed from any mortgage foreclosure including the recording date, and you must demonstrate that you are working toward re-establishing good credit.
  • Student loan debt can be a sticking point. Regardless of whether the loan is deferred or in repayment, the payment must be calculated as follows: the greater of 1% of the balance owing or the actual payment as shown on the credit report or the actual documented payment, provided it will fully amortize over the loans term. Written evidence, from the creditor, documenting the actual monthly payment, payment status, outstanding balance and terms of the loan is required.
  • If you're delinquent on your federal student loans or federal income taxes, you won't qualify.
  • Your front-end debt-to-income ratio (your mortgage payment, HOA fees, property taxes, mortgage insurance, and homeowner's insurance) should be less than 31% of your gross income. In some cases, you may be approved with a 40% ratio.
  • Your back-end debt-to-income ratio (your mortgage payment and all other monthly consumer debts that show up on credit, paystubs, divorce decrees, IRS payment plans or child support), should be less than 43% of your gross monthly income. However, it is possible to be approved with a ratio as high as 50%.
  • You will need a property appraisal from an FHA-approved appraiser, and the home must meet certain minimum standards. .
  • You must have a valid Social Security number, reside lawfully in the U.S., and be of legal age in order to sign a mortgage.

FHA loans are one of many options for home financing. Educate yourself on other programs and compare to see why FHA has the advantages you need to purchase your first home. Happy house hunting!

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