How to get an FHA loan
Do you have too much debt to qualify for a conventional mortgage? Less than stellar credit scores or not much cash for a down payment?
You should consider buying a home with an FHA loan.
The Federal Housing Administration, a division of the Department of Housing and Urban Development, was created 78 years ago to help low- and moderate-income families obtain financing for home ownership.
The FHA doesn't actually make home loans. It guarantees lenders will be repaid if you default on the loan.
That allows banks and mortgage companies to work with borrowers who might not be able to qualify for conventional home loans and at surprisingly competitive interest rates, too.
You can borrow up to $417,000 for single-family homes in most parts of the country or as much as $729,750 in high-cost cities such as New York and San Francisco.
The great majority of lenders work with the government to make FHA loans, and you'll find they allow applicants to buy homes with:
A smaller down payment.
Most FHA mortgages require a 3.5% down payment — that's $3,500 for every $100,000 you borrow. If your FICO credit score is below 580, you'll have to come with a 10% down payment.
Indeed, the average down payment on an FHA loan was 4% last year, according to Ellie Mae Inc., a California-based mortgage technology firm whose software is used by many lenders. It was 21% for non-FHA loans.
Your down payment can also be a gift from a relative, friend or an organization that provides financial assistance.
Borrowers are allowed to work with state and local programs that provide help with down payments, closing costs and low-rate loans. Parents can help their kids come up with the cash, too.
Many conventional mortgages do not allow that, requiring down payment to come from a borrowers' savings or other assets, such as proceeds from the sale of another home.
Before the financial crisis, FHA loans were for borrowers with bad credit.
And we mean bad credit. Applicants with credit scores below 640 scooped up more than half, while those with credit scores below 580 received about a quarter, of all FHA-backed mortgages.
But no more.
Borrowers with credit that bad now qualify for fewer than one out of every 10 FHA loans.
Most of the money goes to home buyers who have average, or somewhat below-average, credit.
Ellie Mae says the average FICO credit score for FHA-backed purchases was right at 700 last year, or about 20 to 30 points below the average FICO score.
The average FICO score of rejected FHA loan applicants was 667, a score that would have placed those borrowers in the top half of FHA borrowers just a few years ago.
The advantage is that the average FICO score for successful applicants was still considerably lower than the 764 average for non-FHA loans.
So what’s the secret to qualifying if you have a credit score in the low 700s or high 600s?
Successful applicants usually have a two-year history of:
- Steady employment and…
- Paying their bills on time.
You can get an FHA loan if you're self-employed. Just be ready to document your income with tax returns and financial statements from your business.
The same big financial problems that derailed FHA applications in the past continue to do so. If you:
- Declared bankruptcy, you must wait two years from the date of discharge.
- Lost a home through foreclosure, you must wait three years.
- Are delinquent on a federal debt, such as a student loan or back taxes.
To obtain most non-FHA loans, borrowers must be spending no more than 36% of their pretax income on all debts, including mortgage payments, student loans, credit card bills and auto loans.
With an FHA mortgage, lenders will allow you to spend up to 41% of your pretax income on debt. Some lenders will stretch that to 43% for borrowers with an excellent payment history. (Use your own discretion on whether you should stretch your budget to spend that much of your pay on debt payments.)
The big disadvantage to FHA financing is the mortgage insurance you have to pay up front. It's the price you pay for having the government stand behind your loan.
All borrowers, regardless of the term of their loan or the size of the down payment they make, must pay the 1.75% Up-front Mortgage Insurance Premium at closing.
That means that you pay a $1,750 insurance premium on every $100,000.
While that can be added to your loan amount, it's still an extra charge.
Most borrowers will also have to pay monthly insurance premiums, which are comparable to what you would pay for private mortgage insurance on a non-FHA mortgage.
For a 30-year loan with a down payment of less than 5%, your premiums will be 1.25% of the outstanding balance each year. If you put more than 5% down, your annual premiums will be 1.20%.
If you wait until next April or later to buy a home, your premiums could be a tenth of one percent higher. For example, if you put less than 5% down, your premiums will probably be 1.35%.
That cost is typically divided into 12 monthly payments and added to your mortgage payment.
You'll have to carry this insurance for at least five years on all loans longer than 15 years until the balance on your mortgage is down to 78% of the original purchase price (not counting any financed up-front mortgage insurance premiums).
On non-FHA loans, private mortgage insurance can usually be dropped after the balance of the loan is down to 80% of the purchase price and after a minimum of only one year.
Private mortgage insurance also allows you to count appreciation toward obtaining the needed equity. FHA mortgages do not.
If you purchase a home with an FHA-backed mortgage after the changes go into effect next April, expect to pay mortgage insurance premiums for the life of the loan.
If you keep your FHA financing for 30 years, higher mortgage insurance premiums for a longer period of time will cost you significantly more money. However, that's not likely to discourage many people from applying for FHA loans, for two reasons.
First, the typical homeowner moves or refinances every seven years, so very few borrowers will have to live with that more onerous requirement.
Second, buyers generally turn to FHA loans because they don't have the credit or down payment needed for a conventional non-FHA mortgage. They can't close the deal without the FHA's help.
"It's still the best game in town," Greg Cook, a mortgage broker in Temecula, Calif. "It's just going to be more expensive."
Here's where to find the FHA loan limits in your area.