How to Get an FHA Loan
Point of Interest
FHA loans are beneficial for first-time homebuyers, low-income buyers or those with higher DTI ratios. These loans fit a wide variety of borrowers thanks to the less restrictive lending guidelines for FHA loans.
Today’s economy has caused millions of Americans to struggle financially due to employment and job market uncertainty. But even in the midst of the pandemic-related recession, many people are looking to buy a new home or move to a new place while adjusting to changes in work and personal lives.
If you’re considering a move or home purchase but think you might struggle to get approved for a conventional loan, an FHA loan could be your best option. Government-backed FHA loans are designed to make the home buying process easier for borrowers who don’t fit the traditional conventional loan requirements. Through looser requirements, you can qualify for an FHA loan with a lower credit score and smaller down payment amount than is required with other conventional loans.
What is an FHA loan?
FHA loans are insured through the Federal Housing Authority and are only offered through FHA-approved lenders. Since they’re government-backed, FHA loans have fewer borrower requirements, along with smaller down payment requirements and lower minimum credit scores. These loans also include lower interest rates than conventional mortgages, making them ideal for first-time or low-income home buyers.
The downside to FHA loans is that they include additional costs not associated with conventional mortgages. If you secure an FHA loan, you’re required to pay for extra mortgage insurance to protect the lender in case of default. This extra insurance is paid through upfront costs as well as annual premiums. Unlike conventional loans, which only require private mortgage insurance when borrowers don’t have a full 20% down payment, FHA loans require a similar mortgage insurance for at least 11 years of the loan — no matter how much you put down.
Still, even with the extra costs, FHA loans can be an ideal alternative to conventional loans. Most of the U.S. is experiencing the economic effects of the COVID-19 pandemic, and an FHA loan may make it easier to purchase a home right now.
Throughout 2020, mortgage rates have fallen, but most lenders have implemented stricter requirements for homebuyers. Banks are raising their loan requirements to mitigate risk amid higher unemployment rates. For example, some lenders have raised their credit score requirements about 9%, from a 640 minimum to 700.
If you’re looking to buy a home, an FHA loan can offer an easier way to gain the funds you need quickly.
FHA vs. conventional loans: What’s the difference?
The biggest difference between FHA and conventional loans is how they’re insured. While the government insures FHA loans, private lenders insure conventional loans. FHA loans are specifically designed to make it easier for people to become homeowners, which is why FHA loans usually have lower requirements.
In general, FHA loans require a minimum down payment of 3.5% for qualified borrowers with a minimum 580 FICO score. By comparison, mortgages that qualify for the Fannie Mae and Freddie Mac guarantee include a 20% down payment.
While FHA loans’ limited requirements make them more attractive for low-income and first-time buyers, other borrowers may also benefit. Regardless of income, FHA loans are more appealing for homebuyers with a higher debt-to-income ratio. In 2019, the FHA set the maximum debt ratio to 43% of total income. Though conventional lenders tend to set similar DTI limits, it’s easier to gain approval if you have a lower DTI.
While these loans come with lower credit and down payment requirements, there is a slight catch with FHA loans. All FHA loans require the borrower to have mortgage insurance for at least 11 years, whereas you’d only have to get mortgage insurance on a conventional loan if you put down a down payment less than 20%.
FHA loan limits are also lower than conventional loans and include property standards, meaning you have fewer options while looking for a home. A conventional loan offers more flexibility for borrowers who have higher credit scores and more money saved up for a down payment.
How to get an FHA loan
Applying for an FHA loan requires a process similar to obtaining a conventional loan. This process includes:
- Preparing to apply: Before applying, make sure you have everything you need. Starting with your budget, you should have at least 3.5% of your home’s cost saved up for a down payment. You should also conduct an income review and begin pulling your credit reports. Though the guidelines change yearly, you’ll likely need a debt-to-income ratio that’s 43% or lower as well as a minimum 580 credit score. If you don’t meet these guidelines, consider consolidating your debt and working toward paying off credit cards to help improve your FICO score. When it comes to the FHA guidelines for qualification, many requirements include a two-year period. Keep this in mind as you prepare for the application process since you’ll want to have a good financial record for at least the past two years before applying.
- Search for homes within FHA guidelines: While you’re shopping for houses, make sure the homes fall within FHA guidelines for loan limits as well as property guidelines. Your home must meet standards for safety, security and soundness. The loan limit will vary depending on where you’re looking for houses, but you can use the U.S. Department of Housing and Urban Development calculator to determine your mortgage limit.
- Get pre-approved for an FHA loan: Pre-approval is not a guarantee that you’ll receive a loan, but it helps increase your odds. To prequalify for an FHA loan, you must meet the following requirements:
- Have worked at least two years with the same employer
- Can show consistent or increasing income over the past two years
- A good credit report with two or less late payments over the last two years
- Any bankruptcy must be at least two years old
- Any foreclosure must be at least two years old
- The mortgage payment will be, at most, 30% of total income
- Apply for an FHA loan: Once you’re ready for the application process, you’re in the home stretch. At this step, you should know which type of loan terms you need — fixed vs. adjustable rates, along with the number of years you want for your loan term. The most common loan type is a 30-year fixed interest.
After you apply, you may need a property appraisal as well. The appraisal will let the FHA know whether your home’s value falls in the scope of your mortgage.
Types of FHA loans
Borrowers can choose from FHA loans in the following categories:
- Fixed-rate — Your mortgage interest rate stays the same throughout the entire length of the loan. The benefit is that you always know what to expect for your interest rate, but you could be locked into a rate that ends up being higher than the average if the market changes.
- Adjustable-rate — With adjustable-rate mortgages, you get an initial fixed rate period for a set number of years. After that initial period, your interest rate will change once per year according to a market adjustment index. There are limits to how low or high it can go, meaning you still get some clarity with how much you’ll end up paying, but it could end up costing you more if the rates increase.
- Jumbo loan — Jumbo loans are for buyers who are looking at more expensive properties that exceed the mortgage limits set by Frannie Mae and Freddie Mac. Though the FHA offers these types of loans, it’s significantly harder to meet the qualifications. Buyers interested in jumbo loans need to have excellent credit scores, higher down payments and lower DTI ratios.
- Condominium loans — Condominium loans may seem like a good option for users who are looking for smaller spaces, but these types of loans may be harder to gain through the FHA. Since the FHA sets property guidelines, it limits the types of condo buildings you’ll be able to look at.
The final word
FHA home loans are a great option for several different types of buyers. Given that the pandemic has caused lenders to tighten their belts, opting for an FHA loan can make it easier to qualify and speed up your home-buying process.
Understanding how to get an FHA loan is key to a smooth approval process. If you’re interested in an FHA loan, you should start by reviewing your finances and making sure you have at least two years of good financial and credit history to qualify.