Do you have too much debt to qualify for a conventional mortgage? Having a less than perfect credit score or not much cash for a down payment or a shorter time period since a foreclosure or bankruptcy? You should consider buying a home with an FHA mortgage loan.
The Federal Housing Administration, a division of the Department of Housing and Urban Development, was created 80 years ago to help low and moderate-income families obtain financing for home ownership when there was not an option for the low income population.
The FHA doesn’t actually make home loans. It guarantees that lenders will be repaid if you default on the loan.
That guarantee 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.
The majority of mortgage lenders are the one that make FHA mortgage loan. One out of every five new home loans is now backed by the FHA according to Ellie Mae, a California-based mortgage technology firm.
FHA has maximum loan limits (loan limits or loan amounts) on how much you can borrow with an FHA loan. (See the FHA Loan Limit based for the county you want to view)
. Most parts of the country the maximum loan amount is up to $271,050 for single-family homes. Some areas are more. You need to see the FHA county loan limit guide
for the county you are in. In high cost areas of the country, as much as $625,550 (areas such as New York and San Francisco).
If the loan amount you need fits in this range then you need to find out more about getting an FHA loan.
They have smaller and more lenient down payment requirements.
FHA mortgages require a down payment of 3.5%. This is $3,500 for every $100,000 you borrow. The average down payment on an FHA home loan is about 5%, according to Ellie Mae statistical reports.
Compared to conventional loans, this is well under the the average non-FHA mortgage loan.
The down payment can come from a gift from a relative, an employer or a community down payment organization that provides financial assistance.
Many conventional mortgages require the down payment to come from a borrower’s savings or other assets, such as proceeds from the sale of another home.
You can qualify with below-average credit scores.
Before the financial crisis, FHA loans were for borrowers with bad credit.
And we mean bad credit. Applicants with FICO credit scores below 640 scooped up more than half of all FHA-backed mortgages, while those with credit scores below 580 received about a quarter of them.
Now borrowers with such bad credit obtain fewer than one out of every 10 FHA loans.
Indeed, the average FICO score for rejected FHA applicants is 665, a score that would have landed in the top half of FHA borrowers just a few years ago.
Most of the money currently goes to home buyers who have below-average, but not terrible, credit. The average credit score for successful applicants is running at 685 so far this year.
But let’s be clear. That’s still way below the average score of 755 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 Chapter 7 bankruptcy, you usually must wait two years from the date of discharge before qualifying.
- Lost a home through foreclosure, you must wait three years. However, if you can prove that the foreclosure was caused by involuntary job loss or income reduction, and your payment history has been good since then, the waiting period can be as little as one year.
- Are delinquent on a federal debt, such as a student loan or income taxes, you can’t get an FHA loan.
- If you have a credit score lower than 500, you won’t qualify under FHA guidelines. Most lenders have a higher minimum of 600.
You’re allowed to carry more debt.
To obtain a non-FHA loan, borrowers must be spending no more than 36% to 45% of their pretax income on all debts, including mortgage payments, student loans, credit card bills and auto loans. The limit depends on the borrower’s down payment and credit score.
With an FHA mortgage, you can stretch that ratio to 47% — or even a little higher in some instances.
“We’ve actually had loans approved over 50%, but they have excellent credit, good job stability, skin in the game and money in the bank after closing,” says Greg Cook, a mortgage broker who specializes in helping first-time home buyers in Temecula, California.
If your credit score is below 580, however, debt-to-income ratio can’t exceed 43%.
Just because you can be approved with a higher debt ratio doesn’t mean you will be. The typical rejected applicant has a debt-to-income ratio of 46.5%, while the typical approved applicant had a debt-to-income ratio of 41%, according to Ellie Mae.
The biggest drawback of FHA loans
The big disadvantage to FHA financing is the mortgage insurance. It’s the price you pay for having the government stand behind your loan.
All borrowers, regardless of loan term or down payment, 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 borrowed.
While that sum can be added to your loan amount so you don’t have to bring more cash to the table, it’s still an extra charge. And if you finance it, you’ll pay interest on it, too.