FHA loans, which are insured by the Federal Housing Administration, help home buyers secure financing to buy a home despite their low income, lack of savings, or poor credit scores—the kind of things that often prevent people from getting a conventional loan.
“FHA loans are a great option for a lot of home buyers, particularly if they’re buying their first home,” says Todd Sheinin, mortgage lender and chief operating officer at New America Financial in Gaithersburg, MD. And while not all lenders offer FHA loans, many do, because their government backing guarantees that lenders won’t lose their money if the buyer defaults. So it’s win-win all round!
Yet although FHA loans have looser qualification requirements than traditional mortgages, that doesn’t mean they have none at all. While the exact rules and thresholds will vary a bit by lender, here’s a ballpark guide to what you can expect you’ll need to qualify.
1. A minimum down payment of 3.5%
With conventional loans, it’s generally recommended that you make a 20% down payment, which would amount to a whopping $50,000 on a $250,000 home. FHA loans lower the bar to a far more realistic level, requiring as little as 3.5%. So, on a $250,000 house, you would only need to plunk down $8,750 to qualify for an FHA loan.
This is a boon, particularly for first-time home buyers, who tend to have less money socked away to put toward their dream of home ownership. In fact, a recent study from Apartment List found that more than two-thirds of millennials don’t even have $1,000 saved up for a down payment. And millennials are now the largest group of home buyers.
2. A minimum credit score of 500
To qualify for an FHA loan, your credit score—the numerical representation of your track record paying past debts—will need to be at least 500—although if your score is indeed in this low range, you’ll have to make a slightly larger down payment, of 10%. To take advantage of that teeny weeny 3.5% down, you’ll need a credit score that’s slightly higher, at 580 or above. All that said, keep in mind that credit requirements may fluctuate not only by lender but based on changes in the housing market.
3. You’ll have to pay mortgage insurance
Because the federal government insures these loans, borrowers must pay an upfront mortgage insurance premium (MIP). Currently, the fee is 1.75%—that’s $4,375 on a $250,000 home loan. However, once you’ve accrued 20% equity in the home, the MIP should drop off from your mortgage payments. (Note: You’ll want to follow up with your lender at that point, to make sure the insurance premium has been removed.)
Borrowers will also have to pay annual mortgage insurance, currently around 0.85% of the borrowed loan amount—or $2,125 more per year. For most loans, this mortgage insurance remains throughout the life of the loan, or until you refinance out of an FHA loan to get rid of it, says Jordan Dobbs, a loan officer at Washington First Mortgage in Rockville, MD.
4. A maximum debt-to-income ratio of 43%
Debt-to-income ratio is a way lenders determine whether you can afford your housing payments, by comparing the amount of money you make to what you owe. Currently, the maximum debt-to-income ratio for an FHA loan is 31%. In other words, if your monthly pretax salary is $6,000, your housing expenses should not exceed about a third of your income, or $1,860.
More realistically, however, debt-to-income ratio should factor in all of your recurring debts, including college and car loans. In this context, the FHA generally looks for a borrower’s total debt load not to exceed 43% of pretax income. To use the $6,000 example above, that would mean that the maximum amount you should be paying for your mortgage and other debts (credit card not included) is $2,580. Check this FHA resource for more information.
5. The home must undergo a rigorous appraisal
While pretty much all loans require a home appraisal, so lenders can make sure their money isn’t funding a shack, FHA appraisal guidelines are more rigid than those for conventional loans, and not all houses will get the green light for FHA approval. This may mean that the seller of your desired home will need to make some repairs in order for your lender to approve the loan.
6. What are the FHA loan limits?
FHA loan programs only insure loans up to the maximum limit, which varies by county. In most areas, the limit is $472,030 for single-family homes. And in certain high-cost areas, the limit is $1,089,300. (That figure rises to $1,633,950 in Alaska, Hawaii, Guam, and the U.S. Virgin Islands.) You can see the FHA loan limits for your county at Hud.gov.
