FHA Mortgage Loans

FHA Loans Explained
 
Federal Housing Authority (FHA)-backed mortgages allow first time home seekers to have the opportunity to buy a home along with the ease of less stringent requirements.  One feature is a low minimum down payment (currently 3.50%)

  • Credit expectations within reason
  • Flexible income requirement options

Providers of FHA loans are willing to look at the entire picture as opposed to frowning upon a borrower for a single shortcoming on a particular criterion in contrast to conventional loans.

Not everyone can qualify for an FHA loan however. The feeling of frustration and not understanding how lenders determine your eligibility for a particular loan program is normal during the application process. We'll discuss some of the basic requirements for FHA financing to help make the complex mortgage application and approval process less harrowing.

Background

It is thought that the money for an FHA mortgage is given to borrowers by the FHA. However, this is not the case. Rather, receiving funds from an FHA-approved lender, followed by FHA guaranteeing the loan is the protocol. In one scenario, different lending institutions may offer you a comparable and similar loan (or possibly turn you down), since the loan guidelines don't change based on whom you borrow the money from.

In another scenario, the FHA offers lenders flexibility in determining loan eligibility based on the applicant's situation as a whole, rather than requiring strict adherence to a list of requirements. Different underwriters are granted permission to interpret the guidelines differently; one institution may give you a loan while another adamantly refuses. Below are the major components that determine borrower eligibility.

Dwellings Eligible for FHA Mortgages

A property financed with an FHA loan must be the borrower's primary residence and must be owner-occupied. This loan program cannot be used for rental properties or investments. Detached and semi-detached houses, townhouses, row houses and condos within FHA-approved condo projects are all eligible for FHA financing. 

Maximum Mortgage Amount

The maximum mortgage a borrower can receive, assuming he or she has the required income, is the lesser of:

  • The statutory limit for the geographic area in which the home is located.
  • The maximum “loan to value” (LTV) ratio.

Limits are indexed to Freddie Mac-conforming loan limits. As of mid-2007, the limit is $417,000 in most areas and more in a few high-cost-of-living areas like Alaska and Hawaii.

Credit Score

A unique feature of FHA is that there are no minimum credit score requirements for its loans. That being said, actions such as falling behind on payments are reflected in borrowers with poor scores and therefore may be disqualified.  A lack of credit history is not a major issue. The lender will however look at other payment-history records, such as utility and rent payments. Further, a previous foreclosure, short sale, or bankruptcy will not disqualify the borrower, as long as enough time has passed. Typically this time frame is three years for a foreclosure or short sale and one to two years for bankruptcy. In addition, by documenting their ability to responsibly manage their finances since the negative occurrence, the borrower will be favorably looked upon
 
Also, consumers who participate in credit-counseling plans are eligible for FHA loans as long as they have been in the program for at least a year and have made all the required payments on time. Consumers who have successfully completed a credit-counseling plan should be prepared to provide documentation of successful program completion.

Employment and Income

Steady income that can be documented, which is your effective income, can only be considered for a borrower's mortgage eligibility. Most lenders, including us, prefer to see two consistent years of employment in the same line of work prior to the mortgage application, with a one-month gap in between employment at most. The job must be expected to continue for at least three years after obtaining the loan.

Unless it has been uninterrupted for the last two years, part time employment is not accounted for. A full-time contract position that is close to expiring may not count, nor will the current salary of a person expecting to retire. (Carrying a mortgage in retirement might negatively impact your finances.
 
If you’re a person who’s had frequent changes in jobs because you’re moving up in your field, and raising income, you will be favorably looked upon. In addition, allowances are given for those who work seasonally or took a longer period away to pursue school or raise a family.
 
For self-employed individuals, 2 years of successful employment history is needed. Tax returns, a current year-to-date profit loss statement, and balance sheet will be further needed to document this. Applicants who have been self-employed for less than two years but more than one year can be eligible if they 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 occupation.
 
Debt-To-Income Ratios

The FHA does not set a maximum limit for the debt- to-income ratio though exceeding a 45% back end ratio takes special consideration and considerable cash reserves. This means that, as of mid-2008, the total of your debt obligations should not exceed 45% of your gross effective income. These obligations can include:

  • Mortgage
  • Interest
  • Taxes
  • Insurance
  • Credit cards
  • Student loans
  • Car payments

So if you and your spouse together make $6,000 a month before taxes, your house payment plus your other monthly debt payments would need to be under $2,700.

Down Payment

FHA loans offer one of the most generously low down payments- just 3.50% of the purchase price.
 
Gift funds from a trusted source, such as a relative or employer, may be contributed to the down payment upon verification. If the gift was given in the distant past, generally three months or more for mortgage purposes, it will not need to be verified or even mentioned in the application.  FHA wants documentation for gifts close to the time of purchase to ensure money is not from a new loan because this would throw off the borrower's previously approved debt-to-income ratio.

Closing Costs

FHA loans allow the seller to contribute up to 6% of the purchase price toward the buyer's closing costs.  Buyers strapped for cash, or those who rather hold on to their cash to invest at another time (to remodel, or purchase a home) use this feature to do so with ease.
 
Mortgage Insurance

Because of their low down payments, mortgage insurance is a requirement for FHA loans. Up-front mortgage insurance is due at the time the loan is taken out. This amount is equal to 1.5% of the loan amount and is typically rolled into the mortgage so the buyer doesn't have to come up with extra cash to close. Combining this premium into the mortgage does increase the monthly payment slightly but does not decrease the total loan a borrower is eligible for. The monthly payment will also include a monthly mortgage-insurance premium, which costs about 0.55% of the loan amount on an annual basis. This premium is generally lower than the private mortgage insurance (PMI) would cost on a non-FHA loan with the same down payment.

FHA Inspection and Appraisal Requirements

Even if you qualify for an FHA mortgage, that doesn't mean you'll be able to purchase the exact home you want. This is because the FHA requires all the mortgages it insures to be backed by homes of a particular caliber. Essentially, the home must be habitable, with running water, toilets, a stove and the other elements necessary to live in a safe and sanitary manner. Extreme fixer-uppers, while they can be a bargain, are not likely to qualify for FHA financing because of this requirement
 
Also, if the property does not appraise at or above the purchase price, it cannot be purchased with an FHA loan unless the purchaser/borrower can come up with enough cash to make up the difference between the appraisal and the sale price.