When you're ready to buy a home, you'll discover a wide variety of loan programs. However, if you have less than perfect credit or a limited amount of money available for a down payment, your options become limited. Federal Housing Administration (FHA) loans are one of the easiest loans to qualify for, because down payments and credit score requirements are much lower than conventional home loans. Below are some general requirements to better understand how these loans work.
What Is an FHA Loan?
The FHA is a branch of the U.S. Department of Housing and Urban Development and offers government-backed mortgages. While the FHA insures these loans, it isn't the lender. Home buyers get FHA loans from FHA-approved lenders. However, because the FHA guarantees these loans, these lenders are often willing to approve borrowers they might not otherwise consider. To qualify for an FHA home loan, you must meet certain credit score and down payment requirements, show proof of employment and steady income and have a favorable debt-to-income ratio that includes your estimated mortgage payment. Plus, the home you wish to purchase must pass an appraisal performed by an FHA-approved appraiser.
Credit issues or less than stellar credit doesn’t necessary disqualify from obtaining an FHA loan, however your down payment requirement will increase. If your credit score is 580 or higher, you may qualify for an FHA loan with a down payment as low as 3.5%. However, if your score is between 500 – 579, you’ll be required to pay at least 10% down. You're generally ineligible for an FHA loan with a credit score under 500, but allowances may be made under certain circumstances, when you meet other criteria.
Down Payment Requirements
Many conventional mortgages require 20% down. FHA mortgage applicants may qualify for down payments as low as 3.5% -- the minimum amount required. However, your down payment hinges on your credit score, and increases as your score decreases. You can pay your down payment from your savings, but it can also be a financial gift from a family member. You can also receive down payment assistance from government grants or city, county or state housing authorities or nonprofit organizations.
Your total closing costs vary based on your state of residence, size of your loan and whether you paid points to lower your interest rate. However, FHA-approved lenders aren’t allowed to charge more than 3% to 5% of your loan amount for closing costs. FHA requirements define which closing costs are allowable and the amounts deemed reasonable. The FHA also allows the home seller, builder and/or lender to pay some of your closing costs.
Mortgage Insurance Requirements
Because FHA loans require less than 20% down, you’re required to pay mortgage insurance. This insurance protects lenders from loan defaults. The FHA requires both upfront and annual mortgage insurance, regardless of the amount of your down payment.
Upfront mortgage insurance is a percentage of your loan amount and one-time premium paid when you close on your loan. However, you’re allowed to roll your upfront premium into your mortgage, which increases your monthly payment.
Annual mortgage insurance is also a percentage of your loan amount, but this percentage varies based on loan amount, loan term (length of loan repayment, usually 15 or 30 years) and initial loan-to-value ratio (loan amount divided by the appraised value of the home). Annual insurance is actually charged monthly, so the total amount is divided by 12 to determine your monthly payment. This amount is added to your mortgage payment for one total payment each month.
If your loan-to-value amount was greater than 90% when you signed your loan, you’re required to pay annual mortgage insurance the entire loan term. If your loan-to-value was less than 90%, you pay mortgage insurance for the loan term or 11 years, whichever comes first.
The FHA adjusts its loan limits annually to set a minimum and maximum amount they will lend on any given loan. These limits are influenced by shifting home prices and conventional loan limits. Maximum loan amounts are usually slightly higher than median home prices in a specified area. Thus, the amount can vary from state to state and even county to county. Cost of living in a specific area and special exceptions for areas with higher home construction costs can also affect these limits.
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