The Federal Housing Administration (FHA) is the branch of government that makes it easier for hopeful homeowners to purchase the property of their dreams. While conventional mortgage loans traditionally request good to excellent credit and substantial savings, the FHA relaxes their requirements so more people have a chance at buying a home. The FHA also backs the loan in the case of default so that lenders have that many more reasons to work with clients.
Understanding an FHA
FHA loans were originally established in the 1930's as a way to inject life into a sluggish housing market. It should be noted however that the FHA is insuring the loan as opposed to actually loaning the money. As a result, officials work with lenders to establish the guidelines for who can apply and how their application will be processed. That being said, it's the lender who makes the final decisions about the rates and terms of the loan. They can choose to strictly adhere to government recommendations, or they can make their own decisions as they see fit.
What You Need to Apply
Getting an FHA loan will require the following:
- 580 credit score
- 3.5% cash down payment or greater
- Steady work history
- FHA-approved vendor appraisal
There are a few exceptions to these rules. For example, if the borrower has at least 10% in a cash down payment, they may be approved with a credit score as low as 500. If the borrower has worked for the same employer for at least two years, they may be approved without an otherwise stable work history.
Running the Numbers
How much a person is allowed to borrow will depend on both their savings and the area in which they choose to live. Conventional loans still get preferential treatment, so if a buyer is looking in a competitive market, they'll have additional limits compared to less popular areas. As with conventional loans though, buyers should strive to match their housing with that of their total income. At most, there should be a 30% discrepancy.
So if the Leawood home buyer makes $5,000 a month in gross income, then their housing fees (e.g., mortgage, property taxes, insurance, HOA fees, etc.) should be $1,500 or less. Striving for these numbers not only make applicants more attractive to lenders, they also make it easier for buyers to meet their monthly payments. When calculating total monthly debt (e.g., student loans, car loans, etc.), buyers should aim for a ratio of 43% or less. In this example, a person should be spending $2,150 a month or less on total monthly debt.
Lenders will work with buyers to a certain extent on many of these factors, especially debt-to-income ratios. However, there are a few hard-and-fast restrictions that buyers should know:
- Bankruptcy: People who filed for bankruptcy need to wait at least two years before they qualify for a home loan. Their credit record will need to be spotless during those two years to qualify.
- Foreclosure: Those who foreclosed on their previous home will need to wait at least three years.
- Appraisal: The home needs to meet the standards of an FHA-approved appraiser. If the home needs repairs or poses any kind of safety risk, it will not be approved.
An FHA loan can be a great way to secure a loan when buyers have few available options. However, there's more to the application process than meets the eye. Buyers are highly encouraged to meet with several lenders to discuss the terms, rates, and monthly payments before making a final selection.