What is an FHA loan?
An FHA home loan is a mortgage that is insured by the Federal Housing Administration. These mortgages are backed by the United States federal government. They are designed to help buyers who cannot qualify for Conventional loans get financing for the home of their dreams.
The Federal Housing Administration doesn’t issue mortgages itself. The agency provides insurance on mortgage payments, so more borrowers can get home financing through an FHA-approved lender, such as a bank. The borrower pays the FHA a mortgage insurance premium (MIP). This allows the FHA to guarantee your loan and make sure the lender is protected from loss if you are unable to repay the loan.
FHA loans are designed to make homeownership more affordable. They originated in the United States in 1934 to help homebuyers with less than perfect credit purchase homes, however, they are now popular with a wider group of borrowers, including first-time homebuyers.
FHA Loan Overview
A loan from the Federal Housing Administration (FHA) can be used to buy a house or refinance an existing mortgage. You can buy a house with a lower down payment than a Conventional loan, or use a streamline refinance to refinance your current mortgage in order to reduce your current payment, with less documentation and information than a traditional loan.
For 2022, individuals may borrow up to 96.5% of the value of a home with an FHA loan, leaving only 3.5% of the home’s value to put down. The FHA loan limit for most of the country is $420,680 and up to $970,800 in costly areas.
FHA Loan Requirements
There are many FHA home loans and FHA loan requirements vary depending on the loan type. The terms and requirements for FHA loans are stricter than Conventional loans because the credit conditions are less limited.
- A credit score of 580 or higher - a lender may accept a credit score as low as 500 if you are able to make a higher down payment
- The ability to pay a 3.5%-10% down payment depending on your credit score
- Proof of steady income and consistent employment – this can include tax returns, pay stubs, or W-2s for a minimum of two years
- Mortgage insurance – the ability to pay the mortgage insurance premium (MIP) is required. The dollar amount of MIP will depend on the amount of the loan. However, all FHA loans will require borrowers to pay an upfront MIP of 1.75%, as well as a monthly mortgage insurance premium for the life of the loan.
- Higher home inspection standards
- Loan must be for a principal residential property
- Higher Debt-To-Income Ratio: FHA loans can have a DTI of as much as 57% under certain circumstance. This makes FHA loans easier to qualify for than Conventional loans where the DTI can only be up to 45%.
FHA Loan Benefits
FHA loans enable more people to achieve homeownership. They allow borrowers who have less than perfect credit, no credit history, or who may have experienced some financial missteps, like a foreclosure or bankruptcy, to qualify.
The program has become popular with first-time homebuyers and move-up buyers because you can buy a house with a lower down payment, and the underwriting standards are more flexible.
With lower down payment options and flexible lending guidelines, this loan type is a top choice for today's buyers.
- Wide Variety of FHA Loan Options: Whether it is a 30-year fixed-rate mortgage or a 15-year fixed-rate mortgage, FHA has you covered.
- FHA Allows Low Down Payments: With a low down payment option, more people can buy a new house. This is great for first-time homebuyers, and those who have little money to put down.
- FHA Loans May be Combined with Down Payment Assistance Programs: This can take the form of funded grants, a low-interest loan, or a forgivable loan.
- FHA Allows 100% Gift Funds: In addition to a low down payment, those funds can come from a gift.
- FHA Insures Various Types of Properties: They are available for single-family detached homes, two-to-four unit homes, condos, and manufactured homes.
- FHA Streamline Refinance: One of the unique features of an FHA loan is the ability to Streamline Refinance. This is the easiest way to refinance. There may be no credit qualification requirements, no income verification, and no appraisals required if you refinance your FHA loan.
One big advantage of FHA loans is that FHA permits the seller of the property to pay some of the closing costs (origination fees, attorney fees, appraisal costs, etc.) on your behalf. Sellers can choose to further incentivize the purchase of their home if they’re having trouble finding a buyer.
Types of FHA Loans
FHA Fixed-Rate Mortgages
FHA 15-Year Fixed-Rate Loan:
- All the benefits of a 30-Year Fixed-Rate Loan
- Save thousands in interest over the life of the loan
- Build equity faster
- Pay your house off sooner
FHA 30-Year Fixed-Rate Loan:
- No prepayment penalties
- Low down payment options
- Gift funds allowed
- Ability to Streamline Refinance
FHA Adjustable-Rate Mortgages
FHA 5/1 Adjustable-Rate Mortgage:
- Keeps interest rates low for 5 years
- Introductory interest rates are typically lower than fixed rates
- Good for buyers who plan to own the home for a short time or refinance in a few years
FHA Streamline Refinance Loans
FHA Streamline 30-Year Fixed-Rate Refinance Loan:
- Lower your payment by lowering your current interest rate
- Convert an FHA Adjustable-Rate Mortgage into a fixed-rate mortgage
- FHA Streamline refinance loans require less documentation than a traditional loan
- No appraisal required
- No income documentation
- Easier to qualify
- No appraisal required
FHA Streamline 5/1 Adjustable-Rate Refinance Mortgage
- FHA 5/1 ARM establishes a lower initial interest rate for the first five years, after which the market determines your rate
- Adjustable-Rate Mortgages typically have lower interest rates than fixed rate loans
- Useful if you plan on selling your home soon
FHA 203(k) Loans
FHA 203(k) Limited Loan
- Good for homes that need renovations (not major structural repairs)
- Can cover mortgage payments during home repairs
- Offers low credit score requirements and down payments
- Can be used for energy efficient upgrades
FHA 203(k) Standard Loan
- Good for homes that need renovations including major structural repairs
- Can be used for repairs and to improve things like home accessibility for persons with disabilities
- Can also cover mortgage payments during home repairs
FHA Cash-Out Refinance Loan
- Gives you cash back
- Can borrow up to 80% of your home’s value
- Low credit requirements
- Can be used to consolidate debt
- Can be used for personal projects like a safety net during a change in careers
FHA Loan or Conventional Loan?
Whether you apply for an FHA loan or a Conventional loan will depend on your specific circumstances. Both loan types offer many advantages. An FHA loan can often be replaced by a Conventional loan. Although Conventional mortgages have different financial requirements for approval, they also sometimes have cheaper interest rates and private mortgage insurance that terminates at 20% equity, which is why some borrowers consider switching to a Conventional loan.
Refinancing your FHA loan to a conventional loan can eliminate your MIP.
Learn more about the difference between FHA Loans and Conventional Loans to find out which loan option is right for you.
FHA Benefits for Seniors
FHA loans can be great for seniors because they generally offer lower interest rates, lower down payments, and approve lower credit scores.
FHA and Retirement
Many people may not consider how important it is for seniors to have the freedom to move to a new home. Whether you want to be closer to family, relocate to your dream city, or simply change to a smaller home that is easier to take care of, there are options for you.
If you choose to stay in your current home after retiring and don't plan on moving, taking a cash-out refinance can be a great way to get additional money that you can use towards traveling and living a stress-free life. However, when applying for a loan, a lender will require proof of a steady income that will allow for the mortgage to be paid. This is where many retired borrowers feel deterred in seeking out a new loan.
When calculating debt-to-income ratio, the lender must follow the specific guidelines set up by the Department of Housing and Urban Development. When it comes to retirement pay, including pension and 401k funds, the lender must verify this information with documentation to show how much income you are receiving and how long that income will continue.
Social Security incomes must also be verified by the Social Security Administration. If these benefits are scheduled to expire within the first three years of the loan, this income must only be considered as a compensation factor. This will disqualify this borrower from being able to secure a loan, unless they can prove that they are getting an income from either a part time job or another qualifying source.
Equal Credit Opportunity Act
But there is a light at the end of the tunnel. As long as your 401k, pension, or Social Security benefits are scheduled to continue for over three years, getting an FHA loan can be a fairly straightforward process. In fact, your age or retirement status should not even be a factor in getting a loan as long as your finances fit into the FHA guidelines. The Equal Credit Opportunity Act has made it illegal for a lender to discriminate against age for any qualified borrower.
Other FHA Loan Considerations
For FHA loans, the property being financed is to be your primary residence and the loans can’t be used for investment or rental properties. Eligible residences include semi-detached homes, townhouses, row houses, and certain condominiums.
For approval, you will need to show that your mortgage payments, HOA fees, property taxes, mortgage and homeowner’s insurance are no more than 47% of your gross income. You can use a mortgage calculator to estimate your monthly mortgage payments.
The amount of the loan you qualify for will depend on where you are located. You will also be required to have the property appraised by an FHA-approved appraiser. You will be forced to pay for repairs at closing if the home does not meet certain FHA standards and the seller refuses to make repairs.
Lastly, it will need to have been at least two years since any Chapter 7 bankruptcy discharge, and you will need to have re-established good credit or chosen not to incur new credit obligations. If you are in an active Chapter 13 bankruptcy but have been paying for 12 consecutive months, you may be eligible for an FHA loan.
If you have been foreclosed upon, it must have been no more recent than three years ago.
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How do I apply for an FHA Loan?
The first step in applying for an FHA Loan is finding the lender you want to work with. Since the FHA insures the loan and doesn’t directly lend the money, you’ll need to find an FHA-approved lender. Each lender has their own unique terms and requirements. You will want to research a few to find which one will work the best for your needs.
After you find your lender, you will want to start gathering documents and figuring out your assets. You will need proof of income. This can be W-2s, tax returns, or pay stubs. You will want to show evidence of other assets like alimony or rental income. You will also need documentation of any debts you currently hold.
Your loan officer will help you submit a loan application online, on the phone, or through email. Once you are approved for the loan, it’s time to begin shopping for your new home.
Does an FHA Loan Cover Closing Costs?
FHA loans allow for certain closing costs to be rolled into the loan amount. For example, a borrower can include the upfront mortgage insurance premium (UFMIP) into their closing costs.
FHA loans also allow sellers to help offset closing costs like origination fees or appraisal costs for the buyer.
How Much Home Loan Can I Qualify for With an FHA Loan?
The amount you can borrow with an FHA loan largely depends on where you reside.
For most of the country, the 2022 limit for an FHA loan is $420,680 for 1-unit properties, $538,650 for 2-unit properties, $651,050 for 3-unit properties, and $809,150 for 4-unit properties.
There are certain areas of the country such as Los Angeles, San Francisco, and others, where the FHA loan limit for 2022 is higher because the home prices in these markets are higher.
Are There Different FHA Loan Options?
Borrowers have a few different FHA loan options available, including:
- FHA 15- and 30-Year Fixed-Rate Mortgages
- FHA Adjustable-Rate Mortgages
- FHA Streamline Refinance Loans
Learn more about the different types of FHA loans to find the right type of loan for you.
Can I Refinance an FHA Loan?
It is possible to refinance an FHA loan. Homeowners can refinance into a different FHA loan or opt to refinance from an FHA loan to a Conventional loan. Borrowers may want to refinance if they can eliminate FHA mortgage insurance, or if they can get a lower interest rate.
How Soon Can I Refinance an FHA Loan to a Conventional Loan?
You can refinance to a Conventional loan when you reach 20% equity on your home.
When Can I Drop MIP on an FHA Loan?
When you can drop MIP on an FHA loan depends on several factors. These can include the date your original FHA loan took effect and the specific terms of your individual agreement with your mortgage company. It is recommended that you contact your mortgage company and see if you can remove MIP from your loan.
If you can’t, then you can also look into refinancing your loan to a Conventional loan. Doing so may eliminate your MIP.
Can You Buy a Foreclosure with an FHA Loan?
Yes, FHA loans can be used to purchase a home that has been foreclosed on. It’s important to know that the FHA property standards still apply. This means the property is subject to an appraisal and must be in good condition. FHA lending rules also apply when buying a foreclosure.
Can self-employed individuals qualify for FHA loans?
For those who are self-employed, the FHA will require proof of two years of tax returns and an up-to-date balance sheet and profit and loss statement to qualify for an FHA loan. If you have been self-employed between one to two years, you may still be eligible for an FHA loan if you have a good work and finance history for the two years leading up to becoming self-employed and you are in the same or related occupation.
Even if you have filed for bankruptcy or been foreclosed upon, you can still qualify so long as you’ve rebuilt your credit. The waiting period is usually 3 years after a foreclosure and 2 years after a bankruptcy.