An FHA loan is a mortgage product that is guaranteed by the Federal Housing Administration. It is commonly used by first-time homebuyers due to its low up-front costs, minimal down payment, and less stringent credit and underwriting requirements compared to other home loan options.
FHA Loan Eligibility
Due to the FHA's requirements, the FHA loan is a great option for first-time and subsequent homebuyers alike. The eligibility requirements are typically less strict than other loan options and open up financing to those who may not have qualified for a conventional mortgage.
To qualify for an FHA loan, a homebuyer typically will need:
- A minimum 500 credit score
- A 3.5 percent down payment for borrowers with a credit score above 580. Borrowers with under a 580 FICO will need to put down at least 10 percent down
- Consistent employment for the last two years
- A debt-to-income ratio, including your mortgage, of 43 percent or less of your gross monthly income (50 percent may be allowed in some situations)
- No bankruptcies in the last two years and no foreclosures in the last three (those with Chapter 13 bankruptcies may qualify as soon as one year with court permission)
Additionally, the property must be used as the homebuyers primary residence, meet FHA and HUD guidelines and appraise for the total loan amount.
Though credit score requirements are lower for FHA loans, a lower credit score may mean a bigger down payment. A score ranging from 500 to 579 requires at least a 10 percent down payment. With a score of 580 or higher, you could put down just 3.5 percent.
FHA Loan Pros and Cons
Relaxed requirements and the low down payment options are some of the biggest benefits of an FHA loan — particularly for first-time buyers.
Additional perks include:
- Low credit score requirements
- Down payment options as low as 3.5 percent
- Down payment funds may be gifted
As for disadvantages, expect the following:
- Not available for investment or income-producing properties
- Mortgage insurance, both up-front and annually
- Set loan limits, which depend on the area you’re buying in
6 Things Homebuyers Should Know About FHA Loans
If you’re considering an FHA loan for your upcoming home purchase, make sure you keep these six things in mind as you're applying:
- They come with annual and up-front fees. An upfront fee of 1.75 percent of the loan amount is added to the total amount you’re borrowing. Annually, you’ll owe anywhere from .45 to .85 percent of the balance — divided into 12 monthly payments. Your annual fee depends on your loan term and loan-to-value.
- You can use gift funds for your down payment and closing costs. This money needs to be a gift from an acceptable source, with no expectation of repayment. Acceptable sources include but are not limited to relatives, friends and down payment assistance programs. Gift funds cannot come from anyone involved in the real estate transaction.
- You can use FHA loans to fix up your property. Buying a fixer-upper? The FHA’s 203(k) can help you cover the costs of repairing the property. You can borrow up to $35,000 to finance nonstructural repairs and roll it into your existing loan balance.
- You can purchase a single-family, two-unit, three-unit or four-unit property. If you’re buying a multi-family home, you must intend to live on the property in order to qualify.
- There are multiple FHA-friendly refinancing options. FHA loans come with several refinancing options, including the FHA Streamline Refinance or the FHA Cash-out Refinance.
- Your property must meet certain standards. FHA loans can only be used to purchase properties that meet guidelines set by HUD (the U.S. Department of Housing and Urban Development) as safe and viable living quarters.
FHA loans also allow other parties — such as sellers, builders and even mortgage lenders — to help cover portions of a buyer’s closing costs, appraisal fees and more. Lenders contributing to these costs may charge higher interest rates as a result.
How to Apply for an FHA Loan
To apply for an FHA loan, get in touch with a Neighbors Bank home loan specialist here. They’ll be able to guide you through your specific scenario and determine if an FHA loan best suits your homebuying or refinance needs.