The FHA loan is a mortgage that’s insured by the Federal Housing Administration (FHA). This loan is popular among first time home buyers because they allow down payments of 3.5% for credit scores of 580+.
The FHA program was created in response to the rash of foreclosures and defaults that happened in the 1930s. It aimed to provide mortgage lenders with adequate insurance and helped stimulate the housing market by making loans accessible and affordable for people with less than stellar credit or a low down payment. Essentially, the federal government insures loans for FHA-approved lenders in order to reduce their risk of loss if a borrower defaults on their mortgage payments.
FHA borrowers must pay mortgage insurance premiums, which protects the lender if a borrower defaults.
- Borrowers must have a steady two year employment history.
- Borrowers must have a valid Social Security number, lawful residency in the U.S. and be of legal age to sign a mortgage in your state.
- Borrowers must pay a minimum down payment of 3.5 percent, but money can be gifted by a family member.
- New FHA loans are only available for primary residence occupancy.
- Borrowers must have a property appraisal from a FHA-approved appraiser.
- Borrowers’ front-end ratio (mortgage payment plus HOA fees, property taxes, mortgage insurance, homeowners insurance needs to be less than 31 percent of their gross income unless a special exemption is granted.
- Borrowers’ back-end ratio (mortgage plus all your monthly debt, i.e., credit card payment, car payment, student loans, etc.) needs to be less than 43 percent of their gross income. Again, an exemption can be granted in certain cases.
- Borrowers must have a minimum credit score of 580 for maximum financing with a minimum down payment of 3.5 percent.
- Borrowers must have a minimum credit score of 500-579 for maximum LTV of 90 percent with a minimum down payment of 10 percent. FHA-qualified lenders will use a case-by-case basis to determine an applicant’s credit worthiness.
FHA Requires Good Credit
- Typically borrowers must be two years out of bankruptcy and have re-established good credit. Exceptions can be made if you are out of bankruptcy for more than one year if there were extenuating circumstances beyond your control that caused the bankruptcy and you’ve managed your money in a responsible manner.
- Typically borrowers must be three years out of foreclosure and have re-established good credit. Exceptions can be made if there were extenuating circumstances and you’ve improved your credit. If you were unable to sell your home because you had to move to a new area, this does not qualify as an exception to the three-year foreclosure guideline.
- The property must meet certain minimum standards at appraisal. If the home you are purchasing does not meet these standards and a seller will not agree to the required repairs, your only option is to pay for the required repairs at closing (to be held in escrow until the repairs are complete).