Understanding the Application Process of FHA Loans
Owning a house is a cherished dream for professionals of all walks of life, with many relying on loans and mortgages to accomplish it. However, with lenders requiring high down payment rates of up to 20% of the total cost, becoming a homeowner is certainly no cakewalk. Individuals from low- to middle-income groups can find it especially difficult to cope with high down payments, and this is where FHA loans can come to their rescue.
What is an FHA Loan?
Specifically designed to help lower-income families achieve homeownership, an FHA loan is a federal government-backed home mortgage that is issued by the Federal Housing Administration (FHA).
While the loans are issued by the FHA, they are actually countersigned and administered by pre-approved third-party lenders. These lenders are insured by the FHA against any losses incurred in case the respective borrowers default on their loans. Since the lenders are insured, they are willing to loan out money to even individuals who cannot afford a high down payment.
What is the minimum credit score for FHA loans?
As of 2022, the minimum credit score required for an FHA loan is 500. However, borrowers with a score between 500 and 579 are required to make a 10% down payment in order to successfully avail an FHA loan. On the other hand, those with a credit score of 580 or higher can avail the loan with a significantly lower down payment of 3.5%.
So, although the minimum credit score for FHA loans is 500, it is accompanied by the caveat of a high 10% down payment. To bypass this caveat and receive maximum financing, borrowers are advised to have a credit score of 580 or above.
Since FHA loans are processed and administered by third-party lenders, the eligibility criteria for an FHA loan can change depending on the lender. Some lenders may require borrowers to have a higher credit score than the aforementioned FHA-approved minimum score.
Other FHA loan requirements
While the credit requirements for an FHA loan are its most defining feature, there are a few other basic requirements that need to be met in order to qualify for the loan. Let us take a closer look at these.
Debt-to-Income ratio
An individual’s debt-to-income (DTI) ratio is calculated by dividing their monthly debt payments by their monthly income. In the context of FHA loans, a borrower’s DTI is split into Front-end DTI and Back-end DTI. While the former is the ratio of a borrower’s monthly income that is being allocated towards mortgage payments, the latter is a ratio of a borrower’s monthly income that is being allocated towards paying all other outstanding debts.
To be eligible for an FHA loan, borrowers are generally required to have a front-end DTI ratio of 31% or less, and a back-end DTI ratio of 43% or less. However, similar to the credit requirements for an FHA loan, the DTI requirements can also change depending on individual lenders.
Property requirements
A property can only be eligible for an FHA loan if it is being used as the borrower’s primary residence. Furthermore, the property should either be a single-family home, a multi-family home with no more than four units, or a manufactured home that sits on a permanent foundation. Lastly, at least one of the involved borrowers needs to occupy the property in question within 60 days of closing.
FHA loan limits
Existing FHA loan requirements include certain loan limits that determine the amount of money an individual can borrow. These limits can depend upon the type and location of the property that needs to be financed. Borrowers are not allowed to surpass these limits in any case whatsoever. In 2022, the FHA loan limit for a single-family home in most locations in the country is $420,680, and this limit can increase up to $970,800 for higher-cost locations.
FHA mortgage insurance
Third-party lenders are not hesitant to offer FHA-insured loans because they know that FHA will pay them back in case a borrower defaults on a loan. Essentially, this financial backing is funded by the borrower in the form of FHA Mortgage Insurance. Borrowers are required to make an upfront premium payment equal to 1.75 of the base loan amount, followed by monthly mortgage insurance payments depending on the term of the loan, total mortgage amount, and the down payment.
Ultimately, there remains little doubt that an FHA loan requirements are much more relaxed as compared to the requirements for other conventional loans. Individuals from the lower strata of society can especially appreciate the low down payment that accompanies an FHA loan. Since an FHA loan has a minimum credit score, it is probably the best path towards home ownership for borrowers who have a less-than-perfect credit rating.
