The FHA loan program is “amazing” for first-time buyers
If you’re looking to buy your first home, an FHA loan may be able to help you do it. These loans tend to be easier to qualify for than conventional financing, and they offer low down payments as well.
Mortgage advisor Ivan Simental recently delved into this “amazing loan program,” as he puts it, on an episode of The Mortgage Reports podcast.
Are you considering an FHA loan for your home purchase? Here’s what you need to know:
Listen to Ivan on The Mortgage Reports Podcast!
Requirements to qualify for an FHA loan
If you want to buy a home or refinance with an FHA loan, you’ll need to meet some basic requirements set by the Federal Housing Administration. Keep in mind that these are FHA’s baseline requirements, and in practice, rules can vary from one mortgage lender to the next:
- 580 minimum credit score in most cases
- 3.5% minimum down payment
- Debt-to-income ratio below 50%
- Steady, two-year history of income and employment
Your mortgage lender will verify your eligibility when you apply by checking paperwork (like bank statements and tax returns) and by pulling your credit score and credit reports.
The home you’re buying also needs to meet FHA requirements.
FHA allows financing for 1-, 2-, 3-, and 4-unit homes, as long as the borrower uses the property as a primary residence. In addition, the home must meet basic standards for safety and livability. And your loan amount has to be within local FHA loan limits.
Credit score matters for FHA loans
With FHA loans, there are different credit score brackets. The bracket you fall into will determine your down payment, your interest rate, and whether you qualify for an FHA loan at all.
Here’s how those brackets breakdown:
- 500 to 579: You’ll need a 10% down payment and can expect the highest interest rates
- 580 to 639: You’ll need a 3.5% down payment. If you have at least a 620, you’ll get much better interest rates than the previous bracket
- 640 to 679: You’ll need a 3.5% down payment, and as Simental puts it, “You’ll get way better interest rates, and the terms of the financing are just much more favorable”
- 680 and up: You’ll need a 3.5% down payment and should consider a conventional loan instead
“A 680 is where you really, really want to start taking a look at conventional financing,” Simental says.
“I wouldn’t want you to stay in an FHA loan for the entire life of your loan. If you have a 680 FICO score or above, definitely ask your lender if you can qualify for conventional financing just because it’s overall a better program for you.”
Options for FHA down payment and closing cost help
Worried about covering that down payment? There are lots of options with FHA loans.
For one, you can use a down payment assistance program. These are often offered through state and local housing agencies or nonprofit organizations and can cover some or even all of your down payment and closing costs.
You can also:
- Get assistance from a family member. Just note that the assistance must be a true gift — not a loan — and be properly documented
- Ask your real estate agent to contribute. FHA allows realtors to contribute all or a portion of their commission to a buyer’s down payment or closing costs
- Use lender credits. This means the lender covers part or all of you fees. In exchange, you typically pay a slightly higher interest rate
If you opt for the latter, you’d take a higher interest rate, and then the lender would contribute money toward your closing costs. As Simental explains, “Yes, your payment will go up a little bit, but you have to come with zero money out of your pocket.”
Buyers should plan to refinance into a conventional loan within a few years if they go this route. This will allow them to get out of that higher payment and reduce their interest rate.
Also, note that FHA isn’t the only type of home loan that allows down payment assistance. You could use gift money, lender credits, and/or seller credits with just about any mortgage program. For more information, learn about closing costs and how to lower them.
Expect mortgage insurance
All FHA loans require mortgage insurance, which protects the lender if you default on the loan. The exact amount of insurance you’ll pay depends on your down payment, loan term, and loan amount. But annually, it typically ranges anywhere from 0.45% to 1.05% of your loan balance. Your premiums are spread out across the year and added to your monthly mortgage payment.
There’s also an upfront mortgage insurance premium fee required by FHA. This is equal to 1.75% of the loan amount, but most borrowers don’t actually pay it upfront. Instead, they roll it into their loan balance.
In some cases, you may be able to cancel your mortgage insurance after 11 years; in others, it may be permanent for the entire life of the loan.
“If you put more than 10% down, your mortgage insurance will fall off after 11 years,” Simental says. For those who made a smaller down payment, “You’ll need to refinance into a conventional product once you’ve gained the 20% equity in your house.”
Social Security recipients get an extra perk
If you’re using Social Security or disability income to qualify for your FHA loan, there’s a nice benefit. According to Simental, these wages are “grossed up” — or rounded up — by 25%. So if you get $1,000 in payments, that would be grossed up to $1,250 instead.
“It’s pretty cool because it gives you that additional income for qualifying purposes,” Simental says.
DACA recipients are eligible, too
As of January 19 this year, DACA program recipients are now eligible for FHA financing just as any other U.S. citizen. Before this, DACA home buyers could only use conventional loans, which are significantly harder to qualify for.
“This makes it really awesome for individuals that are DACA recipients,” Simental says. “They can take advantage of FHA financing with lower FICO scores and still be able to obtain homeownership.”
Using an FHA loan? Have a long-term plan too
According to Simental, FHA loans should be considered “a bridge loan” — a stepping stone on the way toward conventional financing, which is much more affordable and may come with lower rates.
Because of this, it’s important for FHA borrowers to have an action plan going in.
“You should come up with a two-, three-, or four-year plan for you to get out of that FHA loan and into a conventional product,” Simental says.
If you’re not sure how to do that, talk with your loan officer before finalizing your loan application. You’ll want to be sure there’s a clear-cut path to getting out of your FHA loan and into a more affordable conventional mortgage.
Get more FHA loan help
Want to learn more about how to qualify for an FHA loan? Need financing advice or guidance? Reach out to a mortgage broker, loan officer, or financial advisor for help. They can point you toward the right path for your unique goals and budget.