Quick Guide to FHA Loans
Buying a home is a major dream for most Americans. Sadly, for many people, it seems like an unattainable dream. Thanks to the credit and other requirements to obtain a traditional mortgage, too many people are left renting or living in substandard housing.
If your dream is to buy a home but you can’t meet conventional loan requirements, you don’t have to give up hope. There are other options that can help – one of which is an FHA loan.
What Exactly Are FHA Loans?
An FHA loan is a type of mortgage which is guaranteed by the FHA or Federal Housing Administration. The reason that this is important is that, since it is backed by the government, lenders are more likely to approve them.
When you apply for a traditional mortgage, lenders are putting themselves at risk. If you were to default on your mortgage, they are stuck dealing with the financial fallout. The money that they loan you is lost until they sell the property or go through some other means. This is why they require such high qualifications – to ensure they are minimizing their risk.
With an FHA loan, lenders aren’t putting their money at such a high risk. They know that if you default on your mortgage, the government will take care of everything, so they do not lose the money they lend to you.
Imagine a friend asking you to borrow money. You want to loan it to them, but maybe you know that their repayment history isn’t the greatest. You worry you won’t get your money back, so you turn them down.
What if that same friend’s mom promised to repay you if your friend couldn’t, though? You know their mom is true to her word – she just doesn’t have the funds on hand to loan them at the moment. However, you know she has it and has always taken care of things that she promised to do.
You’d probably be more willing to loan your friend the money with their mom guaranteeing the repayment. Lenders are the same way. When a loan is backed by the government, they feel more confident about approving it.
Qualifications for an FHA Loan
In order for the government to back the loan, you have to meet certain requirements. Again, though, these requirements are not quite as strenuous as those with traditional mortgages, but they are as follows.
Most traditional or conventional mortgages require a credit score of no less than a 620. Some individual lenders require higher ones. With an FHA loan, on the other hand, you can have a credit score of as little as 500. Your required credit score, though, will depend specifically on your down payment.
As mentioned above, a conventional mortgage typically requires anywhere between 5 percent and 20 percent of the purchase price for a down payment. This can be difficult for people who do not have much in savings.
An FHA loan is a bit easier to manage. If your credit score is a 580 or higher, you can get approved with as little as 3.5 percent. For credit scores ranging between 500 and 579, you’ll likely be required to pay around 10 percent of the purchase price as a down payment.
Debt-to-Income Ratio (DTI)
Your DTI is the ratio of your debt compared to the income you make. For most conventional mortgages, lenders prefer to see no more than 43 percent. However, this does vary between lenders and some require closer to 31 percent.
An FHA loan provides a little more variation, though your DTI is still important. The maximum DTI is usually about 57 percent but they generally prefer to see the same 43 percent or less as with conventional mortgages.
It will depend on your financial situation, your specific lender, and more. The required DTI is usually determined by the applicant’s overall information – there’s not really a set-in-stone number.
FHA loans also typically allow higher borrowing limits. One very important thing to know is that you’ll still be required to carry private mortgage insurance. The length of time you need to carry it will be determined by your down payment amount and more.
How Do You Apply for FHA Loans?
The FHA doesn’t provide loans itself. Instead, it approves lenders around the country to provide the loans. You’ll need to check to make sure that the lender you are applying through is qualified in handling FHA loans.
If homeownership is a dream that seems out of reach to you because you can’t meet the requirements of a conventional loan, an FHA loan might be the solution for you. Work with a lender that provides FHA loans to determine if you qualify and, if you don’t yet, what you can do to make it happen.