Utilizing a mortgage loan to purchase a home is a necessary financial tool for many. Throughout the United States, FHA home loans are one of the most popular mortgages used for primary residence purchases. The popularity of FHA home loans stems from several unique advantages that make them more appealing than conventional mortgage loans.
Comparatively, FHA home loans come with lower down payment amounts and more lenient credit and debt-to-income guidelines than conventional mortgage loans. This makes FHA loans more attractive to many first-time homebuyers, borrowers with less-than-ideal credit history, and individuals with a small down payment.
Although the FHA home loan program has several advantages, borrowers should understand how FHA loans work, eligibility requirements, pros and cons, and whom FHA loans best serve in the home buying process. Here is a complete guide to FHA home loans to help you with the necessary details.
What is an FHA Home Loan?
As an agency of the Department of Housing and Urban Development (HUD), the Federal Housing Administration or FHA administers FHA home loans. However, borrowers using an FHA mortgage do not receive their loan directly from the US government.
Instead, individuals utilizing an FHA loan work with top FHA lenders, like reputable credit unions, banks, or online lenders. These financial institutions follow the guidelines set by the FHA when underwriting a new FHA home loan.
When a borrower is approved for an FHA mortgage, the loan is funded by the financial institution as the lender. However, the FHA insures the loan to minimize the risk taken on by the lender, given the loan’s less stringent underwriting requirements.
This allows lenders providing FHA loans to have some guarantee that if the borrower fails to pay, the potential financial loss is reduced thanks to the insurance from the federal government.
What are the Eligibility Requirements for FHA Home Loans?
The FHA home loan program is designed to help individuals who want to purchase a home with a lower down payment requirement than conventional loans. However, several requirements must be met to qualify for an FHA mortgage.
Minimum Down Payment Requirement for FHA Loans
Borrowers can use an FHA mortgage to purchase a home with as little as a 3.5% down payment. This is drastically lower than the conventional 20% down payment requirement for many conventional home loan lenders. However, if a borrower’s credit score is low, between 500 and 579, a 10% down payment may be needed.
Minimum Credit Score Required for FHA Loans
The FHA mortgage guidelines allow lenders to approve a mortgage application for borrowers with low credit scores. The minimum credit score to qualify is 500, although this does come with a higher down payment requirement. Borrowers with a credit score of at least 580 may qualify for an FHA loan with a lower down payment.
Debt-to-Income Ratio Requirement for FHA Loans
All mortgage lenders take a close look at a borrower’s debt-to-income ratio when evaluating their ability to repay a loan. However, an acceptable debt-to-income ratio (DTI) for an FHA loan is higher than what is allowed for conventional loans.
a. Front-End Ratio
In most cases, lenders want a front-end ratio – total proposed mortgage payment, taxes, and insurance – of no more than 31% of gross income.
b. Back-End Ratio
A back-end ratio, which includes the mortgage payment and all other monthly debts like credit cards and student loans, typically cannot be more than 43%.
Some lenders allow for higher debt-to-income ratios, up to 50% for the back-end calculation. However, the lender has to justify why the loan is affordable to the borrower, making underwriting more challenging.
Other FHA Loan Requirements
Borrowers must also have verifiable income, either with tax returns, bank statements, or pay stubs. In addition, employment history must be provided and verified for the last two years. FHA loans can only be used for primary residence purchases or refinance transactions. The property must meet FHA guidelines when it comes to the appraisal.
What are the FHA Home Loan Limits?
In addition to the eligibility criteria, FHA home loans come with limits. However, loan limits vary depending on the cost of living in the area or county the property is located. For example, the maximum loan amount for 2022 for a single-family home loan is $420,680 for low-cost areas. For high-cost areas, the FHA loan limit is $970,800.
FHA mortgages are available in higher amounts for different types of properties. For example, the ceiling for an FHA loan for a four-plex property is $809,150 in low-cost areas and $1,867,275 for high-cost areas. These are the highest amounts the FHA will insure a loan through an FHA lender.
What are the Benefits of FHA Home Loans?
Several advantages exist with FHA mortgage loans, including these most notable benefits:
- Low down payment requirement of as little as 3.5%
- Low credit score requirement, as low as 580 (for 3.5% down payment) or 500 (for 10% down payment)
- Less stringent underwriting guidelines for debt-to-income ratios
- Shorter waiting period for borrowers with bankruptcy
- Fixed, competitive interest rates
- Assumable loans that allow the buyer of a property financed with an FHA loan to assume the mortgage
What are the Drawbacks of FHA Home Loans?
Although FHA home loans are appealing for their numerous benefits, some drawbacks exist. Borrowers should consider these cons alongside the advantages of an FHA mortgage.
Mortgage Insurance Premium Requirements
One of the ways FHA home loans are made available to borrowers with lower down payment requirements and lower credit score criteria revolves around mortgage insurance premiums (MIP). FHA mortgage insurance helps protect the lender against default on the loan.
a. Upfront Mortgage Insurance
Borrowers pay an upfront mortgage insurance premium (UPMIP) of 1.75% of the loan amount, which can be rolled into the mortgage loan or paid with closing costs when the loan is funded.
b. Annual Mortgage Insurance
In addition to the one-time UPMIP, borrowers pay an annual mortgage insurance cost. This fee ranges from 0.45% to 1.05%, depending on the length of the loan and the loan-to-value ratio of the mortgage. Most borrowers pay around 0.85%, and this amount is broken up as a monthly charge, added to the mortgage payment.
The ongoing mortgage insurance premiums are paid for either the life of the loan or 11 years, depending on the loan’s loan-to-value ratio and the amount you put down. Borrowers may also refinance to a conventional loan to eliminate the mortgage insurance premium when they have enough home equity.
FHA Appraisal Requirements
Borrowers using an FHA loan to purchase a property must also complete an appraisal. The FHA appraisal guidelines require the evaluation to be completed by a qualified FHA appraiser. For this reason, the cost may be higher than a traditional appraisal. In addition, the property must meet livability standards and minimum safety requirements to pass an FHA appraisal.
Loan Amount Limitations
The Department of Housing and Urban Development imposes loan limits on FHA mortgages because the program was designed for borrowers of modest income and assets. As a result, some prospective homebuyers in high-cost areas of the country may find it challenging to find a property that fits within the FHA loan limits.
Other FHA Mortgage Challenges
There may be additional hurdles to overcome for borrowers using an FHA mortgage in some cases.
a. Additional Paperwork
FHA loans also come with more paperwork than conventional ones, but this is not typically an obstacle for buyers. For example, some condominiums prove more challenging to get through underwriting because the homeowner’s association or condo board must submit additional paperwork for the purchase.
Comparing FHA Loans to VA, USDA, and Conventional Mortgages
Borrowers have many options when it comes to financing a home purchase. Recognizing the differences between loan options is crucial to making the best decision for the borrower’s financial needs, both now and in the future.
Here is a comparison table of the most common mortgage loan options and the differing aspects of each compared to FHA loans.
| Conv. Loan | FHA Loan | VA Loan | USDA Loan | |
|---|---|---|---|---|
| Down Payment | 3% | 3.5% | $0 | $0 |
| Credit Rqmts. | 620 minimum credit score | 580 minimum credit score | No minimum credit score | 640 minimum credit score |
| Loan Limits | $647,200; adjusts annually | $420,680 – $970,800; adjusts annually | None with full ent. Same as county limits for partial ent. | $336,500 in most areas and income limits apply |
| Private Mortgage Ins. | Yes, if less than 20% down | Yes, 0.45 – 1.05% annually; 1.75% upfront | None | No, but guarantee fee of 0.35% annually; 1% upfront |
| Borrower Eligibility | High credit score and low debt-to-income ratio | Less stringent rqmts. than conv. loans | Military service-member, veteran, or eligible spouse | Income & location limits; higher credit score |
3 Top FHA Home Mortgage Lenders
Homebuyers and homeowners have a bevy of lenders to choose from when financing a home purchase or refinancing an FHA loan. Below are our picks for top lenders in the FHA mortgage space.
1. Freedom Mortgage
For more than three decades, Freedom Mortgage has offered competitive home loan solutions to borrowers throughout the United States. In 2021, the lender was named the top FHA lender by Inside Mortgage Finance, and they promise exemplary service with easy processing for its customers.
Freedom Mortgage currently offers FHA home purchase loans, FHA Streamline Refinance loans, and FHA cash-out refinance loans. Each loan option comes with competitive interest rates, fast closing, low minimum down payment requirements, and easy qualification. In addition, the lender helps customize each loan to fit the borrower’s needs and promises a smooth process from application to closing.
2. loanDepot
Established in 2009, loanDepot has grown into a well-known mortgage lender offering its customers a technology-based application, underwriting, and servicing process. loanDepot is one of the largest mortgage lenders in the country, funding more than hundreds of billion in loans since its inception.
loanDepot offers FHA mortgage options for purchase, refinance, or cash-out refinance transactions. Borrowers using loanDepot for FHA home loans can select from 10, 15, 20, or 30-year loan terms, all with fixed interest rates, and quotes are available online or over the phone.
In addition, the FHA mortgage lender works directly with customers to find the right loan for their financial needs and offers fast approvals and streamlined closing to simplify the process.
3. PennyMac
Founded on a set of core beliefs and driving principles, PennyMac has become a leading lender in the FHA home loan space. The financial institution has helped more than 4 million borrowers make their homebuying and refinancing dreams come to fruition by focusing on being accountable, reliable, and ethical in their lending practices.
PennyMac offers FHA loans for purchasing, refinancing, or cash-out refinancing to qualified borrowers. Each loan comes with competitive interest rates, an easy application and qualification process, and a simplified closing. In addition, borrowers can request an instant quote online and view current rates on all mortgage types offered by the lender.
Final Thoughts on FHA Loans
A conventional home loan is not the best fit for every prospective homebuyer. In many cases, individuals need alternatives that require less money out-of-pocket upfront to make homeownership a reality. FHA home loans make this possible.
FHA mortgages are a smart choice for borrowers looking for an affordable way to purchase a home with minimal down payment requirements, far lower credit score minimums, and competitive fixed interest rates. However, it is essential to compare the pros of FHA home loans with the disadvantages, including the ongoing cost of mortgage insurance premiums.
If you have any questions or comments regarding our FHA home loan guide, please don’t hesitate to leave them below.
