FHA-backed loans, which are desirable for many people because they provide flexibility compared to conventional and other home loans, are available to people who meet the Federal Housing Authority’s criteria with respect to these factors:
- Borrower legal status
- Purchase home as primary residence
- Borrower’s credit score
- Borrower’s employment history
- Down payment amount
- Borrower’s debt-to-income ratio
- Mortgage insurance
- Past foreclosures or bankruptcy
- Property appraisal by FHA-certified appraiser
This article explains the detailed requirements of the FHA in relation to each of these factors.
The Federal Housing Authority
The Federal Housing Authority, more commonly known as the FHA, is a government organization that provides mortgage insurance for home loans. The FHA was established during the Great Depression in 1934, to provide access to home ownership for people and families that would not otherwise qualify for mortgages. Because of FHA’s involvement in insuring home loans, lenders are willing to take risks giving loans to borrowers who meet the FHA’s specific requirements that qualify the loans for FHA mortgage insurance, which include (among lots of other factors) having a high enough credit score and being able to demonstrate that you have stable employment.
FHA loans are provided through FHA-approved lenders rather than through the FHA itself. The basic requirements for obtaining an FHA-insured loan are dictated by the Federal Housing Authority in line with its goal of making home ownership possible for more people. In addition to what the FHA requires for obtaining a home loan, individual lenders typically layer on top of those requirements their own filters for qualifying loan applicants.
The official “list” of FHA loan requirements is found among thousands of pages on FHA’s official website at HUD.gov. [There is a shorter 413-page underwriting guideline document that is pretty straight forward.] Instead of reading through a handbook filled with government jargon and confusing legal and technical descriptions, most people are better served reading a summary of the updated, 2018 FHA loan requirements. That’s what you’ve got here.
Here is a quick summary of the criteria involved in FHA-backed loans along with current FHA requirements. Each of these points will be addressed in more detail below. Although there are minimum thresholds with black and white “yes” or “no” decisions associated with them, there is also some interaction between the requirements, meaning that being stronger in one area could possibly compensate for being weaker in another. All of those factors come together to collectively create the offer you’ll get from an FHA-approved lender.
2018 FHA Loan Requirements
Although it is understood that there are lots of other technicalities and individual circumstances to be considered, the following summary explains the general guidelines that need to be met by someone who is applying for an FHA loan.
Legal Status: The borrower must be an adult, at least 18 years old, with legal US residence status.
Primary Residence: The home being purchased must be used as the borrower’s primary residence.
Credit Score: FHA loan applicants must have a minimum FICO credit score of 500.
Employment History: A two-year history of steady employment.
Down Payment: Minimum of 3.5%, based on a credit score of at least 580.
Debt-to-Income Ratio: FHA borrowers have only 43% or less of their income tied up with debt obligations.
Mortgage Insurance: FHA loans require borrowers to pay mortgage insurance
Past Foreclosure and Bankruptcy: FHA loan borrowers need to be at least 2 years past any bankruptcy and 3 years beyond any past foreclosure.
FHA Approved Property Appraisal: The home must have an FHA approved appraisal.
As with other commitments that require you to have legal US resident status and to be an adult, so does getting an FHA loan, naturally. To qualify for an FHA loan, the you need to be either a US citizen or have legal resident status that involves owning a piece of real estate in the United States and its territories.
Because FHA insured loans are intended to help people own their own place of dwelling, they are not intended for second homes or for investment properties. There are circumstances where a homeowner can have more than one FHA-backed loan, such as when an FHA loan was used to purchase a first residence and a homeowner then moves from that home (whether the home is sold or rented) without retiring the mortgage. However, the general rule here is that if you’re going to pursue an FHA loan, the situation should be one in which you are looking to purchase a home that you will move into as your primary residence.
There is an owner occupancy agreement that accompanies an FHA loan, in which you agree to live in the home for at least one year after the loan has been closed. This agreement does provide for extenuating circumstances that would allow an FHA borrower to move out of the home.
One of the primary purposes of FHA, the reason why it was created, is to give access to home ownership to people who might not have the opportunity otherwise. For this reason, FHA makes it easier for those with lower credit scores to quality for home loans. However, in order to continue to exist, the FHA must also mitigate its risk when insuring borrowers. For this reason, similar to how other mortgage insurers operate, you must have good enough credit to qualify.
If your FICO score is 500 or above, you qualify for an FHA loan. If your credit score is lower than 500, except in particular case-by-case circumstances,
If your credit score is in the range of 500-579, you’ll need to bring a down payment of 10% to closing, and your terms (interest rate, mortgage insurance premium, etc) will not be as favorable as if you credit score is 580 or above.
If your credit score is at 580 or above, you only need a 3.5% down payment. The higher your FICO score, the more favorable the terms of your loan will be, because the lender and the FHA consider you to be less risky than those who have lower credit scores.
Although there is some flexibility with employment history, FHA-insured loans generally require a 2-year employment history, preferably with the same employer or at least in the same industry. Other factors, such as a high credit score or a larger down payment, can make this element of being qualified for an FHA a little more flexible.
Employment history is typically proven through tax returns or by providing contact information for the employer. W-2 employees typically have the easiest time demonstrating employment history, because their employers provide easily verifiable tax records to the IRS that include the exact information needed for determining income history related to employment. Independent contractors, whose income is reported using a 1099 and whose gross income is typically much more variable than W-2 employees because of their ability to deduct tax write-offs, often must provide more information with their proof of employment case file.
A loans that is insured by the FHA can be obtained with a lower down payment than with other loan types. If your credit score is 580 or above, you will likely be able to get away with a down payment of only 3.5% of the value of the home you’re purchasing. If your credit score is less than 580 (but not below 500, in which case you wouldn’t typically qualify for an FHA loan), you’ll need to plan on a 10% down payment.
Debt-to-Income or Back-end Ratio
Having too high a debt-to-income (or DTI) ratio means more risk for lenders. FHA sets limits on borrowers’ DTI. Also referred to as back-end ratio, this debt-to-income ratio compares how much total debt you have, including the mortgage you’re getting along with credit card debt, car payments, student loans, child support, and other debt obligations.
The debt-to-income ratio is calculated by adding together all of the monthly debt obligations and diving that total by the monthly income (after tax) received. Ideally, this DTI calculation should be less than 36%. As the percentage gets higher, the risk to the lender makes the terms of the loan less favorable. A DTI of 41% is typically the maximum amount that will be acceptable by most lenders, although in exceptional cases FHA loans are granted to people with DTI as high as 50%.
You can obviously affect this percentage by reducing your debt or increasing your income, both of which have lots of options.
Another ratio that is similar to DTI is called the front-end ratio. This calculation compares the monthly cost of your mortgage to your monthly income. FHA lenders want this ratio to be 31% or less.
Mortgage insurance is required for FHA loans to protect lenders from default. The amount of mortgage insurance you will pay varies according to the type of FHA loan (15-year, 30-year, etc.) you’re getting, the size of the loan, the amount of down payment you make, and other factors.
You can expect your mortgage insurance premium to range from 0.45% of the loan for shorter term loans with higher down payments up to over 1% of the loan for larger loans with smaller down payments.
Past Foreclosure and Bankruptcy
Like other mortgage insurers, the FHA must limit its risk when providing insurance to borrowers. If there are foreclosures or bankruptcies in your past, you must be able to demonstrate to an FHA-approved lender that you’ve changed your ways.
There are waiting periods in place for FHA borrowers who have had foreclosures and bankruptcies. These waiting periods allow the lenders to see that you’re making financial progress and achieving stability so that the loan is not overly risky to them.
There is a three-year waiting period for potential FHA borrowers who have had a mortgage involved in a property foreclosure.
If you have filed a Chapter 13 bankruptcy, you must be able to prove that you have been making consistent payments for at least the past year prior to when the loan is applied for. For a Chapter 7 bankruptcy, FHA borrowers must have waited for a period of at least 2 years since the discharge date of the bankruptcy.
FHA Approved Property Appraisal
Property appraisals (an appraisal is a detailed estimate of the value of the property) are required for almost any home loan as a way of protecting the interests of the lender. Property appraisals ensure that a loan is not being given to purchase something that is worth less than the loan amount.
The FHA requires that property being purchased with an FHA-backed loan be appraised by a certified FHA appraiser. Normally, the FHA-approved lender you work with will have several FHA-certified appraisers they can schedule to appraise the home you’re planning to buy. If you’d rather find your own FHA-certified appraiser, you can find one in the official HUD database of FHA certified appraisers.
Exceptions from Stated FHA Requirements
As you can see from this list of FHA loan requirements, there is a large mix of variables that factor into how FHA and FHA-approved lenders will view your eligibility for an FHA loan as well as how favorable the terms will be.
There are often exceptions made to any one or two of these requirements, depending on specific circumstances. If you feel like you don’t meet the standard requirements, but still are interested in checking to see whether you are eligible for an FHA loan, you can always talk to an experience FHA loan provider, who can address your specific situation.
The FHA Loan Underwriting Process
To begin the FHA loan process, a potential borrower meets a lender and determined what amount of loan he or she is qualified to receive. This is called the FHA pre-approval process, and it usually involves information that is presented by the borrower as being true. This less thorough pre-qualification is what allows the borrower to shop for a home. Often a potential borrower can exaggerate their income or understate debt obligations. The FHA underwriting process is a much more thorough examination of the information presented by the borrower as evidence that he qualifies for an FHA home loan.
The FHA loan underwriting process takes place once a real estate purchase agreement has been provided by the potential borrower to the lender or loan officer. This process will examine each of the FHA eligibility requirements listed above in great depth. Any exceptions to the standard requirements will need to be cleared by the FHA underwriter together with evidence provided by the borrower and the lending agent.