An FHA loan is a mortgage that’s insured by the Federal Housing Administration (FHA). They are popular especially among first time home buyers because they allow down payments of 3.5% for credit scores of 580+.
What is an FHA Loan?
An FHA loan is a mortgage that’s insured by the Federal Housing Administration (FHA). They are popular especially among first time home buyers because they allow down payments of 3.5% for credit scores of 580+. However, borrowers must pay mortgage insurance premiums, which protects the lender if a borrower defaults.
Borrowers can qualify for an FHA loan with a down payment as little as 3.5% for a credit score of 580 or higher. The borrower’s credit score can be between 500 – 579 if a 10% down payment is made. It’s important to remember though, that the lower the credit score, the higher the interest borrowers will receive.
The FHA program was created in response to the rash of foreclosures and defaults that happened in the 1930s; to provide mortgage lenders with adequate insurance; and to help stimulate the housing market by making loans accessible and affordable for people with less than stellar credit or a low down payment. Essentially, the federal government insures loans for FHA-approved lenders in order to reduce their risk of loss if a borrower defaults on their mortgage payments.
FHA Loan Requirements
For borrowers interested in buying a home with an FHA loan with a low down payment amount of 3.5%, applicants must have a minimum FICO score of 580 to qualify. However, having a credit score that’s lower than 580 doesn’t necessarily exclude you from FHA loan eligibility. You just need to have a minimum down payment of 10%.
The credit score and down payment amounts are just two of the requirements of FHA loans. Here’s a complete list of FHA loan requirements, which are set by the Federal Housing Authority:
- Borrowers must have a steady employment history or work for the same employer for the past two years.
- Borrowers must have a valid Social Security number, lawful residency in the U.S. and be of legal age to sign a mortgage in your state.
- Borrowers must pay a minimum down payment of 3.5 percent. The money can be gifted by a family member.
- New FHA loans are only available for primary residence occupancy.
- Borrowers must have a property appraisal from an FHA-approved appraiser.
- Borrowers’ front-end ratio (mortgage payment plus HOA fees, property taxes, mortgage insurance, homeowners insurance) needs to be less than 31 percent of their gross income, typically. You may be able to get approved with as high a percentage as 40 percent. Your lender will be required to provide justification as to why they believe the mortgage presents an acceptable risk. The lender must include any compensating factors used for loan approval.
- Borrowers’ back-end ratio (mortgage plus all your monthly debt, i.e., credit card payment, car payment, student loans, etc.) needs to be less than 43 percent of their gross income, typically. You may be able to get approved with as high a percentage as 50 percent. Your lender will be required to provide justification as to why they believe the mortgage presents an acceptable risk. The lender must include any compensating factors used for loan approval.
- Borrowers must have a minimum credit score of 580 for maximum financing with a minimum down payment of 3.5 percent.
- Borrowers must have a minimum credit score of 500-579 for maximum LTV of 90 percent with a minimum down payment of 10 percent. FHA-qualified lenders will use a case-by-case basis to determine an applicants’ creditworthiness.
- Typically borrowers must be two years out of bankruptcy and have re-established good credit. Exceptions can be made if you are out of bankruptcy for more than one year if there were extenuating circumstances beyond your control that caused the bankruptcy and you’ve managed your money in a responsible manner.
- Typically borrowers must be three years out of foreclosure and have re-established good credit. Exceptions can be made if there were extenuating circumstances and you’ve improved your credit. If you were unable to sell your home because you had to move to a new area, this does not qualify as an exception to the three-year foreclosure guideline.
- The property must meet certain minimum standards at appraisal. If the home you are purchasing does not meet these standards and a seller will not agree to the required repairs, your only option is to pay for the required repairs at closing (to be held in escrow until the repairs are complete).
Benefits of FHA Loans: Low Down Payments and Less Strict Credit Score Requirements
Typically an FHA loan is one of the easiest types of mortgage loans to qualify for because it requires a low down payment and you can have less-than-perfect credit. For FHA loans, a down payment of 3.5 percent is required for maximum financing. Borrowers with credit scores as low as 500 can qualify for an FHA loan.
Borrowers who cannot afford a 20 percent down payment, have a lower credit score, or can’t get approved for private mortgage insurance should look into whether an FHA loan is the best option for their personal scenario.
Another advantage of an FHA loan it is an assumable mortgage which means if you want to sell your home, the buyer can “assume” the loan you have. People who have low or bad credit, have undergone a bankruptcy or have been foreclosed upon may be able to still qualify for an FHA loan.
Mortgage Insurance is Required for an FHA Loan
You knew there had to be a catch, and here it is: Because an FHA loan does not have the strict standards of a conventional loan, it requires two kinds of mortgage insurance premiums: one is paid in full upfront -– or, it can be financed into the mortgage –- and the other is a monthly payment. Also, FHA loans require that the house meet certain conditions and must be appraised by an FHA-approved appraiser.
Upfront mortgage insurance premium (UFMIP) — Appropriately named, this is a one-time upfront monthly premium payment, which means borrowers will pay a premium of 1.75% of the home loan, regardless of their credit score. Example: $300,000 loan x 1.75% = $5,250. This sum can be paid upfront at closing as part of the settlement charges or can be rolled into the mortgage.
Annual MIP (charged monthly) — Called an annual premium, this is actually a monthly charge that will be figured into your mortgage payment. The amount of the mortgage insurance premium is a percentage of the loan amount, based on the borrower’s loan-to-value (LTV) ratio, loan size, and length of loan:
| Loan Term |
Loan Amount |
LTV Ratio |
Annual Insurance Premium |
| Over 15 years |
$625,000 or less |
95% or less |
0.80% |
| Over 15 years |
$625,000 or less |
Over 95% |
0.85% |
| Over 15 years |
Over $625,000 |
95% or less |
1% |
| Over 15 years |
Over $625,000 |
|
1.05% |
| 15 years or less |
$625,000 or less |
90% or less |
0.45% |
| 15 years or less |
$625,000 or less |
Over 90% |
0.70% |
| 15 years or less |
Over $625,000 |
90% or less |
0.70% |
| 15 years or less |
Over $625,000 |
Over 90% |
0.95% |
For example, the annual premium on a $300,000 loan with term of 30 years and LTV less than 95 percent would be $2,400: $300,000 x 0.80% = $2,400. To figure out the monthly payment, divide $2,400 by 12 months = $200. So, the monthly insurance premium would be $200 per month.
How Long Do Borrowers Have to Pay FHA Mortgage Insurance?
The duration of your annual MIP will depend on the amortization term and LTV ratio on your loan origination date.
For loans with FHA case numbers assigned on or after June 3, 2013:
Borrowers will have to pay mortgage insurance for the entire loan term if the LTV is greater than 90% at the time the loan was originated. If your LTV was 90% or less, the borrower will pay mortgage insurance for the mortgage term or 11 years, whichever occurs first.
| Term |
Original Down Payment |
Duration |
| 15 years or less |
less than 10% |
Life of loan |
| 15 years or less |
10% or higher |
11 years |
| Over 15 years |
less than 10% |
Life of loan |
| Over 15 years |
10% or higher |
11 years |
For loans with FHA case numbers assigned before June 3, 2013:
| Term |
Original Down Payment |
Duration |
| 15 years or less |
22% or higher |
No annual MIP |
| 15 years or less |
less than 22% |
Canceled at 78% LTV |
| Over 15 years |
22% or higher |
5 years |
| Over 15 years |
less than 22% |
Canceled at 78% LTV
(5 years minimum) |
FHA Loan Limits
The Federal Housing Authority sets maximum mortgage limits for FHA loans that vary by state and county. In certain counties, you may be able to get financing for a loan size up to $729,750 with a 3.5 percent down payment. Conventional financing for loans that can be bought by Fannie Mae or Freddie Mac is currently at $625,000.
How Do You Get an FHA loan?
A lender must be approved by the Federal Housing Authority in order to help you get an FHA loan. You find top FHA lenders and shop for mortgage quotes for an FHA loan quickly and easily by asking us for a recommendation. Just submit a loan request and you will receive custom quotes instantly from a lender of your choice. The process is free, easy and you can do it anonymously, without providing any personal information. If you see a lender’s loan quote that you are interested in, you can contact the lender directly.
FHA Loan Interest Rates
Below are today’s average FHA interest rates.
| PROGRAM |
INTEREST RATE |
APR |
1 DAY CHANGE |
| 30-Year Fixed FHA |
4.12% |
5.19% |
0.07% |
| 20-Year Fixed FHA |
4% |
5.1% |
0% |
| 15-Year Fixed FHA |
3.64% |
4.74% |
0.08% |
| 10-Year Fixed FHA |
3.63% |
4.88% |
0% |
| 7/1 ARM FHA |
3.94% |
5.13% |
0% |
| 5/1 ARM FHA |
3.59% |
5.04% |
0.05% |
A 30-Year Fixed FHA loan of $300,000 at 4.12% APR with a $10,880 down payment will have a monthly payment of $1,453. A 20-Year Fixed FHA loan of $300,000 at 4% APR with a $10,880 down payment will have a monthly payment of $1,817. A 15-Year Fixed FHA loan of $300,000 at 3.64% APR with a $10,880 down payment will have a monthly payment of $2,165. A 10-Year Fixed FHA loan of $300,000 at 3.63% APR with a $10,880 down payment will have a monthly payment of $2,984. A 7/1 ARM FHA loan of $300,000 at 3.94% APR with a $10,880 down payment will have a monthly payment of $1,421. A 5/1 ARM FHA loan of $300,000 at 3.59% APR with a $10,880 down payment will have a monthly payment of $1,362. All monthly payments displayed assume a maximum Loan to Value (LTV) of 100% and 680 credit score, and do not include the amount for taxes and insurance. The actual monthly payment may be greater.
What was FHA’s Policy Update?
FHA added another layer of evaluation to their current method of identifying high-risk lenders.
Current Policy
FHA’s sole method was to compare an FHA lender with other FHA lenders in the same geographical region. This is known in the lending world as the FHA “compare ratio”.
If a lender had 150% more late-paying loans than other area lenders, it was at risk of getting kicked off the list of FHA-approved lenders.
Many banks and mortgage companies had a problem with this method. If nearby lenders had tougher FHA qualification standards and therefore a better book of loans, other area lenders would look comparatively worse.
In theory, an FHA lender could be shut down because the FHA lender across the street raised its minimum credit score requirement from 640 to 680.
This can and did lead to an escalation of sorts – lenders raised their minimum FHA credit score requirements as high or higher than their competitors. FHA’s own policies counteracted its mission to provide access to homeownership to less-than-perfect borrowers.
Updated Policy
While FHA is not ending the “compare ratio” method altogether, it is adding another layer of evaluation.
Now, FHA will separately examine late-paying loans based on the borrowers with credit scores of
- Less than 640
- Between 640 and 680
- Greater than 680
How will this help borrowers with lower scores?
The lender won’t be at risk of losing its FHA credentials if its lower credit score loans are performing similarly to loans within the same credit score bracket. In addition, the comparison will be made nationwide, not just in the lender’s geographical region.
Here’s how it might look in real life. Lender X issues 100 loans to borrowers, all with scores below 640. Three borrowers eventually stop making their payments, giving Lender X a “bad loan” rating of 3%.
Lender Y across the street issues 100 loans to borrowers with scores above 680. Only one doesn’t pay his mortgage, giving Lender Y a default rate of 1%.
Under the old rules, Lender X might be in trouble. His “compare ratio” is 300% – double the acceptable level. At this point, Lender X raises its minimum FHA credit score to 680.
Under the new rules, Lender X might be just fine, because FHA compares its default rate to the national average for loans with credit scores below 640.
Now, Lender X can continue helping underserved home buyers, in tune with FHA’s core mission.
Original article: Realtor.com
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