For borrowers looking for lower down payment and credit score qualifications, FHA loans are a popular option.
What is an FHA Mortgage?
An FHA mortgage is fully insured by the Federal Housing Administration under the U.S. Department of Housing and Urban Development (HUD). The main initiative of FHA is to lower the barrier of home ownership by decreasing up-front financing costs. Approved FHA lenders, such as Starboard Financial, are able to offer lower down payments because there is less risk due to the government insurance.
Credit qualification guidelines are often easier than other underwriting standards, which allows more people access to the program. This benefit does not come without limitations, as availability is subject to income and primary residency restrictions. Loan amounts are subject to ceilings as well. FHA loans are eligible for both refinance and purchase transactions.
What are the requirements for an FHA Loan?
- Stable income: Like most loans, you will need at least two years of employment.
- Credit Score: Should be between 500-579 for a 10% down payment, or 580+ for 3.5% down payment. Two mortgage insurance premiums are required for an FHA loan if the buyer doesn’t have 20% for a down payment.
- Origination Fee: This is typically 1-8% of the total amount of money being borrowed, which is charged for the processing of the loan. This is usually paid in the closing costs but can be negotiated for the seller to pay for it.
- Collateral: Two types of loans are collateralized and uncollateralized. When borrowers take out a mortgage with an FHA loan, the property serves as collateral. In the event of a foreclosure, your bank or lender will be able to take possession of your property.
- Debt-to-Income Ratio: According to many websites, the maximum debt-to-income ratio is between 31-43%. 31% for housing, 43% for total debt.
Benefits of an FHA Loan:
Low down payments – as little as 3.5%
For homebuyers with a credit score of at least 580, they qualify for the 3.5% down payment. If your credit score is between 500-579, you will need to put a 10% as a down payment. While this will save you on the initial payments, your mortgage premiums will be higher to protect lenders in case the borrower defaults on their payments.
100% of down payment available from a gift
Another way homebuyers can save money for the down payment is through a gift. There are a few stipulations to this type of payment, to ensure it isn’t another loan in disguise:
- Thorough documentation of the payment must be made. This includes employment, income, and assets.
- No repayment obligation should be placed on the source of funds. After all, this is a gift.
- Whom the loan can come from varies between lenders and mortgage programs. Some mortgage programs only allow gifts from close relatives. For FHA loans, employers, unions, and charities are allowed to supply gifts to the borrower.
- A gift letter must be submitted to your lender. Information will have the amount, the date the funds were transferred, donor’s signature and information (name, address, and phone number), their relationship to the borrower, and the address of the property.
Higher debt to income ratios available in most cases
Debt-to-income ratio is the monthly debt divided by gross monthly income. When homebuyers apply for an FHA loan, they are required to supply documentation of their debts. Since FHA is a government backed loan, the guidelines for their debt-to-income ratio are more lenient. The highest it can be is 57%.
Lower credit scores welcome
The reason behind this is due to the government insurance. This type of loan is appealing to homebuyers with poor credit scores or first-time homebuyers who don’t have much credit history. Keep in mind this will increase your private mortgage insurance payments.
Waiting periods less following Bankruptcy, Foreclosure, or Short Sale
The waiting periods following Bankruptcy, Foreclosure, or Short Sale on FHA loans tend to be more lenient than other loans.
- For a chapter 13 bankruptcy, there is no waiting period. Compared to Fannie Mae/Freddie Mac, which is 2 years. And VA-guaranteed, which is 2 years.
- For Foreclosure, 3 years. Compared to Fannie Mae/Freddie Mac, which is 7 years. And VA-guaranteed, which is 2-3 years.
- For Short Sale, 0-3 years. The 0 year waiting period comes with a few stipulations, such as the buyer was not in default on the prior mortgage at the time of the short, or that mortgage payments were paid on time in the past 12 months. 3 years for everyone else applying for an FHA mortgage. Compared to Fannie Mae/Freddie Mac, which is around 4 years. And VA-guaranteed, which is usually around 2 years.
Reduced documentation on FHA streamlined refinance
When compared to other loan programs, FHA refinances come with less stringent requirements:
- No income documentation required
- Faster closing times
- Appraisals are not required
- Upfront mortgage insurance is eligible for a partial refund from original mortgage loan
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