Buying a home is a big investment that takes a lot of thoughtful financial planning. Luckily there are several financing options, some that even offer the opportunity to purchase a home with a lower down payment and lower credit score.
An FHA loan is a type of mortgage insured by the Federal Housing Administration (FHA) that was created to help unlock homeownership for many Americans that would otherwise be unable to afford it.
Although qualifying for an FHA loan is easier than qualifying for a conventional loan, there are still requirements that need to be met and a few drawbacks that are important to keep in mind before you sign on the dotted line.
Home buyers with lower credit scores (500-579) could still qualify, but they would be required to make a down payment of at least 10% instead.
Since FHA borrowers are considered higher-risk, they are required to have mortgage insurance, which protects the lender in the event that the borrower defaults on the loan.
Loan applications are not submitted directly to the Federal Housing Administration. Instead, the borrower applies for the loan through an approved lender, who will be responsible for evaluating the borrower’s income, debt, and creditworthiness.
The max loan amount you can secure with an FHA loan will depend on the property’s location and value. Additionally, the FHA sets maximum loan amounts for each county.
FHA loans have a similar repayment structure as traditional loans, ranging from 15-30 years with fixed and variable rate options available.
The Types of FHA Loans
The FHA offers a variety of home loan options beyond the traditional mortgage. Here is a breakdown of each FHA loan type.
Section 245(a) Loan
A Section 245(a) loan is best for borrowers anticipating an increase in household income over the loan’s repayment term. This loan type is also called a Graduated Payment Mortgage (GPM).
A GPM falls under the category of a fixed-rate mortgage, and the monthly payments increase each year. This loan is an excellent option for borrowers who expect their income to go up because they will likely be able to pay off their mortgage balance faster (e.g. recent law school graduate).
FHA 203(k) Loan
An FHA 203(k) loan is designed to help borrowers that are interested in purchasing a fixer upper. An FHA 203(k) loan includes the cost of the home and the cost of repairs and renovations into the final loan amount.
FHA Energy Efficient Mortgage
An FHA Energy Efficient Mortgage (EEM) will help families finance energy efficient improvements to their homes, like solar panels, improving insulation, upgrading a/c units, etc. This loan program is best for home buyers interested in upgrades that could help lower their utility costs.
FHA Streamline Refinance Loans
An FHA streamline refinance loan allows homeowners with an existing FHA loan to refinance to a lower interest rate, change the rate type or change the loan term. One of the best advantages of an FHA streamlined refinance is that it does not require a new appraisal.
What Are the Perks?
Many advantages come with FHA loans and make them stand out from traditional ones.
Below are some of the benefits of financing a home using this method:
Flexible Credit Score Requirement
To qualify for an FHA loan, borrowers need a minimum credit score of 580. Those with credit scores ranging from 500-579 could still be approved with a higher down payment (10%).
FHA loans offer both 15 and 30-year terms, regardless of whether the loan’s interest is variable or fixed.
Less Strict on DTI Requirements
FHA loan borrowers have more wiggle room regarding their debt-to-income ratio, allowing them to qualify with a DTI as low as 31/43. For comparison, conventional loans typically require at least a 33/45 ratio.
DTI stands for Debt-to-Income and it is a ratio used by mortgage lenders to calculate a borrower’s income relative to their expenses (mortgage, car loan, insurance, credit cards, etc.).
As mentioned earlier, once you’ve secured your FHA loan you will have the ability to refinance in the future using an FHA streamlined refinance loan that offers fewer requirements and no appraisal.
This can be used if you want to take advantage of a recent rate decrease or you want to switch from a variable to a fixed rate.
While the pros appear to outweigh the cons, it’s still worth mentioning that there are some potential disadvantages when it comes to this type of mortgage loan.
Here are the things you’ll need to be prepared for:
You must purchase mortgage insurance if you obtain financing via an FHA loan. Buyers are responsible for paying an upfront mortgage insurance premium (MIP) equivalent to 2.25% of the loan’s value. The premium can be paid at the time of approval or rolled into the loan and paid over time.
FHA home loans can only be used to finance your primary residence. You cannot use them to purchase vacation or investment homes.
The only exception is if you buy a multi-family property (2-4 units) and live in one of the units. The remaining units can be rented out.
Even if you meet the eligibility criteria for an FHA loan, the property you want to finance may not qualify. Properties financed using an FHA loan must be appraised by an FHA approved appraiser and meet all safety, security and structural standards set by the FHA.
What Are the Requirements?
When a lender is evaluating an application, they will consider several factors. They will examine an applicant’s credit report and income — to name just two.
Here are some criteria you’ll need to meet to be considered for approval for the loan amount you’re requesting:
As we covered previously, to qualify for an FHA loan, borrowers will need a minimum credit score of 580.
However, those with credit scores ranging from 500-579 could still be approved with a higher down payment (10%). With most conventional mortgages, applicants need a FICO score of 620 or higher to be considered.
Home buyers with a 580 credit score (minimum) can access borrowing power of up to 96.5% of a property’s value. The down payment owed would be the remaining 3.5% of the home’s value.
If you qualify for an FHA loan and want to finance a home valued at $200,000, your down payment requirement is $7,000.
A lender wants to ensure the person receiving the funds can pay them back easily. They will request copies of documents such as pay stubs, tax returns, and profit-and-loss statements, along with your employment history dating back two years from when you applied.
There is no minimum length of time you’re required to have held your previous or current role(s), but you must be prepared to explain any gaps if you have them.
Positive Payment History
A lender will also want to verify that potential home buyers have a history of paying their other bills on time. If you have an account of missing other loan payments (i.e., student loans), credit card payments, or neglecting to pay your taxes, your application will be rejected.
FHA lenders may make an exception if you agree to establish and honor a payment plan.
This also goes for applicants who filed for bankruptcy or had a home foreclosure within the past three years. The application is likely to be rejected, but according to HUD, lenders may make exceptions for those actively working to rebuild their credit.
What Are the FHA Loan Limits in Florida?
FHA loan limits can range based on the county and state in which the property is located and the housing type it falls under. Across Florida's 67 counties, the FHA limits range from $472,030 for a single unit in Alachua County on the low end to $1,680,800 for a four-plex unit in Monroe County. You can check out the specific limits on the FHA's website.
For those interested in the South Florida real estate market, here is a breakdown of the FHA limits in a few thriving South Florida counties:
Palm Beach County
The Bottom Line
If you’re looking to purchase a home and want to learn how you can qualify for an FHA mortgage loan, we’re here to assist you. Head to our purchase portal, and our loan specialists can get you started on buying your dream home in 2023.
At Vaster, we offer personalized assistance. Let us know your goals and preferred communication style — we pride ourselves in being flexible to the needs of each individual we work with.