FHA home loans are government loans that are insured by the Federal Housing Administration, which is part of the U.S. Department of Housing and Urban Development (HUD).
What are FHA loans?
FHA loans require the purchase of mortgage insurance to lessen a borrower’s risk of default, but offer less stringent underwriting requirements. Consequently, FHA loans can be a good alternative for people who don’t have the down payment or credit score necessary to qualify for a conventional mortgage.
Is good credit required for an FHA loan?
Good credit always helps, but isn’t necessarily required. All FHA loans are initially scored through an automated underwriting system. If they are not approved by the automated system, they are referred to a human underwriter for manual review.
The scoring system considers the following:
- Credit score
- Down payment
- Property type
- Job history
- Total debt
Borrowers who have a very low credit score can still be approved with the minimum 10% down payment if they have other positive compensating factors like stable, long-term employment and very little debt.
When loans are referred for manual underwriting, a larger down payment is sometimes required and a lower debt ratio will be approved. In addition, if an FHA loan is manually underwritten, asset reserves will generally be required due to the increased credit risk.
A credit score of 500 is generally the lowest credit score accepted by the FHA and will require compensating factors.
FHA home loan requirements
Evaluating income requirements and loan limits for FHA loans can be complicated and confusing. Also, limits and regulations may change frequently, so it’s important to work with an approved lender who can access current and accurate information. If you’d like to speak with some smart folks who can clear away the jargon and explain FHA loans in simple terms, we can help.
What are the advantages of an FHA loan?
The lower credit score requirement is one advantage of an FHA loan, especially since mortgage rates on FHA loans are still competitive, despite the lower underwriting standards.
For comparison, conventional loans require at least a 5% down payment and a minimum credit score of 620 to qualify — and that’s just for the loan, not the best interest rates. To get the best rates on a conventional home loan, you’ll generally need a much higher credit score.
Also, like many other home loan programs, FHA loans can be manually underwritten (evaluated by a real human), so a lender may examine a loan application the old-fashioned way — By carefully looking at a borrower’s total picture (employment history, credit and income), before making a final loan decision.
In general, borrowers may qualify for an FHA loan with:
- Payment-to-income ratios as high as 55%.
- Short sales or foreclosures on their credit reports that are over three years old.
- The Chapter 7 bankruptcy waiting period is two (2) years after the bankruptcy discharge date (not the filing date).
Also, certain fees may be lower on an FHA loan since the program allows for some of those costs to be covered by the seller or other applicable third party.
What are the disadvantages of an FHA loan?
Perhaps the biggest disadvantage of an FHA loan is the potential for the mortgage insurance to exceed that of a conventional loan. However, although the FHA mortgage insurance premium (MIP) may be higher than a conventional loan’s private mortgage insurance (PMI), the interest rate on an FHA loan is often lower — This means that the overall monthly payment may be about the same.
Also, FHA financing requires an “up-front” mortgage insurance premium in addition to the monthly mortgage insurance payment. This initial fee is 1.75% of the loan amount and can be financed as part of your loan.
When should I consider an FHA loan?
FHA loans are best suited to borrowers who don’t have a lot of cash on hand for a down payment, or need some flexibility when it comes to past credit history. For example, they have a bankruptcy that is over two years old, or are self-employed or in a new job. Conventional loans may also be more inflexible when it comes to employment history and allowed payment-to-income ratios.
If you do have the resources to make a large down payment and your credit score is in good shape, you’re probably better off going with a conventional mortgage. Given that you can skip the PMI and probably net a lower interest rate, you’ll likely secure a more affordable monthly payment.