May 12th, 2018 8:32 AM by Jackie A. Graves, President
Learn how you can qualify for an FHA loan with a low down
payment and flexible approval requirements.
For most Americans, the purchase of a home is made possible with
a mortgage. However, saving a 20 percent down payment is an unattainable goal
for many would-be buyers in areas with high home prices. Compounding the
challenge are strict underwriting requirements, including some that were put
into place to protect the housing market from a crash. Underwriting is the
process mortgage lenders use to determine whether to approve a loan, based on
the borrower’s risk profile.
The Federal Housing Administration, or FHA, loan program was
created to help Americans buy homes following the Great Depression, and it
remains a popular choice for people who need an affordable mortgage option. FHA
loans are a popular solution because they allow for smaller down payments,
while also resolving some of the underwriting challenges borrowers face. FHA
mortgages are made by lenders and insured by the Federal Housing
Administration, a U.S. government agency. With a government guarantee, the
lender can offer more flexibility in its underwriting requirements, including
credit guidelines and the size of the down payment.
“If a borrower has good credit but limited cash on hand, other
government-backed loans are available for less money down,” says Stephen Moye,
senior loan officer for Citywide Home Loans. “For a borrower with a bankruptcy,
foreclosure or other credit issue, the FHA loan has a much lower barrier to
This guide explains the FHA loan process and offers
recommendations of lenders that can meet your home buying needs.
How FHA Loans Work
An FHA loan works like any other mortgage in that the lender that
approves your application pays for the home you want to purchase and you repay
that lender, with interest, over time. A mortgage is a secured loan and the
house is the collateral. Your name will appear on the deed, but the lender will
keep a lien against it until the loan is repaid in full. If you default, the
lender has the right to sell the property and recover the balance due.
FHA loans are made by lenders, just like traditional mortgages.
The difference is that FHA loans have a government guarantee. This guarantee
allows lenders to loan to borrowers who might not qualify for a conventional
Traditional conventional mortgage lenders typically expect a 20
percent down payment, but the FHA minimum down payment requirement is 3.5
percent. FHA loans have lower credit score requirements and may allow a higher
debt-to-income, or DTI, ratio.
General FHA loan requirements include:
Waiting period with extenuating circumstances (nonrecurring events beyond your control that result in sudden, significant, prolonged reduction in income or a catastrophic increase in financial obligations)
Chapter 7 or 11 bankruptcy
Chapter 13 bankruptcy
Two years from discharge, or four years from dismissal
Five years if more than one filing in last seven years. Most recent bankruptcy must have been caused by extenuating circumstances.
Three years from most recent discharge or dismissal
Three years, with additional requirements after three years up to seven years: 90 percent maximum loan-to-value purchase, principal residence, limited cash-out refinance
Deed-in-lieu of foreclosure, preforeclosure sale (short-sale), or charge-off of mortgage account
Two DTI ratio figures are calculated when considering an FHA
The front-end DTI ratio is your total monthly housing expense,
which includes the mortgage principal and interest, mortgage insurance,
homeowners insurance, property taxes and applicable homeowners association
fees, divided by your total monthly income. The back-end DTI ratio is your
total monthly debt obligation, including housing, minimum credit card payments,
auto loans, student loans and any other required monthly debt payment, divided
by your total monthly income.
Standard FHA front- and back-end DTI limits are 31 percent and
43 percent, respectively. If you earn $3,500 per month, your front-end DTI
cannot exceed $1,085 and the sum of all your monthly debt obligations cannot
Applications for borrowers with lower salaries and higher DTIs
are manually underwritten. Manual underwriting means that your lender assigns a
person to review your loan application and documents, versus running your
information through an automated underwriting system. Manually underwritten FHA
loans allow for front- and back-end DTI ratios of up to 40 percent and 50
percent, respectively. To qualify for these higher DTI limits, you will need to meet other
FHA Loan Limits for 2018
FHA loan limits are based on median local home values, county by
county. Where the median local home value exceeds the baseline loan limit, the
limit is raised. Most of the U.S. is subject to standard loan limits:
Standard FHA loan limits
Loan limits are higher in high-cost areas including San Francisco, New York
City and Washington, D.C.
High-cost FHA loan limits
Special exception loan limits apply in a select few very high-cost areas, such
as Honolulu, Hawaii.
Max special exception FHA loan limits
You can use HUD’s FHA loan limit lookup tool to find out
the limit in your county.
The loan term is the number of years you will make payments.
Typical mortgage loan terms are 10, 15, 20 or 30 years. FHA loan terms depend
on the lender. One lender may offer only 15- or 30-year loans, while another
may offer a customizable term between eight and 30 years.
Interest Rate Types
The two main types of mortgage interest rates are fixed and
Fixed-rate mortgage: Fixed-rate loans are the most popular type of mortgage.
With a fixed-rate loan, the interest does not change over the life of the
mortgage. The advantage of a fixed-rate loan is a predictable payment set for
the life of the mortgage. The disadvantage is that even if market conditions
cause rates to fall in the future, the rate will not change.
Adjustable-rate mortgage: With an adjustable-rate mortgage,
also called an ARM, the interest rate fluctuates along with a benchmark rate.
The primary advantage of an ARM is that it often starts out at a rate that is
lower than the lowest available rate on a fixed-rate mortgage. Not all FHA
lenders offer ARMs.
With the most popular type of ARM, the hybrid ARM, the rate is
fixed for a few years at the beginning of the loan and then adjusts
periodically according to market conditions. For the early years of the loan,
you might save money on interest. However, when the adjustable rate kicks in,
the rate on an ARM is usually higher than the rate available for a fixed-rate
With an interest-only ARM, you make only interest payments for a
period of time. In this case, the principal balance does not go down during
this time. After this interest-only payment period is over, you have to start
paying on the principal of the loan.
You can save money in the short term with a payment option ARM
by making low payments. However, at some point, the required payment could
spike depending on the payment option you choose. The lender will recalculate,
or recast, the required payment amount at periodic intervals, based on the
remaining loan term and the loan balance. If your balance has grown and the
remaining number of years on the loan has gone down, your required payment will
When comparing loan options, keep in mind that the annual
percentage rate, or APR, on your loan is not the same as the
interest rate. The APR is a measure of the total annual cost of the loan,
including the mortgage interest, points, fees and any additional costs.
Mortgage points are a fee you can pay at the start of the mortgage to lower
your interest rate for the duration of your mortgage.
Each point costs 1
percent of your total loan amount. The interest rate reduction depends on the
lender, but it is common to lower your interest rate by 0.25 percent in
exchange for every point purchased.
Since costs vary from one lender to the next, you should compare
APRs to make a meaningful comparison between similar loans.
Whether your lender requires mortgage insurance hinges on your
loan-to-value ratio, or LTV. This number refers to how much you’re borrowing
compared to the value of the property. Mortgage insurance is typically required
on any mortgage with a loan-to-value ratio of more than 80 percent. It protects
the lender from losses if you default on the loan. If you make a 3.5 percent
down payment, your LTV is 96.5 percent and will be higher if additional costs
are rolled into the loan.
Private mortgage insurance, or PMI, is one of the most important
aspects of FHA loans to understand because it can make FHA loans more costly
than conventional mortgages. FHA lending standards are less stringent than
conventional mortgage lending standards, so FHA borrowers pay two different
mortgage insurance premiums, or MIPs: upfront MIP and annual MIP.
Upfront MIP is 1.75 percent of the loan amount. This may be paid at
closing or rolled into the loan.
Annual MIP depends on the loan size, loan term, LTV ratio and annual
outstanding loan balance (see the chart below).
For example, if the loan is less than $625,500, the term is more
than 15 years and the down payment is lower than 5 percent, the premium is
equal to 0.85 percent of the outstanding balance. Annual MIP is calculated each
year, based on the current outstanding loan balance, and divided into 12 equal
monthly payments (which are added to your regular payments).
term of more than 15 years
Base loan amount
Less than or equal to $625,000
= 90 percent
> 90 percent but = 95 percent
Life of loan
> 95 percent
Greater than $625,000
term of less than or equal to 15 years
> 90 percent
= 78 percent
> 78 percent but = 90 percent
Borrowers who make a down payment of 10 percent or more will pay
annual MIP for 11 years; borrowers who make smaller down payments are obligated
to pay this premium for the entire mortgage term.
Here’s what these costs might look like for a typical borrower:
Home purchase price
Down payment (3.5 percent)
Closing costs (2 percent)
Total amount financed with upfront MIP and closing costs rolled into loan
Annual MIP first year
$1,489, or $124 per month
If this loan has an interest rate of 5 percent, the principal, interest and MIP
monthly payment in year one is $1,065. This figure does not include property
taxes, homeowners insurance or homeowners association fees if required.
Hawaiian Home Lands loans are not subject to either form of MIP,
and Indian Lands are not subject to upfront MIP.
Applying for an FHA Loan
The process of obtaining an FHA loan is largely the same as the
process for obtaining any other mortgage. The main difference is that the search
for a suitable lender is limited to those that offer FHA loans. As with any
borrowing decision, it’s helpful to compare the loan terms you may qualify for
with multiple FHA-approved lenders before committing to a mortgage. You can
then move on to the next steps to get prequalifed or preapproved for a loan.
Prequalification: You’ll supply basic information to the lender about your
debt, income and assets. No verification or credit check are performed. This
allows you to start your home search with a general idea of the loan size and
terms you might qualify for.
Preapproval: You’ll provide more detailed information and documentation to
the lender about your income, assets, debts and regular expenses. The lender
will check your credit and tell you what loan amount and terms you qualify for.
Preapproval does not guarantee loan approval, but can alert you to problems in
your credit report so that you are not surprised during the application
Application: If you are preapproved, the lender will confirm all of the
details you provided and may require up-to-date documentation. If you were not
preapproved, you’ll begin the process. The lender will now require details
about the specific property you want to buy.
Loan estimate: Within three business days after you apply, the lender
will give you a loan estimate. This is a standard three-page document that
explains the terms and details of your loan. If you apply with multiple
lenders, you can compare loan estimates and choose the best one. You must
notify the lender within 10 business days if you intend to proceed.
Processing: After you notify the lender of your desire to proceed, the
lender will verify all your financial information and order a property
appraisal and title report.
Additional documentation: If questions arise during loan
processing, the lender may ask you to submit additional documentation.
Appraisal: An appraisal lets the lender and borrower know the value
of the home. For an FHA loan, the lender will choose a professional
HUD-approved appraiser to evaluate the property you want to buy and give an
opinion of its value. By law, the lender must provide a copy of the appraisal
to you no later than three days before closing.
Underwriting: Once the application and appraisal are complete, a loan
underwriter will evaluate the entire package and determine whether the loan is
acceptable. It must meet guidelines set by the FHA and the lender.
Closing disclosure: The lender will provide a closing disclosure at least
three business days before your loan closes. This is a standard, five-page form
that describes the final details of the loan. You can compare it to your loan
estimate to find out whether any terms or details have changed.
Insurance: Before your loan closes, you will need to purchase
homeowners insurance that is effective no later than your closing date. You
must bring proof of insurance to your closing.
Closing: To close your loan, you’ll meet with your lender’s closing
agent. At this meeting, you’ll show identification and proof of insurance, sign
all the necessary documents and deliver a cashier’s check for the down payment
and closing costs. Then you will receive the keys to the home.
For more information about the mortgage process, including how
interest rates are determined and details about additional costs and fees, see
the U.S. News Mortgage Guide.
Choosing an FHA Lender
To find the best FHA mortgage lender to meet your needs, you
should consider criteria including:
Product offerings include loan terms and loan types. A large
menu of product offerings may mean that the lender is more likely to have the
right loan to meet your needs. Examples of popular product offerings include:
While a 3.5 percent-down FHA loan is technically available if
you have a FICO score as low as 580, lender guidelines vary. You should verify
that you can qualify for each lender’s FHA loan offerings before applying in
order to minimize credit inquiries and save time.
Although the FHA will guarantee the loan, not all lenders will
make loans to borrowers who meet only the minimum requirements. Research the
lender’s minimum credit score and maximum DTI ratio requirements.
Compare APRs from one lender to the next. Since this figure
includes the interest rate, points and other fees, the APR will be higher than
the interest rate and is a more accurate measure of the true cost of the loan.
Even a few tenths of a percent can equate to thousands of dollars saved over
the life of a loan.
While fixed rates don’t tend to be widely different from one
lender to the next, you may find a broader range of options on adjustable-rate
mortgages, so if you’re shopping for an ARM, pay special attention to the APR.
Virtually all FHA lenders offer fixed-rate loans, but not all
offer adjustable-rate loans.
You might find detailed closing costs on a lender’s website, or
you may need to talk to the lender’s representative or apply for a loan in
order to get a more clear picture of the lender’s costs. Since an application
does not obligate you to a loan, you may wish to apply with multiple lenders
before making a choice. Some lenders are willing to negotiate or waive certain
costs in order to gain your business.
Evaluate closing costs along with the interest rate to determine
the total cost of the loan over time. Low closing costs and a high interest
rate could cost more over time than higher closing costs and a lower interest
rate. Remember, if you roll closing costs into your loan, you will pay interest
on those costs.
Each factor is rated on a scale of zero to five. A lender with
an overall score of five is rated “among the best.” A score of four means its
rating is “better than most.” A three means “about average,” and a two means
Not every lender is included in the J.D. Power report. You
should review these and other lenders with the Better Business Bureau.
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