How to get an FHA mortgage: A guide for homebuyers
Whether in the city, suburbs or perhaps someplace more rural, owning a home is something virtually everyone sees themselves doing at some point. But when you have a family to support, are on your own for the first time or simply don't have enough saved to use toward a down payment, circumstances of the moment can make homeownership seem like a pipe dream.
An FHA mortgage can help bridge the gap so you can live out your aspirations. Backed by the Federal Housing Administration, FHA loans are available through most mortgage providers and are ideal for individuals who have steady income, but may lack certain other financials that are asked for when filling out a loan application. For example, if your credit score is less than perfect or you can't afford a 20 percent down payment toward a property's purchase price, a loan from an FHA lender can make a lot of sense.
That said, there are a few key aspects that must be fleshed out in order to qualify for an FHA loan. Here, we'll address these elements, as well as a few other important considerations so you can qualify for an FHA on the first try.
How does an FHA mortgage compare to a conventional mortgage?
FHA loans are a lot like conventional loans, in that you can buy them with fixed-rate or adjustable-rate interest - typically in 15-year and 30-year increments - and require an initial down payment, among other similarities. However, the approval process isn't as stringent for an FHA mortgage versus a traditional loan product. For example, instead of a 20 percent down payment, you can put as little as 3 percent down, which is slightly less than what the average is these days (5 percent), according to the National Association of Realtors.
What you spend in interest is largely determined by your credit history, meaning how reliable you are at making your payment on time. Here as well, FHA loans have looser credit restrictions than conventional mortgages. Generally speaking, FHA loans require a minimum credit score to be close to 600.
However, should your down payment be larger - say 10 percent or 15 percent - you may be approved with a FICO® score that's a bit lower. It's worth noting that any down payment that's less than 20 percent requires the purchase of mortgage insurance, which we'll discuss a bit further later on.
Another key distinction FHA loans have versus conventional loans are interest rates. FHA rates are typically lower than conforming loans. But again, your creditworthiness - among other financial characteristics - will factor in to how much you can expect to spend in interest, which is also influenced by market dynamics that are almost constantly in flux.
What should my debt-to-income ratio be?
You've probably heard about debt-to-income ratio, but if you're new to homeownership, you may not be exactly sure what it means. It's pretty straightforward: It basically is an assessment of how much of your gross income goes toward monthly payment expenses. You can calculate this through the use of mortgage calculators, but you can also do it on your own by simply dividing the totality of your monthly debt payments (i.e. installment and revolving, not including household utilities) by what you earn in the typical month, before taxes are taken out. Multiplying the answer by 100 will give you a percentage, which is your DTI.
In order to be approved for an FHA loan, the DTI should be no higher than 43 percent, which is an indication that less than half of your monthly earnings are put toward existing expenses. The lower your DTI, the more likely it is you'll be approved, with the ideal ratio being between 28 percent and 36 percent. However, it's important to emphasize that no single factor will be the deciding one as to whether you'll be given the green light. Lenders take into account the totality of your financial and employment situation.
What's the deal about mortgage insurance?
Although there are exceptions, such as with VA loans, mortgage insurance is typically required on any loan where the down payment is less than 20 percent of the purchase price. This rule applies to FHA loans, regardless of how much money you use toward the upfront cost. Mortgage insurance is included in your monthly mortgage payment. FHA requires mortgage insurance for the life of the loan unless you are able to refinance due to an increase in equity.
What else should I know about FHA loans?
Perhaps the best aspect of loans backed by the FHA is they offer a tremendous amount of flexibility. For example, say that you're able to put 3 to 5 percent toward the down payment of a home, but you'd like to put more money toward the cost so you can pay off your mortgage more quickly. If you've received gift money from a parent or, close friend or relative, you can use these funds so you can pay off a bigger chunk. These gift funds can be used in conjunction with what you spend or can cover the cost in its entirety.
Lastly, you may be wondering the maximum loan amount you can be approved for with an FHA mortgage. The amounts have changed from year to year, and in 2019, the ceiling rose to $726,525, HousingWire reported. That's up from $679,650 in 2018. With the median value for a property among all housing types nearing $250,000, according to the most recent estimates from the NAR, the new maximum loan amount is certainly sufficient to cover the cost of the majority of houses up for sale.
Homeownership is the American dream. The flexibility and payment options available with an FHA loan can help turn those dreams into reality. With the home buying season rapidly approaching, getting in touch with your favorite loan officer to learn more, and let the search begin!