Everything You Need to Know About FHA Loans
FHA loans are a spectacular option for first-time homebuyers and new house hackers to help build equity or repair the effects of a bad credit history.
Here’s everything you need to know about FHA loans to get started:
What is an FHA Loan?
An FHA loan is a mortgage that is insured by the US Federal Housing Administration and issued by an approved third-party lender.
Because they are government-backed, lenders typically hand these loans out to a wider pool of candidates and they come with competitive interest rates, lower down payments, and more flexible underwriting guidelines.
In many cases you can get a loan with only a 3.5% down payment and a fixed rate over a 30 year term!
FHA loans are popular among first-time homebuyers.
Who Can Qualify for an FHA Loan?
The FHA has specifically geared these loans toward low and moderate-income homebuyers with their less stringent requirements.
Typically, you will need a credit score of at least 500 and a debt-to-income ratio of less than 43% to qualify for an FHA loan. However, even borrowers with no credit history or a history of bankruptcy may be able to qualify.
Lenders also require that you show proof of steady employment and income.
FHA Credit Score Requirements
FHA credit score requirements are significantly lower than those associated with conventional mortgages.
You need a FICO score of at least 500 to qualify for an FHA loan, and borrowers with a score of 580 higher are eligible for a low down payment advantage.
Lenders will also look into your payment history and any previous bankruptcies or foreclosures.
FHA Debt-to-Income Ratio Limits
Your debt-to-income ratio (also called your “DTI ratio”) is the sum of your total monthly payments divided by your monthly income. Your DTI ratio must be lower than 43% in order to qualify for an FHA loan.
However, there are special circumstances that might grant wiggle room in this department. For example, if you pay a larger down payment, have a high net worth, or have enough savings, you might be able to go slightly above the 43% DTI ratio requirement.
If want to start house hacking a multi-unit property, you can likely raise your effective income for DTI ratio purposes. That is, lenders will generally factor in the income that the additional units will throw off when calculating your monthly income.
So you’ll be able to qualify for a bigger loan if the multi-family property will produce income while you live in it. This makes something like an FHA loan an excellent option for house hacking.
Definitely talk with a lender to better understand your options.
FHA Down Payment Requirements
With a credit score of 580 or higher, borrowers can qualify for a low down payment advantage of 3.5%. This is much lower than the standard 5%, 10%, or even 20% associated with conventional mortgages.
If your FICO score is between 500 and 579, you can still qualify for an FHA loan with a down payment of at least 10%.
However, the higher you can get your credit score, the better terms you’ll be able to unlock.
FHA Loan Limits
FHA loan limits vary depending on the county where you purchase your property and the number of units in the home.
The following chart is provided by the Federal Housing Authority and should give you a rough idea of loan limits for various property sizes in low and high-cost areas.
For more information on your specific situation, check out the HUD search engine to calculate loan limits in your area.
Low-Cost Area (FHA Loan Limits)
High-Cost Area (FHA Loan Limits)
FHA Frequently Asked Questions
How Long Do You Have to Stay in the Property with an FHA Loan?
If you finance a property with an FHA loan, you must occupy the home as your primary residence within 60 days and live in the property for the majority of one year after the purchase.
Can You House Hack with an FHA Loan?
Yes, you can house hack with an FHA loan as long as you meet all lender requirements, the property is composed of four units or fewer, and the property is a primary residence.
FHA loan rules do not permit short-term rentals or Airbnb operations.
What Happens If You Don’t Live in Your FHA Home?
If you don’t live in your FHA home for the majority of one year, you risk being accused of occupancy fraud. Occupancy rules are in place to ensure that you do not use the property as a rental immediately after purchasing.
Breaking occupancy rules could lead to an investigation by the FHA.
Since mortgage fraud is a federal crime, if you’re guilty, you could face financial penalties, raised interest rates, and even foreclosure or imprisonment.
Do FHA PMI Payments Stop?
No, FHA premium mortgage insurance (PMI) payments do not automatically stop. Removing PMI requires refinancing your FHA-backed mortgage with a non-FHA mortgage that does not require PMI payments.
FHA-backed loans require you to get premium mortgage insurance (PMI), including an upfront payment and subsequent monthly payments. PMI is an extra payment you make each month to your lender.
That said, you’re eligible to remove your PMI after 11 years if you put at least 10% down and don’t miss your monthly payments.
You’ll also need a credit score of at least 620 and a 20% equity balance on the property.
Can You Have 2 FHA Loans at the Same Time?
Yes, you can have 2 FHA loans at the same time if you need to relocate for a job or your family size increases substantially.
Your debt-to-income ratio must support both payments. In some cases, expected rental payments for your first property may help you qualify for a second.
What is the FHA 100-Mile Rule?
The FHA 100-mile rule stipulates that if you are relocating for a job and you qualify for a second FHA loan, the second property must be at least 100 miles away from the first.
This is to ensure that it would take an unreasonable amount of time to commute to your new place of employment if you were to stay in your first residence.
What is an FHA 203(k) Loan?
An FHA 203k loan is an FHA loan that covers the cost of rebab for a property along with helping the borrower to close on the property. The program provides borrowers with the funds required to purchase and renovate a home all in one loan.
Can You Rent Out a Property with an FHA Loan?
Yes, you can rent out a property with an FHA loan as long as you live in the home for the first year. You can rent out spare rooms or additional units in the meantime.
You can usually rent out the entire property after the first year with no legal issues, but you may want to check in with your lender to make sure your occupancy requirements are met.
How Do I Apply for an FHA Loan?
To apply for an FHA loan, submit all required documentation to an FHA-approved lender. Ideally, you should apply with multiple lenders and choose the bank that offers you the best terms.
Commonly required documents include the following:
- Tax returns for the last two years
- Last two pay stubs
- Government-issued identification
- Bank Statements
The lender will also pull your credit, so make sure you have improved your credit score as much as possible before starting the application process.
Are FHA Loans Worth It?
Yes, FHA loans are worth it in many cases. They allow you to finance homes with relatively low down payments and competitive interest rates. The flexible lending requirements often make them easier to obtain than a conventional residential mortgage.
This is especially useful for prospective homebuyers looking to stop renting as soon as possible and start building equity through homeownership and house hacking.
On the other hand, if you have a good credit history and you can afford a larger down payment, you may find that a conventional mortgage is more advantageous for your situation.
Conventional mortgages also offer competitive interest rates for highly qualified lenders, and as long as you put at least 20% down, you will likely not be required to pay mortgage insurance premiums.
You may also find that conventional loans offer a lower APR.
That said, the FHA loan program remains a staple for house hackers for good reason.
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