What Is an FHA Loan?
Not everyone may have a large amount of money lying around. There might be a great opportunity but you just don’t have 20% down for the house. That’s not a problem because the FHA loan is designed to help borrowers who are unable to make a large down payment. The FHA loan is a mortgage insured by the Federal Housing Administration (FHA). The FHA loan was created during the Great Depression due to a number of foreclosures and defaults. The loan is government insured, giving the mortgage lender a piece of mind.
Why An FHA Loan?
Since the FHA loan is insured by the government, they are more willing to offer to low-medium income individuals with average or low credit scores. The FHA is more flexible with their qualifications and may even offer creditors who have gone bankrupt or foreclosure loans.
Benefits of An FHA Loan
- Easier to Qualify. FHA loans are less stringent and more flexible with applicants that have low credit scores to qualify.
- Competitive Interest Rates. FHA loans usually offer interest rates lower than the traditional subprime borrows
- A Smaller amount of money down needed. May go as low as 3.5% down
- FHA Allows 100% Gift funds. Very few programs allow 100% gift funds to be used as the down payment.
- Many FHA–Approved Lenders – The good news is that there are many FHA lenders, which makes it a competitive market. Lenders compete in lowest interest rates and lowest fees. Even if you get turned down at Lender A, lender B may approve you. It is a good idea to shop around for rates until you have found the right one for you.
- FHA Loans are Assumable – The home buyer may “assume” the existing FHA mortgage on the being that’s being purchased. The only requirement is that the buyer must qualify for its existing terms. This is attractive in a market where there are rising mortgage rates.
FHA Loan Requirements
Here Are Some Examples Of the Requirements
- Borrower(s) must have a steady employment history
- Must have valid SSN, be of legal age to sign mortgage
- Must pay a minimum of 3.5% down payment
- Property must be appraised by an FHA-approved appraiser
- The property must meet minimum standards during appraisal. If it does not meet the standards and the seller is not willing to pay then it must be paid during closing fees.
- Must meet their Debt to Income ratio
- Must be two years out of bankruptcy and have established good credit. Exceptions can be made depending on the circumstances
- Must be three years out of foreclosure and have established good credit. Exceptions can be made depending on circumstances
Mortgage Insurance Requirements
Why do I need mortgage insurance? Well, that’s the catch. Mortgage insurance is what makes FHA loans possible. The insurance gives the lenders a piece of mind in event that the borrow defaults the loan. The insurance premiums can either be financed into the mortgage or into monthly payments. The other requirement is that the house must be approved by an approved FHA appraiser and meet the minimum conditions required.
How much house can I Afford?
This is actually two separate questions.
- How much of an FHA can I qualify for?
- How much of a mortgage payment can I afford?
The first question is based on the criteria set out for loan approval, while the second is based on budgeting and affordability.
How much of an FHA Can I qualify for?
Income is a major deciding factor but it is not the only factor. The other fact is debt. Lenders use a formula known as a debt-to-income ratio(DTI).
DTI is a comparison between after tax income each month and the amount spent on debt you have to pay no matter what. Think rent, cable, electricity, phone bill etc. There are two ratios.
- Front-end ratio. This includes only housing costs
- Back end ratio. This is all recurring debts like car payments, and credit cards etc
The general rule used for FHA approval the 31/43. The total debt load should be no more than 43% of after-tax income.
Let’s take for example the gross monthly income is $5,000. The total monthly debts(mortgage payment, and other recurring expenses) should be less than $2150. It is simply calculated like this: 5000 x .43 = 2150
The house payment should be less than $1550. It is calculated like this: 5000 x .31 = 1550
These aren’t set in stone. There are many exceptions to the general rule for FHA Approval. This will vary from lender to lender.
How much mortgage can I afford?
It is quite possible to be qualified for a loan that may be a too big for your own good. This may leave you with a huge burden later on or even foreclosure. It is recommended to set up a budget to ensure success down the road and saving you many headaches.
How to set up housing budget?
The first step would be to take a look at your net income( take home pay). Now compare this to your expenses, this will be everything that is not housing related. It will include everything from food, entertainment, gas, credit cards etc.
The amount left over is the amount that can be put towards a mortgage payment. It is a good idea to only use a portion of that amount so you can budget for an emergency fund.
Another thing to consider is job security. I was a former oil field worker and the last two years it was a rough time to find work. To keep in consideration of boom and bust jobs and aim to save 6 months mortgage payments in event that a layoff does occur. 6 months is a realistic time frame until you can find another job. It is wonderful if you can get another one right away but having 6 months savings will keep the stress at a minimum.
Once you have figured out how much you can afford to spend on a mortgage per month you can contact your FHA lenders. They can only tell you what you are qualified for, not how much you are comfortable to pay for expenses. Use the budget you have set out when getting a mortgage so you don’t get something you can’t truly afford.