What Is an FHA Loan?

An FHA loan is a mortgage backed by the Federal Housing Administration. Borrowers pay for insurance that will cover the cost of the loan in case they are unable to make their mortgage payments.

This may have people wondering why anyone would sign up for an FHA loan if it carries mandatory insurance. Thanks to the insurance, FHA loan requirements are less strict than traditional loans. Additionally, these mortgages can be acquired with a smaller down payment.

What Are the FHA Loan Requirements?

FHA Loan Requirements Provide Wiggle Room for People with Average Credit Scores

FHA loan requirements vary depending on each borrower’s financial situation and needs. One common requirement for any credit product is a decent credit score. Individuals may have inadequate credit scores for a variety of reasons. They may have a bad payment record and are therefore an unattractive candidate based on their history. On the other hand, a generally responsible individual may have a poor credit score because they have a limited credit history.

Whatever the case may be, FHA loans provide a nice option for those hoping to secure a mortgage despite a mediocre credit score. The FHA requirements may simply require that a borrower with a low credit score put down a larger down payment. Then again, this is relative since FHA loans typically carry smaller down payments thanks to the accompanying mortgage insurance.

For instance, a borrower wishing to access the low down payment of 3.5 percent must have a FICO score of 580 or over to qualify. While that will come as a disappointment to some, the good news is that the FHA mortgage requirements do not completely restrict those with credit scores lower than 580.

Instead, anyone with a credit score lower than 580 will be required to provide a down payment of 10% or more. So while those in this situation are required to fork over more cash up front, the requirements for an FHA loan still make it possible for them to become homeowners. 

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How Do FHA Loans Work?

FHA loan requirements do not make receiving a mortgage through the agency inaccessible. In fact, the point of them is to make homeownership attainable to more people in a way that is financially sustainable. But it does leave the question of how the FHA mortgage system works.

For starters, it’s important to note that the Federal Housing Administration does not actually lend homebuyers the money. In fact, that loan is still furnished by a bank. To be more specific, FHA-approved lenders provide the money. The FHA loan requirements are meant to determine if a person’s mortgage will be insured. Naturally, insurance makes banks more comfortable with providing such competitive features.

FHA loans were created to encourage more homeownership. For a lot of aspiring homeowners, the large down payment required of borrowers in addition to factors like a high credit score and certain income level made it difficult to secure a mortgage.

As expected, banks are hesitant to take on that kind of risk and were unlikely to approve these individuals. The FHA loan requirements make it more attractive for banks to lend their money to mortgage seekers. If an aspiring homeowner is approved for an FHA loan, then the bank is guaranteed payment should the borrower default.

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FHA Home Requirements: Livability of the Property

FHA loan requirements do not stop at examinations of your financial health. Beyond paystubs and tax forms, FHA mortgage requirements include an examination of the house you are taking out the mortgage for. Houses purchased with FHA-approved mortgages are required to be habitable from the very first day of ownership. Fixer-uppers that cannot be lived in immediately are not permissible.

A review of a home’s safety and livability is included in the FHA home requirements. Issues like poor plumbing or broken smoke alarms may result in delays or denial of an FHA loan.

This FHA home requirement presents quite a predicament for those looking to acquire an FHA loan. If they wish to buy the property, they will need the loan, but in order to get the loan they need to fix up the property…and in order to fix up the property, they need a loan. To address these issues, the Federal Housing Administration created the 203(k) Streamline program. This program provides loans of up to $35,000 for buyers needing to carry out major but non-structural repairs to their homes.

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FHA Loan Requirements: An Appraisal

Next to making sure you are living in a safe house is making sure the house is worth the amount you are willing to pay for it. This FHA loan requirement is meant to protect you and the bank. After the negotiations with the sellers are done, you will be seeking a mortgage based on this amount you discussed.

If you secure this mortgage and move in only to find out that the house is worth significantly less, this spells out a lot of unnecessary hardship down the road. Most importantly, you will lose profit because when you sell the house it will be for less than you bought it (and less than the loan you are obligated to pay off).

In fairness, appraisals can also be subjective, but if they come back as less than your negotiated amount, your FHA loan could be delayed. That said, buyers can try and work something out by offering to pony up the difference and only take a loan for the appraised amount.

FHA Loan Requirements: Debt-to-Income Ratio

While the FHA loan requirements are designed to make mortgages available to more people, they are not meant to simply give mortgages out. Rather, they serve as a way to consider of the entirety of individuals who may otherwise be ruled out because of singular factors like credit score.

In order to grant mortgages responsibly, the requirements for an FHA loan also take into consideration an applicant’s debt-to-income ratio. Your debt-to-income ratio is essentially a monthly percentage determined by the amount of debt payments you make (mortgage, car payments, etc.) versus the amount of monthly income you receive. The higher your number is, the more precarious your situation.

Even if your number is high, it is still recommended that you apply. While the debt-to-income ratio calculated based on your potential home may be at odds with the FHA loan requirements, those requirements are still more lenient that regular banks – so you will never know if you qualify unless you apply.

FHA Mortgage Requirements: The Application Process

Depending on your financial situation, and taking into consideration factors like your debt-to-income ratio, the ease of your application process will vary. If you have a credit score that is over 580, you might be more quickly approved. In other cases, people have to jump through some hoops in order to eventually meet the FHA requirements.

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Standard Paperwork

Applicants are required to fill out the standard Uniform Residential Loan Application form. Some lenders may require buyers to fill out the form before they have found a home, but the form is typically completed afterward. In order to faithfully meet the FHA home loan requirements, applicants must truthfully and thoroughly fill out the form. The Uniform Residential Loan Application form is a comprehensive document that asks questions about your job history, your various expenses, all of your sources of income and debt, and more.

The Appraisal

The next step in the process is the appraisal. The licensed appraiser takes a number of factors into consideration when determining the home’s real value on the current market. They will look at the condition of the house in addition to the quality of the neighborhood and the price of similar homes. This is not an exclusive FHA mortgage requirement. Most lenders require an appraisal so that they know the resale value in case they need to foreclose the house.

If the appraiser determines that the house is equal to or more than the amount you agreed to pay, then, all things considered, you can move on in the process. If the appraiser determines the house is worth less, you may find your FHA loan denied. In this scenario, there are a couple of options. You could forget about that particular house altogether and look for another one. If you want this house and also want to meet the FHA loan requirements, you can take out a loan for the appraisal amount and pay the difference out of pocket or negotiate a lower price from the sellers.

Underwriting Your Loan

The underwriting process is where your financial situation will be put under the most scrutiny. This FHA loan requirement is probably the most vital step when it comes to deciding whether you will be given a loan. This is because the underwriter is responsible for determining if it is a smart idea to give you this loan.

The underwriter may request a letter of explanation (LOE) if they see any issues with your financial history. This is not unusual, and prospective homeowners should promptly meet this FHA loan requirement by providing a thorough explanation in the letter. This is your opportunity to explain any extenuating circumstances for a given issue. If, however, the issues are serious and put the loan in jeopardy, the underwriter may classify the loan as unsound, effectively killing the loan.

This underwriting process is where you find out whether you meet both the financial institution’s requirements and the FHA’s requirements.

Remember: the FHA is not actually providing the loan. The bank does that. So bank guidelines are also taken into consideration, but meeting the FHA loan requirements will most likely be the deciding factor in whether you qualify for a lower down payment.

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FHA Mortgage Requirements: Upfront Mortgage Insurance Premium

One of the FHA mortgage requirements is an upfront mortgage insurance premium (UFMIP). This is in addition to the regular private mortgage insurance you are required to pay on a monthly basis. Private mortgage insurance is a bitter pill to swallow since you are paying for something that does not protect you. Private mortgage insurance is meant as a safety net for the lender in case you default on your mortgage. It is typically required of borrowers whose loan-to-value ratio (LTV) is 80% or more. Your loan-to-value ratio is the amount of money you owe on the house versus the value of the house.

How to Find an FHA-Approved Lender

Borrowers should make an honest assessment of their options. If they qualify for a regular loan, it may be best to take that route and pay for that financial institution’s private mortgage insurance instead of paying twice for an FHA loan. While some groups, like first time homebuyers, may find FHA mortgages an attractive option, these mortgages are best suited for those with poor credit scores who will find it difficult to get approved elsewhere. If you believe you meet the FHA loan requirements and you are interested in acquiring an FHA mortgage, you can simply run an online search for financial institutions that provide them or see if your regular bank offers them as well.

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