Mortgage loans from institutions such as the Federal Housing Agency (FHA) are a great option for potential homeowners with a low income and a poor credit score.
What are FHA loans?
FHA loans are government-backed mortgage loans which are insured by the Federal Housing Administration and financed by approved lenders such as credit unions or private banks. They are popular with first-time home buyers and low-income earners as they require lower down payments. Should the borrower be unable to make payments, the government promises to repay the lender.
Requirements for an FHA loan
Just like other loans, there are numerous requirements that the lender must meet to qualify for a loan.
You are required to provide proof of identification by providing your Social Security number. While there is no minimum income requirement, you must show proof of a reliable income stream by providing recent original pay stubs, valid tax returns, or W-2 forms. You must have worked for the same employer for at least two years or demonstrate a steady employment history.
To qualify for a low down payment mortgage, which is currently around 3.5%, you have to have a minimum credit score of around 580. For people whose credit score is lower than this, they have put down a 10% down payment. Borrowers with credit scores lower than 500 might not qualify for an FHA loan. It is important to point out that FHA doesn’t issue loan mortgages, rather they insure them in case the borrower’s default. For this reason, approved lenders may recommend slightly higher credit scores, which are normally between 600 and 620.
The debt-to-income ratio (DTI) is a percentage which shows how much of your income is used to repay your recurring debts. To qualify for an FHA loan, your mortgage loan, property tax, homeowner’s association fees, and homeowner’s insurance premium must be less than 31% of your gross income. Debt payments such as credit card payments, car loans, and other loans must also not be more than 43% of the gross income.
One of the FHA loan requirements is private mortgage insurance (PMI) or mortgage insurance premium (MIP). MIP refers to an insurance policy on your loan in case you default. There are two types of mortgage insurance you will pay on your FHA loan: An up-front insurance premium of 1.75% of your total loan amount and an annual MIP. Effective 2015, lenders can no longer cancel their MIP once the LTV gets to 78% or less.
Your FHA loan limit depends on whether your home will be in a high-cost or low-cost area. The Department of Housing and Urban Development recently revised the FHA loan limit to $726,525 and $314,827 for high-cost and low-cost living areas, respectively.
Foreclosure or bankruptcy
A borrower who has gone through a foreclosure and filed a Chapter 7 bankruptcy has to wait for at least two years to qualify for an FHA loan. Borrowers who file for Chapter 13 bankruptcy might qualify for the loan before completing the plan.
Just like any other mortgage loan, your FHA-approved lender will look into loan repayment ability and creditworthiness. We encourage borrowers to first come up with their housing budget before beginning the FHA loan application process.