What is an FHA Loan and How Do You Qualify?

Home Ownership couple buying a home

Buying your first home? An FHA loan might be the answer to financing your purchase.

An FHA loan is a mortgage that’s insured by the Federal Housing Administration (FHA), which allows lower qualifications for the borrower than the norm. They’re most popular for first-time home buyers since the down payment can be as low as 3.5%, while some types of mortgage loans require 20-30%.

If you’re weighing your loan options, learn more about the FHA loan requirements, along with the pros and cons to determine if it’s the right fit for you.

What are the Requirements for an FHA Loan?

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An FHA loan makes becoming a homeowner feasible for people of all income levels since the government is guaranteeing the payment of your loan. Unlike most mortgage loans, there is no minimum income required to qualify for an FHA loan, but you do need to show that you can repay the loan. Take a look at our complete guide to all FHA loan requirements:

Credit score. Your credit score factors into the percentage of down payment you put on the house. If you have a credit score of 580 or higher, you pay a 3.5% down payment, but if you have a credit score lower than 580, you pay a 10% down payment.

Employment history. You must have a steady employment history or worked at the same employer for the past two years.

Legality. You must have a Social Security number, be a resident of the U.S. and be of legal age to sign a mortgage.

Income ratio. This is dependent on your lender, but typically your mortgage payment — including HOA fees, property taxes, mortgage insurance and homeowners insurance — needs to be less than 31% of your gross income. Additionally, your mortgage including your monthly debt needs to be less than 43% of your gross income.

Bankruptcy background. You should be at least two years out of bankruptcy and have re-established good credit, but some lenders may make exceptions.

Foreclosure background. You should be at least three years out of foreclosure and have re-established good credit, but similar to your bankruptcy background, some lenders may make exceptions.

Private lenders, whether a bank or credit union, may have stricter qualifications than the FHA requirements, so it’s recommended to check with a variety of lenders before making your final decision.

How Does an FHA Loan Work?

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The requirements to qualify for an FHA loan may sound too good to be true, but it’s all made possible through one thing: mortgage insurance.

Private lenders issue the loan for your home, but the FHA provides the backing for part of the loan, so if you don’t repay your loan, the FHA will pay the lender instead. This provides the lender with the reassurance that your loan will be repaid, thus providing you with a better deal.

Pros and Cons of an FHA Loan

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It’s important to evaluate the benefits and disadvantages of an FHA loan to make sure it’s a decision that will help you reach your financial goals.

Pros of an FHA Loan

Low credit score requirements. A major benefit of an FHA loan is that it’s one of the easiest loans to qualify for. If you have above a 580 credit score, you’ll benefit from paying a lower down payment, but a low credit score doesn’t necessarily take you out of FHA loan eligibility.

Low down payment. Your down payment is dependent on your credit score, which can be as low as 3.5% if your credit score is above 580. If you have below a credit score, you’ll pay 10%, which is still lower than the typical 20-30% from private lenders.

Assumable mortgage. What many people don’t know is that an FHA loan is also an assumable mortgage, which is the type of loan where the buyer could take over the seller’s mortgage rather than applying for a new loan. This is beneficial to the borrower because even if you have a low credit score, you could still qualify for an FHA loan.

Debt-to-income ratio. What is debt-to-income ratio? This is the percentage that shows how much a person’s income is used to cover his or her debts. The debt-to-income ratios are 31% for housing-related debt, and 43% for total debt.

Borrowing for home repairs. The FHA has a loan for borrowers who want to repair their home called the 203(k) loan. The 203(k) allows you to buy a house and address the necessary repairs in one transaction, or refinance the rehabilitation of your existing home.

Cons of an FHA Loan

Low down payment. Although this is most commonly seen as a benefit, a low down payment can also be seen as a drawback. If you only have a low down payment available, it may mean that you’re not quite ready to purchase a home until you have more money saved.

Mortgage insurance. There are two types of mortgage insurance premiums to pay — the upfront premium and the annual premium. You typically pay 1.75% for the upfront premium, but the more you borrow, the more you will pay. For the annual insurance premium, you typically pay between 0.80% and 1.05% of your loan balance.

Lender restrictions. The lender must be FHA-approved to offer an FHA loan, but that also means that they can set their own standards for who they approve for the loan.

Minimum property standards. If you’re looking to flip a house, it will need to be in liveable condition to use an FHA loan to purchase it. This is to protect the lender, so if you were to stop making payments on the home, they would be able to resell it.

Loan limits. The FHA changes the maximum and minimum loan amount that it will insure based on the area of the U.S. you live. You can use the FHA Mortgage Limit tool to check the loan limit in your area.

Candidates Who Should Consider an FHA Loan

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As mentioned before, first-time home buyers are the most popular candidates for an FHA loan given the requirements to qualify. FHA loans also work well for those who are working on building their credit, don’t have a large down payment or those who have high debt.

If you’re considering an FHA loan, look at advantages and disadvantages, and compare lenders before making the final decision.

Sources: HUD.gov: Let FHA Loans Help You | HUD.gov: The Federal Housing Administration (FHA) | Zillow: What is an FHA Loan? The Complete Consumer Guide | Realtor.com: What is an Assumable Mortgage? | The Balance: FHA Home Loan Pitfalls | FHA Handbook: debt-to-income ratios | Investopedia: The FHA’s minimum property standards | HUD.gov: 203K Rehab Mortgage Insurance

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