Best FHA Loans
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What is an FHA loan?

FHA loans are insured by the Federal Housing Administration (FHA). This doesn't mean the FHA itself issues the mortgage. Instead, financial institutions such as banks seek approval from the FHA. An approved lender can then issue loans and the FHA repays the lender the amount that is owed if you ever default. Since the FHA steps in if you fail to make your monthly payments, FHA-approved lenders bear less risk and are therefore willing to offer favorable terms to people who might not usually qualify for conventional loans.

FHA loans are helpful for people who can't afford a sizable down payment or have a troubled credit history. According to the most recent guidelines, the 203(b) mortgage insurance program which is the most common FHA loan for one to four-unit residential properties can cover up to up to 96.5% of the value of the property. This means your down payment could be as low as 3.5%. 

To be eligible for a 3.5% down payment, your credit score must be 580 or more. People with a credit score between 500 and 579 might still qualify for an FHA loan but it would only cover up to 90% of the value of the property so you would have to put a 10% down payment.

Requirements for an FHA loan

To qualify for an FHA loan, you must meet all of the following:

Proof of income and employment stability

There is really no restriction to how much or how little you have to earn to qualify. What lenders will focus on is evaluating your ability to pay back the loan by reviewing your credit history, your current debt, and verifying your employment and income. 

Lenders will also pay close attention to  your debt-to-income ratio (DTI). DTI is calculated by adding up your monthly debt and dividing it by your gross monthly income. For example, if your monthly debt from an auto loan and a credit card amounts to $600 and you earn $2,500 monthly, your DTI is 24%. According to the Consumer Financial Protection Bureau (CFPB), “borrowers with a higher debt-to-income ratio are more likely to run into trouble making monthly payments” and the highest ratio lenders may agree to is 43%.

Lenders will also verify your employment history for at least the two most recent years. This doesn't mean that you must have the same job for two years. A shorter work history is acceptable as well as gaps taken to study or for maternity leave, for example. What a lender is looking for is stability and a sign that you’re likely to remain in your current position and therefore be less likely to default on the loan. 

Some of the documentation you’re expected to provide includes:

• Personal tax returns

• W-2s and 1099s

• Pay stubs

• Statements from bank, retirement and/or investments accounts

If you’re self-employed, a lender will need proof that you’ve been working for a minimum of two years and that your income has increased or remained stable. They might also accept a shorter self-employment history if your current line of work is related to a past employment—for example, you worked in an advertisement agency and now you freelance as a copywriter. 

You’re expected to provide the same documents mentioned above but you’ll also have to provide tax returns from your business if your personal tax returns don’t show an increase in income, or the funds for closing come from a personal account and not a business account.

The property must be your primary residence

You can use an FHA loan to buy a single or multi-family home for up to four families as long as the property will be your primary residence—you can also buy a condo, manufactured home, or mobile home. 

FHA loans can’t be used to purchase investment properties or vacation homes specifically. You are expected to be an owner-occupant which is a resident that owns the property and lives in it as well. You or your co-borrower will be required to occupy the property within 60 days of closing and remain there for at least one year. After a year, you are free to move out and only then can you rent out the property if you wish to do so. 

According to HUD, the only instances in which an FHA loan may be approved to purchase a second home is if you don’t already have one and:

• The new property won’t be used primarily for recreational purposes

• The commuting distance from your primary home to your workplace creates an “undue hardship” for you

• There’s no affordable rental housing based on your financial situation within 100 miles of your workplace. You’ll be asked provide written evidence such as a letter from a local real estate agency that can verify a lack of acceptable housing in the area)

Get the property appraised by an FHA-approved appraiser

In addition to the one-year-occupancy requirement, the property has to meet the structural standards designated by the Department of Housing and Urban Development (HUD). An appraisal must determine if the property’s value is equal to or less than the amount you wish to borrow and, most importantly, that it’s structurally sound. 

As HUD’s Single-Family Housing Policy Handbook describes, “‘Minimum Property Requirements’ refer to general requirements that all homes insured by FHA be safe, sound, and secure.” Some requirements can be expected, such as “a continuing and sufficient supply of safe and potable water” and “sanitary facilities and a safe method of sewage disposal.” Others may not, such as how excess noise from roads, railways, or airports affect the marketability and value of the site. 

You could still be able to purchase even if the appraiser finds that the property is not up to code as long as the problems found can be repaired. The seller of the property would have to agree to complete the repair before closing. If the seller refuses, you may do the repairs yourself by applying an additional FHA program known as a Limited 203(K) Rehab Mortgage. This loan allows for repairs capped at $35,000. There’s also a Standard 203(K) Rehab Mortgage. This one allows for more costly renovations such as structural alterations and reconstructions as long as “the existing foundation system remains in place” explains the HUD. The property must have been completed for at least a year prior to be eligible for these renovation programs.

Different types of FHA loans

Basic Home Mortgage Loan 203(b): the most widely known FHA loan. According to the HUD, its purpose is “to provide mortgage insurance for a person to purchase or refinance a principal residence.” To apply, you just meet standard FHA requirements detailed above.

203(k) Rehabilitation Mortgage: designated for properties that may need some repairs. The loan will be based on the value of the home after the renovations. There’s a Limited and a Standard version of the loan. With the Limited 203(k), you can finance repairs of up to $35,000. The Standard 203(k) is meant for more extensive repairs such as structural alterations and reconstructions, reconditioning or replacing plumbing, or enhancing accessibility for a disabled person.

Condominium Mortgage Insurance: covers the purchase or refinance of a one-family condo unit as long as the unit is located in an FHA-approved condominium project. The condo may still be covered if it’s not in an FHA-approved project but meets the FHA requirement for Single-Unit properties. 

Mortgage Insurance for Disaster Victims Section 203(h): helps disaster victims get a mortgage to buy or rebuild a home. To be eligible, the property must be located in an area that was designated as a disaster area and it must be damaged to such an extent that it needs to be reconstructed or replaced. This loan doesn't require a down payment but you are expected to pay for closing costs and other prepaid expenses.

Energy-Efficient Mortgages (EEM): can be used for energy-saving home improvements such as solar panels. The total amount financed for a new system must not exceed 20 percent of the property’s appraised value.

Title I Property Improvement Loans: can be used for renovations on an already owned property. According to the HUD, the “improvements must substantially protect or improve the basic livability or utility of the property.” The maximum loan amount is about $25,000 for a single-family home and up to $60,000 for a multi-family home.

Mortgage Insurance Premium (MIP) Requirement

Typically, a mortgage with a down payment of less than 20% of the property’s value requires mortgage insurance to protect lenders in case you ever default on your loan. In the case of FHA loans, the required mortgage insurance is known as a Mortgage Insurance Premium (MIP). 

The MIP will be divided into two costs: a one-time Upfront Mortgage Insurance Premium (UFMIP) and an annual insurance premium. The UFMIP, as its name suggests, is paid up front when you get the loan and its cost is always 1.75% of the loan’s total amount. You can also choose to finance the UFMIP with your mortgage but keep in mind that your monthly payment will increase. 

The annual insurance cost, on the other hand, is always paid monthly and it ranges between 0.45% to 1.05% depending on the amount you borrow, your down payment and the term of your mortgage (15 or 30 years). 

A Mortgage Insurance Premium (MIP) is not the same as a Private Mortgage Insurance (PMI)

FHA loans require a Mortgage Insurance Premiums (MIP). This type of insurance differs from private mortgage insurance (PMI) mainly in for how long you’re required to pay for the insurance. 

In the case of an FHA loan, an MIP is mandatory for the life of the loan. The only way you could ever get rid of the MIP is if you put down a down payment of 10% or more when you purchase the property. Still, you’d have to pay the MIP for at least 11 years.

PMI is a type of insurance required for conventional mortgage loans when you give a down payment of less than 20%. For example, if you took out a loan for $100,000 and gave a $10,000 down payment, since your down payment amounts to 10% of the purchase price, you’ll need PMI. You could request to cancel your PMI once your loan-to-value (LTV) ratio drops below 80% since borrowers with an LTV above 80% are considered to have a higher risk of defaulting.

The LTV measures the difference between what you owe on your mortgage and the value of your home. It’s calculated by dividing the total amount you borrowed by the property’s value. For example, if you take out an $80,000 mortgage on a property appraised at $100,000, your LTV is 80% ($80,000/$100,000 = 0.8 or 80%). Making your monthly mortgage payment brings down your LTV eventually by decreasing the amount you owe and increasing your equity. Doing renovations can also lower your LTV as they increase the value of your property while the amount you owe remains the same.