The Federal Housing Administration (FHA) provides mortgage insurance for loans through FHA-approved lenders, known as FHA loans. An FHA loan is a great option for buyers who have less-than-perfect credit scores or don’t have enough money for a traditional 20% down payment. If you’re thinking about applying for an FHA loan, here’s what you need to know.
- Your debt-to-income (DTI) ratio compares your gross effective income to your monthly debt payments.
- Your home-to-income (HTI) ratio compares your housing payment to your gross income.
- Depending on your credit score and ratios, you may need to have compensating factors to qualify for an FHA loan, like money in reserves.
- The FHA loan limit for 2021 in most areas is $356,362.
What Are the Requirements for an FHA Loan?
Qualifying for an FHA loan is based on a variety of factors, including your credit score, debt-to-income ratio, and minimum down payment.
Some acceptable compensating factors may allow you to qualify even if you don’t meet the minimum requirements. This chart summarizes the requirements, which we’ll discuss in more depth below.
|FICO Credit Score||Maximum Home-to-Income and Debt-to-Income Ratios||Minimum Down Payment||Acceptable Compensating Factors|
|580 and above||40/50||3.5%||Two of the following: Cash reserves verified/documented Housing payment minimal increase Substantial additional income not included in effective income Residual income|
|580 and above||40/40||3.5%||No discretionary debt|
|580 and above||37/47||3.5%||One of the following: Cash reserves verified/documented Housing payment minimal increase Residual income|
|580 and above||31/43||3.5%||No compensating factors required|
|580 and above: Energy Efficient Home||33/45||3.5%||No compensating factors required|
|500-579 or no credit score||31/43||10%||No exceptions|
|500-579 or no credit score: Energy Efficient Home||33/45||10%||No exceptions|
When applying for an FHA loan, two ratios are in play: the borrower’s debt-to-income ratio (DTI) and home-to-income ratio (HTI). The latter is also known as "PTI" and "front-end DTI."
DTI represents your monthly debt payments divided by your gross effective income, Melinda Wilner, chief operating officer for United Wholesale Mortgage, told The Balance by email. HTI is your housing payment (including your mortgage payment, insurance, property taxes, and mortgage insurance) divided by your gross income.
“Effective income” refers to your gross wages, including salary, overtime, bonuses, tips, commissions, and employer-provided mortgage assistance.
In the table above, the ratios are shown as two numbers separated by a backslash. The first number is your HTI and the second number is your DTI, Wilner explained.
For example, if you have a credit score between 500 and 579, your maximum HTI/DTI ratios are 31/43; if you’re buying an energy-efficient home, the limits increase to 33/45.
“While these ratios were designed to help many first-time homebuyers, percentages are subject to change depending on your credit and financial profile,” Wilner said. “The better your credit and financial profile, the better your terms will be—and you’ll notice this will be a recurring theme throughout.”
When your DTI ratio exceeds the benchmark guidelines, sometimes the FHA will allow compensating factors to help approve a loan. Examples include demonstrating the ability to accumulate savings, having substantial cash reserves (from retirement accounts, etc.) conservatively using credit, or having additional income (like food stamps) that would not be reflected in your effective income.
“Banks and lenders pay attention to these numbers because it helps us help our homebuyers ensure that they won’t be saddled with an unsustainable debt burden,” he said.
Credit Score Requirements
“In general, a borrower with a FICO score as low as 500 can qualify for an FHA loan,” Wilner said. “Your credit score determines how much money you will need to put down on a home, and the higher your score, the better terms you’re able to receive.”
You’ll notice from the chart above that you only need a 3.5% down payment if your FICO score is 580 or higher. However, if your score is in the 500-579 range, you’ll need to put 10% down.
A higher credit score is also advantageous for other reasons.
“In general, a credit score of 740 or higher will get you the best mortgage rates and terms,” Dorn noted. “But right now, due to the record low rates nationwide, even people with much lower credit scores are still able to get payment rates better than some of the high-credit borrowers of the past.”
People who qualify for FHA loans have credit scores in every category. In January 2021, the percentage of FHA loans distributed by credit scores was as follows:
|Credit Score||Portion of FHA Loan Borrowers|
FHA Down Payment Minimums
The minimum down payment requirements vary by credit score and, in some cases, Wilder said, by lender. Generally, you’ll need a 3.5% down payment if your FICO score is 580 or higher and a 10% down payment if your score is in the 500-579 range.
Other FHA Requirements
The FHA loan limit for 2021 is $356,362 for single-family homes. In addition to credit score and DTI requirements, you’ll have to pay for mortgage insurance. Depending on the loan amount and your down payment, you’ll pay insurance for 11 years or the full mortgage term.
The home also needs to meet minimum property requirements and pass FHA inspections.
To apply for an FHA loan, you’ll likely need to submit the following documentation:
- Proof of Social Security number
- Driver’s license
- Original pay stubs
- W-2 forms
- Tax returns
- Bank statements
- Account statements from investments and interest-bearing accounts
How to Get an FHA Loan
It’s important to understand that when you’re applying for an FHA loan, you’re not borrowing money from the FHA itself. The administration insures loans from various lenders nationwide.
So, how does this process work? When you submit your application to an FHA-approved lender, the application will be underwritten and then submitted to the FHA for approval.
There are many advantages to getting an FHA loan. However, you should always shop around and discuss your options with lenders to get the best FHA loan for your needs.
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