The Federal Housing Administration (FHA) provides mortgage insurance for loans through FHA-approved lenders. These are known as FHA loans.
An FHA loan is a great option if you want to buy a home but do not have a perfect credit score. You might also use an FHA loan if you don’t have enough money for a 20% down payment.
Are you thinking about applying for an FHA loan? If so, 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 other factors to get an FHA loan, like money in reserve.
- The FHA loan limit for 2021 in most areas is $356,362.
How Do You Get an FHA Loan?
Getting approved for an FHA loan depends on a few factors. These include your credit score, debt-to-income ratio, and how much of a down payment you can afford to pay. No single factor comes with a hard limit, rather the FHA will consider your situation in full based on a picture they can get from all the factors. So even if you don't meet the minimum requirements, you might still be able to get an FHA loan. For example, if you have enough cash in reserve, you could qualify, even if you already have high debt.
|Requirements to Qualify for FHA Loan in 2021|
|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: Cash reserves verified/documented OR housing payment minimal increase OR enough additional income not included in effective income OR residual income|
|580 and above||40:40||3.5%||No discretionary debt|
|580 and above||37:47||3.5%||One of: Cash reserves verified/documented OR housing payment minimal increase OR 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 first is your debt-to-income ratio (DTI). The second is your home-to-income ratio (HTI). The latter may also be referred to as your "payment-to-income ratio" (PTI) or "front-end DTI."
DTI shows your monthly debt payments divided by your gross effective income.
HTI is your housing payment divided by your gross income. Your housing payment includes your mortgage payment, insurance, property taxes, and mortgage insurance.
“Effective income” for the purpose of an FHA loan refers to your gross wages, including salary, overtime, bonuses, tips, commissions, and employer-provided mortgage assistance.
In the table above, the first number is your HTI and the second number is your DTI.
For example, if you have a credit score between 500 and 579, you cannot have HTI:DTI ratios higher than 31 and 43. If you’re buying an energy-efficient home, the limits go up 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,” Melinda Wilner, chief operating officer for United Wholesale Mortgage, told The Balance by email. “The better your credit and financial profile, the better your terms will be."
When your DTI ratio is too high, sometimes the FHA will allow other factors to help approve a loan. These could be showing that you can increase your savings or that you have enough cash reserves. Cash reserves can come from places like retirement accounts.
You can also show that you aren't often using your credit or that you have extra income (like food stamps) that is not part of 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.”
This means that the higher your credit score, the lower your down payment can be. You only need a 3.5% down payment if your FICO score is 580 or higher. But if your score is in the 500-579 range, you’ll need to put 10% down.
A higher credit score can also help you in other ways.
“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 of all types. These can be as low as 500 or as high as 850.
|FHA Loans by Credit Score January 2021|
|Credit Score||Portion of FHA Loan Borrowers|
FHA Down Payment Minimums
How much you'll need for a down payment will change based on your credit score. In some cases, Wilder said, it changes based on your lender.
In most cases, you’ll need a 3.5% down payment if your FICO score is 580 or higher. You'll need 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.
How long you'll pay for this insurance depends on your loan and your down payment. You may pay mortgage insurance for only 11 years. Or, you may need to pay it for the full term of your loan.
The home also needs to meet minimum property requirements. It will also need to pass FHA inspections.
To apply for an FHA loan, you’ll likely need to submit:
- 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
When you get an FHA loan, you’re not borrowing money from the FHA itself. The agency insures loans from lenders around the country. Your loan comes from one of these lenders.
When you submit your application to an FHA-approved lender, the application will be underwritten and then sent to the FHA for approval.
But to get the loan, you have to go through a bank or other lender. This is the same process as any other mortgage application.
There are many advantages to getting an FHA loan, such as more lenient qualifying standards and smaller down payments than conventional loans. But it's still important to shop around and discuss your options with lenders. This will help you get the best FHA loan for your needs.