FHA Program Requirements and Guidelines: A Detailed Look
For many potential home buyers, the FHA loan is a fundamental part of their buying strategy. This particular mortgage has been a staple program over multiple generations and has helped numerous people realize the dream of owning a home.
FHA Loan Requirements and General Guidelines
FHA, an acronym for Federal Housing Authority, does not directly offer the loans. Instead, they have a list of guidelines and rules that must be followed for their loans. Banks, credit unions and mortgage lenders are then approved by FHA to offer the loans to consumers.
In general, FHA is looking for individuals that have showed stability in the past 2 years in regards to their payment history. This does not mean that a person needs absolute perfect credit. Rather, FHA is looking for a pattern of making debt and rent payments on time. The most recent 12 month history is the most important factor in determining if a person will get approved for a loan.
FHA is also looking for steady employment. This could mean that the person has had the same job for at least 2 years. It could also mean the person has been in the same industry but has improved their position with a better role and more income.
Along the same lines, FHA prefers a borrower that has lived at the same address for the past 2 years. The stability demonstrated by the payment history, employment and residency improves the odds of getting approved for a loan.
There are also some guidelines about a person’s income compared to their existing debt and potential house payment. Put simply:
- 29% of a borrower’s gross, monthly income can be used for the home payment
- 41% of the gross, monthly income can be used for the existing debt plus the home payment
In some cases, FHA loans can be approved at higher debt ratios than listed above.
FHA has a cap on their products known as an FHA loan limit. This cap is the maximum amount that can possibly be approved for a mortgage. It is important to note two things in reference to the loan limits:
- The loan limits vary by state as well as by city. Certain markets, such as New York City or Los Angeles, have much higher loan limits than most other places around the country.
- Every borrower does not qualify for the maximum loan amount. Getting approved for an FHA loan is partly dependent on the borrower’s yearly income.
A qualified mortgage lender can provide details about the loan limits in your area as well as the amount of the FHA loan that you qualify for. FHA loan limits in Wisconsin, Illinois, Minnesota and Florida can be downloaded below.
Except for certain family member to family member purchases, in which the down payment could be higher (FHA Identity of Interest Transactions), FHA only requires that borrowers pay 3.5%* of the purchase price as a down payment. However, it does not have to be the borrower’s own money, gifts from family are very a common practice.
Gift for FHA Down Payment
FHA states that 3.5%* of the purchase price must be paid at the time of closing. For example, if a home is priced at $185,000 then the borrower will need to pay $6,475 at closing. HOWEVER, this money does not have to come directly from the borrower. These funds can come from a gift (family member), checking, savings, and withdrawn or loaned from a 401K/IRA account. (Penalties may apply to retirement accounts).
FHA realized that parents and other family members were more than willing to assist their relatives in buying their first home. In order to accommodate the involvement of family funds, the guidelines for a gift of cash were developed.
- The donor and receiver need to complete a gift letter.
- Various bank printouts before and after the gift will need to be prepared.
- The receiver needs to deposit the money and leave it alone until the loan closing.
This is but a general overview of the subject. Detailed information, as well as tax notes, can be found at the following link How to Document an FHA Cash Gift Down Payment
The most important takeaway from this section is the fact that a young couple or family does not have to wait 4 or 5 years to save up the necessary down payment if they have relatives willing to help with the money.
FHA Loans Allow for a Non-Occupying Co-Borrower that Will not Live in the Home!
Other than the down payment requirement, the biggest hurdle for some borrowers is the strength of credit needed to buy a home. Many young people simply have not established much debt in their own name, other than a rent payment. In order to overcome this situation, FHA will allow a non-occupying co-borrower.
This is a perfect situation for a parent or grandparent to sign on the mortgage and allow a young person to buy a home and build up their credit. It is important to note that the co-borrower is not required to live in the home. However, the co-borrower is legally responsible for the loan just as much as the person(s) that intend to live in the property.
Here are some other guidelines concerning a non-occupying co-borrower.
- All underwriting rules will be applied to each borrower on the loan in regards to credit history, income, and length of residency.
- The co-borrower must be a current resident of the United States.
- The same 3.5%* down payment rule will be applied.
There are various situations that are prime candidates for a non-occupying co-borrower. More details can be found in the following article The Non-Occupying Co-Borrower Option
Flexibility of FHA Loans
Besides the fact that FHA will approve borrowers who use gift funds and have less than perfect credit, FHA also has some flexibility in their mortgages.
Various types of rates
Some people may be starting on a new job that has noticeable wage increases over the next few years. In order to afford the home now, the borrower may choose to get an ARM (Adjustable Rate Mortgage). This type of loan would have a lower interest rate for the first 1 to 3 years and then a fixed rate for the remaining term.
Purchase More than a Single Family Residence
Some ambitious people want to eventually become a real estate investor. Although FHA does not allow financing for investment properties, there is a small loop hole. FHA will approve a mortgage for a duplex or a building that has up to 4 units as long as the borrower intends to live in one of the units. Some people use the FHA mortgage to buy such a building and rent out the remaining units in order to cover their mortgage payment and save money for their next investment purchase.
More than just purchase loans
FHA is not designated just for purchases. Current homeowners can streamline refinance or cash-out refinance their mortgage using an FHA loan. They can choose to refinance in order to get cash to pay off other debt or they can simply refinance to take advantage of a better interest rate.
FHA for Condos
While the majority of FHA borrowers choose to buy a stick built home on its own lot, FHA will allow people to buy a condo unit. While a condo unit will have a few more requirements than a standard home, it is still a good loan to consider.
First and foremost, the condo building must be approved by FHA (FHA approved condo list). This simply means that certain documents have been completed and signed off by FHA. This is usually handled by either the management agency for the building or the condo association.
There are various guidelines regarding approving a condo. New construction condos have a certain set of rules while existing condos have a slightly different set of rules. Your mortgage lender can help borrowers in finding out if the proposed condo is either already approved by FHA or in the process of gaining approval.
In order for the building or condo complex to be approved by FHA at least 51% of the total units must be occupied by the owners.
All of the basic guidelines for an FHA loan are applied to a condo purchase.
FHA 203k Program
Considering all of the advantages of the FHA loan discussed above, it would seem that this loan program could not get any better. However, the 203k program is another FHA offering that can open up a whole new world of opportunity to potential home buyers.
The 203k loan will allow buyers to purchase a home and borrow extra money to make repairs or renovations to the home. All of the money is rolled in to one mortgage with one low rate and one payment. Basically speaking, a person can find a fixer-upper, buy the home, make repairs and improvements to the home and have one loan. All of this can be done with the low down payment and relaxed credit approval requirements for a typical FHA loan.
The 203k can be used in 2 different ways for people considering a purchase
- Borrowers may buy a home, move the home to a different lot and then repair and/or improve the home
- Borrowers can buy a home and make repairs and/or improvements to it on its existing lot
This loan will allow a wide range of modifications to a home. For example, with an FHA 203k mortgage, a buyer can do the following:
- Repair or completely replace the home’s roof
- Add on a new room
- Repair or completely replace the HVAC system
- Improve accessibility for people with a handicap
- Improve the landscaping
- Finish out an existing basement
- Basic improvements such as fresh paint, new carpet, and more efficient windows
In a sense, FHA is providing a type of construction loan to the buyer. The only difference is that the 203k program is only available for existing homes that were built a minimum of 12 months ago.
The easiest way to approach this type of loan is to use a mortgage lender that is experienced with the 203k program as well as a licensed contractor that also has 203k experience. The contractor can work side-by-side with the buyer to determine what repairs need to be made as well as outline any potential improvements. The contractor can then submit a formal proposal to the lender which is used in the loan approval process.
However, the 203k is not reserved only for home buyers. This loan can also be used for people that currently own a home. All of the same guidelines apply for loan approval. For a purchase or refinance, there are two options. There is the standard 203k loan that will allow all of the items mentioned above, and more. There is also the FHA Streamlined 203k loan. The streamlined version basically limits the amount and the repairs or improvements that can be made.
FHA Helps Individuals with Prior Bankruptcy, Foreclosure, or Short Sale
When the economy took a downturn in the years 2006-2009, millions of people were affected. The number of people forced to file for bankruptcy skyrocketed along with foreclosures and short sales. In 2014, FHA recognized that the existing guidelines the required people to wait a significant amount of time after one of these financial hardships was making it quite difficult for people to qualify for a new home loan. Therefore, the FHA Back to Work program was introduced.
Individuals or couples that have experienced any of the following financial problems are now a candidate for an FHA loan
- Pre-foreclosure sale
- Chapter 13 Bankruptcy
- Chapter 7 Bankruptcy
- Short sale
- Mortgage modification
In order to qualify for the Back to Work FHA loan, the borrowers will need to meet a few requirements.
- The borrower must have suffered through a financial difficulty included on the list above
- The borrower must show that they have recovered from the financial problem
- The borrower will need to provide evidence that their income dropped by at least 20% for a minimum of 6 months
- The borrower must attend a full housing counseling program prior to buying their next home.
With the Back to Work program, borrowers only have to wait 12 months after their financial difficulty before they can apply for an FHA loan. This is much better than the 2 to 5 years waiting periods that previously existed.
In addition to the reduced waiting periods, all of the FHA programs are available through the Back to Work initiative. This means that people can apply for an FHA 203k loan, or a refinance, or even as a repeat home buyer. The same low down payments, flexible approval guidelines and low interest rates common to FHA loans are all available for qualified borrowers through the Back to Work program.
As of this writing, the FHA Back to work program is scheduled to end at the end of September in the year 2016.
PMI Can be a Benefit to Homebuyers
Throughout this discussion of FHA mortgages, we have not mentioned Private Mortgage Insurance, also called PMI. This is insurance that the borrower must pay if they do not pay at least 20% down at the time of purchase. The insurance protects the lender from losing the entire loan amount in case the borrower is no longer able to make the house payments.
As of this writing, FHA will charge 1.75% of the loan amount at the closing and then 0.85% of the outstanding balance each year. The 0.85% charge is factored in to the monthly payments. View current FHA mortgage insurance rates.
Just as an example, if a borrower receives a mortgage in the amount of $178,000 then there would be $3,115 charged in mortgage insurance at the closing. In addition, the borrower will pay $126.08 each month for the first year in mortgage insurance. As long as the borrower makes their payments on time, the mortgage insurance will drop each year as the outstanding balance drops.
While it may sound like PMI is a necessary evil that only protects the lender, it really is a great benefit to the buyer.
The single biggest benefit to the borrower is that they can buy a home NOW, rather than wait until they have saved up a 20% down payment. By paying a small fee as insurance, the mortgage insurance company accepts the risk that the customer may not be able to pay the complete mortgage. With that risk out of the way, the borrower is now able to enter an agreement with the mortgage lender to buy a home. The Minimalist Guide to Understanding How PMI Actually Helps Homeowners.
Thanks to PMI, millions of people have been able to buy a home through FHA with a small down payment and begin the process of establishing their spot in their community and society. Home ownership has been linked to many positive outcomes such as better health for kids, improved chances for graduating high schools and overall better home life. In addition, homeowners generally take better care of their property which leads to improved home values for their neighborhood.
- Important Disclosure
*3.5% down payment on $193,000, 4.125% / 5.713% APR, 640 FICO, 30-year fixed rate mortgage. Mortgage insurance is required. Rates subject to change. Subject to credit approval.