FHA loans are government sponsored loans backed by the Federal Housing Administration. In the event that the borrower is unable to keep up with his or her mortgage payments and goes into default, the FHA will pay the balance of the loan. The FHA does not actually issue loans to buyers. Rather, they only insure loans that are made by private lenders.
Reasons Why FHA loans Are So Common
FHA loans have become popular because they allow people to purchase a home with a lower down payment than would be required by many other types of loans. Borrowers will usually pay around 3.5 percent of the total value of the loan. So, if you’re buying a $500,000 home in Orange County, then you’ll have to put $17,500 down.
This may seem like a lot of money, but the FHA has made making the down payment easier by indicating a number of “acceptable sources” where the funds can come from. Savings bonds, IRAs and 401K accounts, investments, gift funds, and the profit from selling personal property are all permissible sources for the down payment.
The threshold required to qualify for an FHA loan is much lower than many other types of conventional loans that are found on the market. There also aren’t income limits. But there are limits in place on how much borrowers are able to take out to cover the FHA home purchase. Typically, borrowers will only be able to take out a modest loan amount that is partially calculated by the values of other houses in the area that you live.
Qualifying for an FHA loan
Being able to qualify for an FHA loan requires that the borrower has a decent debt-to-income ratio (DTI). You can calculate your DTI by adding up all of your monthly expenses including recurring debts like car loans. Once you have that figure you must then divide it by your total gross income.
In previous years, lenders have been willing to work with potential borrowers with DTI ratios as high as 55 percent. But recent improvements in the housing market and jobs sector have allowed lenders to be more selective in whom they lend to. Currently, the maximum ratio to qualify for an FHA loan is 43 percent. Your DTI ratio will give you a good idea of how much you can afford to pay for housing every month.
A borrower’s FICO score doesn’t need to be perfect to qualify for an FHA loan, but it should still be acceptable. An acceptable FICO score according to FHA guidelines is 580 at a minimum. However, 620 or higher is preferable, but keep in mind that a lender is free to reject your application even if you meet the minimum requirements. Lenders are also looking for you to have steady employment. You need at least two years of steady employment with income that is either the same or increasing.
Getting approved for a home loan has gotten considerably easier in today’s market than it has been in years past. But positive economic indicators and a resurgence of home sales have helped to create new competition. If you have less than perfect credit and are having a hard time making a down payment, then you should definitely find out whether you qualify for an FHA loan.