One of the biggest barriers to buying a house for most first-time buyers is coming up with the down payment. The Federal Housing Administration (FHA) was founded in 1934 to help solve that problem.
The FHA insures mortgages offered by partner banks to make it easier for first-time homebuyers to buy a house. Homebuyers can put down much less for the home than they would with a conventional mortgage, and the FHA mortgage insurance protects lenders if the homeowner defaults on their mortgage. It’s less risk for the lender and less barrier-to-entry for first-time buyers.
Since its founding, the FHA has insured more than 46 million mortgages. While the FHA loan makes homeownership easy, it still has some of its own requirements for down payments, credit scores, debt-to-income ratio, private mortgage insurance, and inspections. Let’s dig in.
FHA loan requirements for down payment & credit score
No matter the type of mortgage you choose, credit scores are a big factor in your eligibility. The same goes for an FHA loan.
Your credit score often determines the cost of the down payment. With conventional mortgages, the lender usually requires a 620 FICO score with 20 percent down payment – much higher than the FHA loan requires.
An FHA loan has a minimum credit score of 500. If your credit score is between 500 and 579, the FHA requires a 10 percent down payment. If your credit score is 580 or higher, you only need to come up with 3.5 percent down. Put another way, that’s only $3,500 for every $100,000 borrowed.
FHA loan requirements for debt-to-income ratio
Your debt-to-income (DTI) ratio is the percentage of your monthly gross income used to pay for monthly expenses. Lenders look at two DTI ratios: total debt and mortgage debt. Lenders use maximum ratios to ensure borrowers have enough monthly income to pay all debts – particularly the home loan.
An FHA loan is more generous than some other home loans when it comes to the maximum DTI. The FHA sets the limit at 43/31. The first number refers to your total monthly debt. That means that when you add up all your monthly expenses – mortgage, car payment, credit cards, student loans – it can’t exceed 43 percent of your monthly income. The second number is the maximum amount the mortgage can be of your monthly income – not more than 31 percent.
For example, if you make $5,000 per month, you can’t have more than $2,150 going toward debt each month. The maximum mortgage payment caps at $1,550 per month.
FHA loan requirements for private mortgage insurance
Private mortgage insurance, or PMI, is a type of insurance that protects lenders if a homeowners defaults on the loan. It’s required when you put less than 20 percent down on a home. Don’t confuse it with homeowners insurance, which protects the home against physical damage.
With an FHA loan, homebuyers are required to have mortgage insurance and pay what is called upfront mortgage insurance premium (UFMIP). The upfront amount is 1.75 percent of the loan amount paid at closing. It can also be rolled into the mortgage.
The monthly mortgage insurance premium (MIP) is between 0.45 and 1.05 percent of the loan amount. The variation depends on the loan down payment and term. You pay the MIP for the life of the FHA loan if you put down less than 10 percent. If you put down 10 percent or more, you pay mortgage insurance premiums for 11 years.
In either case, you can get PMI removed by refinancing to a non-FHA loan. Learn more about refinancing options.
FHA loan requirements for home as primary residence
An FHA loan is designed to help people become homeowners, not investors. That’s why the FHA requires that the home must be the buyer’s primary residence. In other words, you have to live in the home you’re buying with an FHA loan.
FHA loan requirements for inspections and appraisals
All new home purchases with an FHA loan must meet minimum property requirements established by the Department of Housing and Urban Development (HUD). The inspection report must prove the home is safe, sound, and secure.
While most homebuyers use the inspection report to negotiate for repairs or credits, the FHA looks at the report to make sure the home meets minimum HUD requirements.
HUD’s Single-Family Policy Handbook has a complete list of the requirements, but the property must have:
- Structurally sound foundation.
- Water drainage away from the home.
- Functioning utilities.
- Functioning appliances.
- Hot and cold water with adequate water pressure.
- No chipping or peeling paint.
- Properly functioning electrical outlets and switches.
- Windows that can open, close, and lock.
- No roof leaks and a roof with at least two years life remaining.
- Ventilated and damage-free attics and crawl spaces.
- No active termite infestation.
- No environmental hazards, unreasonable odors, or excessive noise.
An FHA loan can be denied if the property doesn’t meet these requirements. The inspection and the appraisal may happen at different times. While the inspection looks at the function of things in and around the house, the appraisal considers market value compared with other homes in the area.
The appraisal must meet or exceed the amount of the loan. If your appraisal comes in under the loan value, the loan will either not be approved or you will have to come up with cash to make up for the difference.
Final note on FHA loan requirements
The FHA loan makes it easier for many new homeowners to afford a property, but it’s not without its requirements. Be sure to compare different types of mortgages to make sure you get the loan that’s right for your needs. But don’t be afraid to explore the FHA – it can be a great way to enter the world of homeownership sooner than you may have expected.