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One of the great things about the Federal Housing Administration’s loan programs is its ability to open up home ownership to a wide range of people. Everyone knows that if someone is lucky enough to have good income and excellent credit, they’ll have no trouble qualifying for a mortgage. But what about the rest of us? What if you’ve fallen on hard times, suffered an illness, joblessness or been a victim of a natural disaster. Or what if you’re just starting out, a recent graduate who landed a solid job but has little to no credit history? If that sounds like you, an FHA Loan may be just the ticket to get you on the road toward landing your dream home.
An FHA loan is a type of mortgage that is insured by the federal government. The Federal Housing Administration, which is a part of the Department of Housing and Urban Development (HUD), was initially established to revitalize the housing market after The Great Depression. By offering insurance to banks and other lending establishments, the government lessens the amount of risk these institutions face when loaning money to people with less than stellar credit. This results in a much greater portion of the general public qualifying for home mortgages.
Who Should Apply
There is a myth that FHA loans are just for first-time home buyers. That is absolutely false. It is true that first-time home buyers are a great fit for an FHA Loan, but so are many other people in many other situations. For instance, maybe you have fantastic credit but can’t swing a decent down payment. Or you’re selling your current home that carries a 30-year fixed conventional mortgage, but because of market conditions you have hardly any equity available for a new house. It’s possible that you may have a foreclosure or bankruptcy in your past. Any of these circumstances might make an FHA loan right for you.
How to Know if you are Eligible?
Let’s get into the nitty gritty. How do you know if you qualify for an FHA home loan? We’ve already said that you can qualify with little money down and less than perfect credit, but what does that mean exactly? First, it’s important to reiterate that the government is not the one loaning you money. The money is provided by a bank, credit union or other type of lending institution. All the government (in this case the FHA) does is tell the bank they will cover part of your loan if the
worst happens and you default on your mortgage. This is why lenders have minimum guidelines in place – to mitigate their risk of lending you a large sum of money. But having the backing from the FHA makes them more confident about taking a chance on you.
Don’t think that just because you have extra insurance on your loan that you’ll get away scot-free if you can’t pay it back. Having a foreclosure on your credit report is devastating to your financial situation and can take a long time to rectify. Anytime you are lent money in good faith, it’s vitally important that you pay it back in a timely and responsible manner. But
the worst can happen to the best of us, which is why the FHA set up this program in the first place. So, what are the eligibility requirements to qualify for an FHA mortgage?
This is probably the number one thing lenders look at when you apply for any mortgage. Your credit score is also known as your FICO score, called that because it is calculated by the Fair Isaac Corporation. FICO monitors the many different factors that can influence your score, including your payment history, total debt load, credit card usage, the age of your credit as well as the number of credit inquiries you have. It also looks at the type of credit you have. Do you have fifteen credit cards and no car loans? Do you have 3 car loans and 5 personal loans? All of these elements are put into an
algorithm which converts the information into a three-digit number. This is your credit score. The higher the number, the better your credit. And ideally, the higher your score, the lower your credit risk. In general, the scores break down like this:
· Exceptional: 800+
· Very good: 740 to 799
· Good: 670 to 739
· Fair: 580 to 669
· Poor: 579 and below
Because FHA loans are backed by the federal government, you can qualify for an FHA loan with a credit score as low as 580, which is considered the low-end of fair credit. There are some circumstances where you may even qualify with a score between 500 and 59, which is considered poor credit. We’ll go into that further down below. Before you apply for a mortgage, it’s always a good idea to check your credit score. A quick Google search will net you several companies who will even give you your score for free. In any case, FHA loans are one of the most forgiving loans available when it comes to qualifying with a low credit score.
Income, Proof of Employment and Other Documentation
Both the bank and the FHA will want to know that you have the means to keep up with your mortgage payments. Of the three parties that hold stake in this loan (you, the lender and the FHA), not one of you wants to wind up going through the foreclosure process. There are no minimum or maximum income limits for any FHA loans, but you will need to provide original pay stubs and previous W-2 forms to prove that you have had steady employment. These documents will also provide evidence that you bring in enough monthly income to comfortably afford your mortgage. And that brings us to…
Also known as DTI, your lender needs to be sure that you have enough money for proper care of your new home as well as any additional expenses. The actual definition of DTI is the comparison of a person’s monthly debt payments vs. their gross monthly income. Your gross monthly income is the amount of money you bring in before taxes are taken out. You get your DTI by dividing your monthly debt payments by your gross income. Note that we specified debt payments, which does not include utilities, food, gas and the like. Debts are considered things such as car payments, student loans, credit card payments, alimony and child support and yes, your mortgage! To put it into real numbers, let’s say you bring in $5,000 per month before taxes. Your debts include a car payment of $350 per month, a student loan for $150 per month and 2 credit cards with minimum
payments totaling $75 per month. Your mortgage would add a monthly debt of about $1,350 per month. That’s a total of $1,925 in monthly debt divided by your income of $5,000 per month, giving you a DTI percentage of 38.5%.
Now, most lenders prefer a DTI of no more than 36% when considering an application for conventional financing. However, with an FHA mortgage raises that number up to 43%. Based on the scenario above, you would likely find getting approved for a conventional mortgage difficult, but have no trouble fitting into FHA qualification guidelines.
The majority of FHA loans require only a 3.5% down payment toward the purchase of your new home. This is significantly less than the standard 20% down payment preferred under conventional financing. But with an FHA loan, as long as your credit score sits at 580 or higher, a 3.5% down payment is all that is needed. If your credit score falls somewhere between 500 and 579, don’t give up home! You may still qualify for a loan as long as you have enough cash to put up a 10% down payment. This
is a huge advantage as a credit score below 580 puts you out of the running for almost all other financing options.
Of course, 3.5% is still a big chunk of money to save up for. Often, family members, close friends, or even your employer may offer to help you with monetary gifts to be used toward the down payment. Be careful if this is the case as there are rules about getting such gifts, and you should always be up front with your Lender about receiving them. For instance, the money must be an actual gift, not a loan you are expected to repay. If you take a $10,000 loan from your parents with the understanding that you’ll pay it back in five years, technically your lender should be including that in your DTI calculation. If you are given a gift of this nature, be sure it’s documented via a written statement from the giver. The statement should state the nature of your relationship and/or relation and that the money is a gift with no expectation of repayment.
Property Requirements and Loan Limits
Because your mortgage will be insured by the FHA, they have certain requirements surrounding the property you are seeking to finance. FHA loans are meant to be used for a principal residence, and you must be able to occupy the home within 60 days of closing. You can’t use these loans to finance a second home or an investment property. The home must also pass an FHA appraisal. FHA appraisals tend to be more vigorous than your typical home appraisal. Because they government is backing the loan, they want to make sure they are making a wise investment. The appraiser will visit the home and inspect it closely to make sure the house is safe and sound. Note that this is a separate process from a home inspection, which looks for specific and potential problems within the home. The appraiser is more concerned with verifying the market value of the home as well as assessing its overall condition and livability.
In the End
As you can see, an FHA loan can be a great fit for just about anybody. It’s perfect for a first-time home buyer that has little in the way of money with a limited credit history. It’s ideal for someone who needs to sell their current house and purchase another without a lot of equity available to them. It’s a lifesaver for someone who may have fallen on hard times and
declared bankruptcy or dealt with a foreclosure. It may fit your needs for any number of reasons. Our loan specialists will look at your details and find the very best loan to finance your dream home. Get more information by calling us at 785-323-1111, or visit our website and start your application online today
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