FHA Requirements—5 Things to Improve Your Mortgage Application

April 29, 2021

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5
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Is an FHA loan right for you? Let's find out.

In your search for suitable mortgage loan products, you may have heard about Federal Housing Administration (FHA) loans and how they may be more attainable for low-to-moderate income borrowers. These loans come with favorable terms and are popular among first-time homebuyers with minimal savings or lower credit scores. Read on to discover whether an FHA loan is right for you.

Quick Plan

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Know the types of FHA loans.

There are many types of FHA loans, be sure to understand how they work and if they’ll fit your individual circumstances.

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Make sure you fit the bill.

FHA loans have minimum requirements for credit scores and down-payments.

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Increase your chances of approval.

You can maximize the odds on your mortgage application with a few changes to your finances.

FHA Loans: The Basics

To better understand FHA loans, you’ll first need a bit of background on what the FHA is and why they exist. The organization was created in 1934 as a measure to help re-stabilize America’s struggling housing market. They’ve long been instrumental in ensuring that Americans can obtain mortgages and own homes by providing mortgage insurance on loans made by their approved lenders. Through the FHA, lenders bear less risk on potential defaults, and are thereby able to provide more favorable terms to borrowers with less-than-stellar credentials.

This brings us to the modern-day FHA loan. These are mortgages insured by the FHA that you can get from an FHA-authorized lender. Broadly speaking, you can obtain an FHA loan with a down payment as low as 3.5 percent of the home’s purchase price and credit score of 580 or higher. It’s worth noting, though, that you’re also required to have mortgage insurance with these loans. Mortgage insurance for FHA loans cannot be canceled unless you refinance to a conventional loan after establishing 20 percent equity in your home.

If you’re a first-time homebuyer looking for a loan that offers a good deal of latitude, you’ll definitely want to familiarize yourself with FHA loans.

There are several subtypes that fall under the umbrella of FHA loans. Here are five that you should keep on your radar:

1. Standard Home Mortgage

This is your run-of-the-mill mortgage used to finance a primary residence. First-time homebuyers are known to favor these, as they offer flexibility in the form of lowering credit requirements for acceptance, coming with terms of 15 or 30 years, and putting borrowers in a position to choose from a range of eligible home types (provided they have a steady income).

2. Construction to Permanent (CP) Loan

This variety of FHA loan helps to finance new builds, rolling the purchase of land, the construction of the home on the property, and lender fees. It’s like a combination of a standard long-term FHA loan with a shorter-term construction loan. After closing, the loan will convert to permanent mortgage following construction of the home.

3. Title I Property Improvement Loan

Title I loans are a useful tool for financing home improvements and renovations. Since the definition of the term “improvement” is broad, it’s possible to add a Title I loan to another mortgage and get the money you need to fix up a property in need of repairs or furnish it with appliances that it might be missing.

4. FHA 203(k) Improvement Loan

FHA’s 203(k) loans allow you to purchase a home (or refinance your current home) while rolling the costs of extensive renovations into the mortgage. FHA 203(k) loans come in one of two varieties: limited loans up to $35,000 dollars (excluding serious structural repairs), and standard loans of at least $5,000 (that may include structural repairs with oversight from a HUD consultant).

5. FHA Energy Efficient Mortgage (EEM) Program

Loans under the Energy Efficient Mortgage program also cover home upgrades, but are geared toward improvements that increase energy efficiency and lower your monthly utility bills. This might include solar panels, wind energy systems, or improved insulation. Done correctly, the reduced energy costs provide savings that should cover the up-front costs of improvement.

6. Section 245(a) Loan

For first-time homebuyers who expect their incomes to increase, Section 245(a) loans allow them a way to get a mortgage while their monthly earnings are still limited. Under a graduated payment system, your monthly mortgage payments would start low, then gradually increase on a predictable schedule. These mortgages are fixed-rate and available to anyone.

7. Home Equity Conversion Mortgage (HECM)

These are one of the most popular kinds of reverse mortgages, and they allow senior borrowers to convert home equity into cash. Borrowers can withdraw the funds from their Home Equity Conversion mortgages as a line of credit, a fixed monthly sum, or a combination of both. HECMs provide fixed loan amounts, but the terms are often better than private reverse mortgages.

Key Benefits of FHA Loans

FHA loans are great for homebuyers of limited means, as you can qualify with a lower minimum credit score and down payment than you’d need with a conventional loan.

Circumstances may vary, but for many first-time homebuyers, a standard FHA loan best fits their needs, offering substantial benefits when compared to conventional loans. FHA loans offer the following advantages.

Minimum Down Payments

For starters, the difference in minimum down payments is substantial. While it’s true that down payments with conventional loans can be as low as 3 percent, that end of the spectrum is usually reserved for those with higher credit scores and substantial savings. With an FHA loan, you can qualify for a down payment as low as 3.5 percent if your credit score is 580 or higher.

Credit Scores

You’ll need a credit score of at least 580 to qualify for an FHA loan with a 3.5 percent down payment. You can even qualify for an FHA loan with a credit score as low as 500, but that will require you to make a down payment of at least 10 percent. With a conventional loan, you’d need a 620 credit score to qualify.

Property Assessment

When it comes to property requirements and appraisals, FHA loans are definitely more stringent. While this means a bit more red tape, it also means that any property you purchase with an FHA loan is going to be more thoroughly evaluated for its safety, construction, and adherence to building codes. That way, you’ll know your home is livable for the long term.

Ease of Refinancing

FHA loans make it easy to refinance when the time comes. With an FHA streamline refinance, you can skip past the appraisal portion of the process, turning it into a quick and easy way to reduce your loan term or interest rate. You’ll need to make sure that you meet certain requirements to qualify, like not being delinquent on your loan, but this process improves the overall speed with which you can get refinanced on your mortgage.

What Are the FHA Requirements for Obtaining a Loan?

To qualify for an FHA loan, you’ll need to meet these minimum requirements:

  • A credit score of at least 580 for a 3.5 percent down payment, or a score of 500 to 579 for a 10 percent down payment.
  • At least two years of verifiable employment history.
  • Verifiable income, via pay stubs, tax returns, and bank statements.
  • Debt-to-income (DTI) ratio under 50 percent. Specifically, your front-end debt ratio should be under 31 percent and your back-end debt ratio should be under 57 percent.

In addition, you’ll want to make note of the following potential flags on your credit history:

  • Having no credit history—If you don’t have a standard credit history, you might need to develop a non-traditional credit report or establish a credit history through alternate means so you can qualify.
  • Undergoing Bankruptcy—Going through bankruptcy doesn’t automatically disqualify you from obtaining an FHA loan, but you’ll need to put about one to two years between your bankruptcy date and your loan application to re-establish a good credit history. At the time of this writing, Chapter 13 bankruptcy waiting period is 12 months, while Chapter 7 is two years from date of discharge.
  • Making Late Payments—A history of late payments can hinder your loan application, so it’s best to have a solid history of on-time payments (at least 12 months) before attempting to apply for an FHA mortgage.
  • Experiencing Foreclosure—Like going through bankruptcy, going through foreclosure doesn’t immediately disqualify you from an FHA loan. You will, however, need to wait about three years after a foreclosure to apply (barring exceptions for extenuating circumstances).
  • Being subject to judgements and collections—As a general rule, you’ll need any judgements against you paid off or resolved prior to receiving an FHA loan.

FHA loans are easier to qualify for than conventional loans, but there are still standards you’ll need to meet in order to qualify.

Finally, in order to qualify for an FHA loan, the property you intend to buy must be used as your primary residence. It will also need to undergo an appraisal by an FHA-approved representative to ensure that it meets the necessary HUD property guidelines.

How to Improve Your FHA Mortgage Application

There are circumstances well within your control when it comes to optimizing your chances for FHA mortgage approval, including your credit score and debt-to-income ratio.

If you want to improve the chances that your FHA loan application will be approved, you’ll want to follow these tips:

1. Maximize Your Credit Score

Poor credit is one of the greatest hurdles to potential homebuyers. Even for an FHA loan, you’ll need a minimum score of 500 to qualify for a 10 percent down payment, and a score of 580 to qualify for a 3.5 percent down payment. There’s no room to negotiate with these requirements so you’ve got to stay on the ball with your credit score.

Your loan advisor will pull your full credit report and review it with you—just get in touch.

2. Minimize Your Debt-to-Income (DTI) Ratio

For FHA loans, you need to have a DTI of less than 57 percent, meaning your monthly debts should not exceed 57 percent of your monthly income. The higher your DTI, the more likely your application will be rejected, so part of your strategy for improving your FHA mortgage application should be keeping your DTI as low as possible.

Adopting an aggressive repayment plan for debts is one way to get your DTI down. You might ask for a salary increase at work, take on a second job, start a business, or turn some hobby into a casual money-making venture to help pay down debt.

3. Save for Your Down Payment

Both 3.5 percent and 10 percent sound like small numbers, but they can still amount to thousands of dollars up front for your home. If you can’t make the down payment, you won’t be able to purchase your property, so you’ll need to develop a plan for saving that will work with your situation.

Generally speaking, your savings plan should involve paying down your debts first (freeing up significant monthly income you can put toward savings), then turning to additional potential sources of income, like a second job or freelance work. You might even be able to tap into retirement accounts if you have them, but know that this comes with a certain degree of risk.

4. Steer Clear of Bankruptcy and Foreclosure

While they won’t automatically disqualify you from obtaining an FHA loan, bankruptcy and foreclosure will certainly hurt your chances. Avoid both of these situations if you can, and, if you cannot, you’ll need to wait a few years to re-establish a good financial history before applying for an FHA mortgage.

5. Keep a Steady Job

Verifiable income and employment history are vital to your ability to secure a loan. If you’re skipping around from job to job or have significant gaps in your employment, you might be seen as more of a risk when it comes to defaulting on a loan. Try to stick with your job for a few years before applying for an FHA loan to maximize your chances of approval.

Wrapping Up

FHA loans can be a great option for first-time homebuyers, especially if your finances don’t quite qualify you for a conventional loan. You’ll need to make sure you can satisfy the core requirements for obtaining an FHA mortgage, and you’ll want to go the extra mile in optimizing your circumstances so that your application has the best chance of being approved.

Now that you have all the details—let’s see what you qualify for.

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