Over the past few years, qualifying for home financing has become increasingly difficult. So when working with first time homebuyers, I often see that the desire to own is there, but the ability to qualify for financing is lacking. As a result, FHA (The Federal Housing Administration) loans have become increasingly popular for first time homebuyers. There seems to be a classic ‘disconnect’ regarding financing for conforming loan amounts. While the credit on jumbo loans has been tightened significantly, FHA loans under the conforming limits has been easier to qualify for. Additonally, low down payment options and flexibility in financing the closing costs has made these loans attractive for first time homebuyers with a limited amount of cash on hand. This is a breakdown of the top level FHA lending guidelines, straight from the FHA, or the horses mouth.
Who Should Consider FHA Loans. According to the FHA’s Web site, FHA-backed loans are especially attractive for first-time homebuyers who fit certain criteria.
Buyers attracted to FHA-backed loans
- Have a little cash for a down payment and closing cost.
- Have imperfect credit
- Want to keep their monthly payments as low as possible.
- Are concerned that they may not be able to qualify for a loan.
- Are concern about the possibility of monthly payment increase.
What are the advantages of FHA-insured loans?
There are several advantages to obtaining a loan backed by the FHA.
- Competitive interest rates.
- Smaller down payment required as a percentage of the purchase price.
- A gift from a family member, employer or charitable organization can be put toward the down payment.
- Minimum credit score not required, though some lenders expect a score of at least 580.
- Lender can consider payment of utility bills, rent, auto insurance premiums and other items if the borrower doesn’t have an established credit history.
FHA Loan Limits. In San Mateo county, Santa Clara county and San Francisco county are $729,750 for a single family residence. These limits increase accordingly for two, three and four unit properties.
FHA Closing Costs. Defined by the FHA as allowable costs to the buyer, these may vary from office to office. These fees include buy may not be limited to origination fees, transfer fees, credit reports, document preparation and cost of insurance and title examination. These are generally paid for by the buyer.
Mortgage Insurance. Mortgage insurance is protection for the lender against borrower default, and is required by the FHA for borrowers who are putting less than 20% down. It translates to an addtional monthly fee and is used by the lender to qualify the borrower. Mortgage insurance is charged to the homeowner each month at the rate of .5 percent per year of the total loan amount. FHA also charges an upfront mortgage insurance premium of 1.5 percent.
Debt. The FHA, like most lenders, has guidelines as to the amount of debt a borrower can incur in order to qualify for a loan. These guidelines are referred to as debt to income ratios, and are calculated as a percentage of a borrowers gross monthly income. There are two ratios, the front end ratio (mortgage payment expense to effective income), and the back end ratio (total fixed payment to effective income). The front end ratio, which is calculated by taking the total house payment (PITI) and divided it by the borrower’s gross montly income, is limited to 29%. The back end ratio, which is calculated by taking the mortage payment from above plus all recurring monthly debt (credit cards, auto payments, student loans, etc) and dividing this buy the borrowers gross monthly income, is limited to 41%. See the full example HERE.
Credit Issues. Before approving the loan, the lender does a full analysis of the borrowers ability to repay, including a full past credit performance. Pretty straightforward stuff – good borrowers have a track record of repaying their debts in a timely manner. Potential borrower’s whose credit history is marred by slow payments, poor financial judgment and delinquent accounts is could be well out of luck. A minimum credit score is not required, though most lenders expect a score of 580 to qualify. It is important for the borrower to be honest and up front during the application process, as these issues will surface eventually. A list of items that can marr a borrowers credit and reduce the chances of approval are lack of credit history, bankruptcy, late payments, foreclosures and judgements/collections/federal debts.
FHA Loan Types. There are two popular types of loans offered by the FHA. The fixed rate mortgage, and the adjustable rate mortage. The fixed rate mortgage, known as loan 203b, is the most popular loan of the FHA. it allows individuals to finance up to 97 percent of their home loan which helps to keep down payments and closing costs at a minimum. The 203(b) home loan is also the only loan in which 100 percent of the closing costs can be a gift from a relative, non-profit, or government agency. As mentioned above, mortage insurance will be required for a fixed rate loan with less than 20% down payment (80% of the appraised property value). The adjustable rate loan is good for borrowers when interest rates are high. Borrowers qualify for the loan at the lower initial rate, but the interest rate will adjust over the life of the loan. The maximum amount of fluctuation in your interest rate in any given year cannot exceed 1 percentage point. And over the life of your loan, the interest rate cannot increase more than 5 percent from your initial rate. Borrowers can qualify for a 3% down payment, as this loan will cover up to 97% of the appraised value. Mortgage insurance will be necessary as well.
An FHA loan is not acquired by borrowers directly through the FHA, but through an FHA approved lender. These lenders vary on turnaround times, underwriting guidelines and certain fees. There are many FHA approved lenders available, consult with your Realtor or mortgage professional.
For more information, visit the Federal Housing Adminstration HERE
FHA loans are good for first time homebuyers. Contrary to the popular belief that credit is tightened or unavailble for first time homebuyers, the FHA can help provide borrowers with low amounts of cash a home loan with a lower down payment. Addtionally, lender programs may also be able to support transactions where the seller can help finance a portion of the closing costs. Contact your realtor or mortgage professional for more information.
Filed under: Buyer's Blog, borrower, federal housing administration, FHA, first time homebuyer, low down payment
Joe Capote 