Everyone has questions about financing.
We have answers.
The portion of your monthly payment that applies to and reduces your loan balance is called principal.
Interest accrues on your loan every day. When you make a payment, the interest that has accumulated since your last payment is paid first, bringing your accrued interest balance to zero.
FHA Mortgage Insurance
Upfront Mortgage Insurance Premium (UFMIP)
Financed into every FHA loan is a one-time premium charged at the loan’s inception. UFMIP is calculated off and added to the FHA base loan amount.
Annual Mortgage Insurance Premium (MIP)
Annual MIP is actually paid monthly as part of your FHA loan payment. The premium is calculated every year, divided by 12, and included in your monthly payment.
FHA loans require your property taxes be paid yearly by your lender. Your annual property tax amount is divided by 12 and added to your monthly house payment.
Similarly to property taxes, homeowners insurance is paid annually by your lender. The premium is divided by 12 and added to your monthly payment.
Since these payments are made annually (sometimes semi-annually or quarterly), your lender will hold the funds in an account called an escrow or impound account. The lender then pays from this account when the bills come due.
FHA loans are a great alternative for first-time and experienced homebuyers alike. While credit standards and down payment requirements are more generous than conventional mortgages, not everyone will qualify. Here's what you need to know.
Source: Complete FHA loan guidelines can be found on HUD's website.
FHA loans are available in all 50 states and territories like Puerto Rico, Guam, and U.S.Virgin Islands. However, there are limits to how much you can borrow. FHA loan limits are established annually and typically released each December for the coming new year. Limits are broken down by county, and your FHA loan amount cannot exceed it. If you spend more than the limit, you'll have to make a down payment large enough to bring your loan amount down to the maximum.
Loan limits are generally the same for the majority of U.S. counties. However, many areas have higher costs of living and less affordable housing. FHA designates these high-cost areas as such and adjusts the county loan limits accordingly. A typical three-bedroom, two-bathroom home in Cedar Falls, IA will not fetch a price as considerable as one in San Diego. Therefore, the limit is higher, and those in a high-cost market are able to make the purchase with an FHA loan.
It's imperative you know your county loan limit BEFORE you start shopping.
Tool: FHA Loan Limit Lookup
Can I meet the down payment requirement?
It’s true, mortgage lenders love borrowers who are able to make 20% down payments. But think about how long it would take for a family of four living on $70,000 per year to save $40,000 to buy a modest $200,000 home. FHA was created to solve this very problem. Wages (income) have not accelerated with the pace of home prices. FHA's 3.5% minimum down payment is vital to the health of America's residential real estate market.
Expect your lender to verify you have your down payment saved and ready to go. You'll be asked for bank statements confirming the funds are yours. If the money is a result of a large deposit, expect to identify where it came from. The minimum amount you'll need is 3.5% of the purchase price. Remember, you'll have closing costs if the seller hasn't agreed to pay them (seller paid closing costs), so your actual cash out of pocket will likely exceed your 3.5% down payment.
What if I don't have 3.5% for my down payment?
One of FHA's greatest features is the allowance of a financial gift to cover your down payment. Saving is difficult and takes time. Often, the path to homeownership begins with a parent or family member's generosity. It's important to note the gift cannot come from just anyone. Particularly, the gifter cannot be party to the transaction, such as a real estate agent, builder, or even the seller.
It's also important to note that it must be a GIFT. There can be no expectation of repayment or reciprocation. Your lender will advise you on how the exchange of funds and documentation should be handled, including if the gift is coming from an employer, charitable organization, or someone other than a family member.
An FHA down payment gift can be a fast-track to homeownership. It's worth exploring if you do not yet have your down payment saved.
FHA Loan Income Requirements
You’ve made it this far and the question remains: Do I qualify or not?
There's a lot that goes into obtaining a mortgage loan. FHA is no different. If you're house hunting in a price range that's less than the county loan limit and you've got your down payment covered, you’re ready to look at income. Obviously, you need to have income if you want an FHA loan.
But how much income do you need and where can it come from? This topic can get pretty deep. If you need to go there, it's best you connect with an FHA approved lender. We'll cover the gist of FHA income requirements, but again, an FHA approved lender can determine if your quirky income meets FHA guidelines.
How much income do I need?
Pardon the vagueness, but there isn't a clear, definitive, or concrete answer or figure. If you've heard the term debt-to-income (DTI) ratio, this is where it applies. DTI is your total monthly debt payments divided by your monthly gross income. Debt means debt. It does not include subscriptions, utilities, memberships, or other recurring payments that are not paying down money you owe (i.e. credit cards, auto loans, student loans) to creditors. Add all your monthly minimum debt payments to your new house payment, including property taxes, homeowner's insurance (HOI), and homeowner's association dues (HOA) and divide it by your monthly income before taxes. This is your debt-to-income ratio.
What should my DTI be?
Most FHA loans are approved by an automated underwriting system (AUS), which factors in your entire loan application profile. If your profile is strong, your loan might be approved by the AUS even if your DTI is above the FHA manual DTI guideline of 43%. Additionally, FHA deems a housing ratio (monthly house payment including taxes, HOI, and HOA divided by gross income) of 31% acceptable. Again, a strong overall profile with compensating factors (a term FHA uses for reasons for allowing exceptions) may be approved despite a higher housing ratio.
Confused? Don't be. While there is no substitute for getting preapproved, use our FHA loan calculator to compute your payment, and divide it by the combined monthly gross income of all borrowers to be on the loan. You'll want that number to be less than 30%. If you have a large amount of monthly debt, you may have to adjust that number down.
If we've learned anything about income and FHA, it's the importance of working with a lender ahead of time to avoid DTI surprises. A good lender will verify your income and process your application through the AUS prior to issuing you any kind of prequalification or preapproval letter. You should proceed with caution if a lender has not verified your income with paycheck stubs, W2s, or, if applicable, tax returns.
FHA Credit Requirements
The elephant in the room. Maybe you've heard FHA loans are perfect for the "credit challenged". There might be some truth to that, but people who pay their bills will always have a better chance of being approved for an FHA loan than those who do not.
What if I've had a bankruptcy?
There are two types of consumer bankruptcies, chapters 7 and 13. They differ and thus are handled differently by FHA.
Let's start with chapter 7. Your discharge date must be more than two years ago. Additionally, you must have re-established a good credit history. If your discharge date was less than two years but more than one year ago, you may be able to qualify if you can demonstrate your bankruptcy was due to extenuating circumstances and those circumstances are unlikely to return. So, no, a chapter 7 bankruptcy does not disqualify you from obtaining an FHA loan, but you must be able to document you've managed your finances appropriately since it was discharged.
Chapter 13 works a bit differently. You must be at least one year into your payout period with all payments made on time. You also need written permission from the bankruptcy court to enter a new mortgage agreement. Similarly, homebuyers in consumer credit counseling are subject to the same contingencies. Like chapter 7, you must prove you've righted the ship and your finances aren't likely to result in a future bankruptcy or default.
What about foreclosures?
You're generally not eligible after a foreclosure or pre-foreclosure sale until three years after the foreclosure date. As always, there are extenuating circumstances exceptions (death of primary wage earner, serious illness), but be prepared to document the scenario and demonstrate your credit was good before and since. Divorce is NOT considered extenuating, nor is foreclosure resulting from a job transfer or relocation and not being able to sell your existing home.
Bankruptcies and foreclosures are serious. FHA is sympathetic to difficult times, but you must have demonstrated responsible borrowing for the required two- or three-year period after the event completion date. To be clear you should consult with an FHA approved lender to determine eligibility.
All mortgages are nuanced, and every scenario is a bit different regardless of how similar they might appear. The tools we've created are here to help you plan, budget, and decide which home loan might be right for you. However, we cannot stress enough the importance of working with a lender right away to determine which loan program is right for YOU and for how much you might qualify.
There are a gazillion ways to find a mortgage lender, but the best way might be by talking with friends and relatives who have already purchased homes. Loan officers appreciate referrals and are likely to treat you with respect and honesty if they know they come highly recommended.Congratulations on making the leap into homeownership. It's exciting, and we're rooting for you. If you have questions along the way regarding our FHA loan calculator, ask us. We're here to help. Good luck and enjoy your journey.