What is an FHA Loan?
The Federal Housing Administration (FHA) was established in 1934 to improve housing standards and conditions and to provide an adequate home financing system through insurance of mortgages. Families that would otherwise be excluded from the housing market were finally able to buy the homes of their dreams under this program.
An FHA loan allows you to buy a house with as little as 3% down, instead of the higher percentages required to secure many conventional loans. Taking advantage of the FHA loan program is a great way for first time buyers, or anyone with a shortage of down payment funds, to buy a home.
The FHA does not make home loans–it insures them. If a home buyer defaults, the lender is paid from the insurance fund. This is a perfect mortgage solution for those starting out or those having a tough time qualifying for conventional loans.
FHA Loans vs. Conventional Home Loans
The main advantage of FHA home loans is that the credit qualifying criteria for a borrower are not as strict as conventional financing. FHA will allow the borrower who has had a few “credit problems” or those without a credit history to buy a home. FHA will require a reasonable explanation of these derogatory items, but will approach a person’s credit history with common sense credit underwriting. Most notably, borrowers with extenuating circumstances surrounding bankruptcy that was discharged 2 years ago can work around the credit hurdles they created in their past. Conventional financing, on the other hand, relies heavily upon credit scoring. Credit scoring is a rating given by a credit bureau (such as Experian, Trans-Union, or Equifax) that ranks you upon your credit profile. For each inquiry, credit derogatory or public record that shows up in your credit report, your score is lowered (even if such items are in error). If your score is below the minimum standard, you will not qualify–end of story.
I’ve had a bankruptcy in recent years. Can I get an FHA loan?
Generally a bankruptcy will not preclude a borrower from obtaining an FHA loan. Ideally, a borrower should have re-established a minimum of two credit accounts (such as a credit card, car loan, etc.) and wait 2 years since the discharge of a Chapter 7 bankruptcy or have a minimum of 1 year of repayment with a Chapter 13 (the borrower must also seek permission of the courts to allow this). Furthermore, the borrower should not have any late payments, collections, or credit charge-offs since the discharge of the bankruptcy.
Although rare, if a borrower has suffered through extenuating circumstances (such as surviving cancer but had to declare bankruptcy because the medical bills were too much), special exceptions can be made.
What documents are needed for an FHA Loan?
It is important to understand that the loan approval is 100% dependent on the documentation you provide. To insure a smooth transaction, it is crucial that you have all your documentation in order before the initial application of the loan.
Employment Information
- Most recent two years complete tax returns with all schedules.
- Most recent two years W-2′s, 1099′s, etc.
- Most recent pay stubs covering one month period.
- If applicable: Self-employed will need three years Tax Returns and Ytd Profit & Loss Statement.
Savings Information
- Most recent three months complete bank statements for any and all accounts with all pages.
- Most recent statement from retirement, 401k, mutual funds, money market, stocks, etc.
Credit Information
- Most recent statements from your bills, indicating minimum payments and account numbers.
- Name, address, and phone number of your landlord, or 12 months cancelled rent checks.
- If applicable: Should you have no credit, copies or your most recent utility bills will be needed.
- If applicable: Copy of complete Bankruptcy and Discharge papers.
- If applicable: If you co-signed for a mortgage, car, credit card, etc, need 12 months cancelled checks. front and rear, indicating you are not making payments.
Personal Information
- Copy of Drivers License.
- Copy of Social Security Card.
- If applicable: Copy of complete Divorce, Palimony, Alimony Papers.
- If applicable: Copy of Green Card or Work Permit.
- If applicable: If you own another home(s) – see below
If a Refinance or you own Rental Property:
- Copy of Note & Deed from current loan.
- Copy of Property Tax Bill.
- Copy of Hazard (homeowners) Insurance Policy.
- Copy of Payment Coupon for current mortgage.
- If applicable: If property is multi-unit, need Rental Agreements.
How big of an FHA Loan can I afford?
For an FHA loan, your monthly housing costs should not exceed 29% of your gross monthly income. Total housing costs include mortgage principal and interest, property taxes, and insurance. Those four terms are often lumped together, and referred to as PITI.
Example:
Monthly income X .29 = Maximum PITI
For a monthly income of $3,000, that means $3,000 x .29 = $870 Maximum PITI
Your total monthly costs, adding PITI and long term debt, should be no more than 41% of your gross monthly income. Long term debt includes such things as car loans and credit card balances.
Example:
Monthly income x .41 = Maximum Total Monthly Costs
For a monthly income of $3,000, that means $3,000 x .41 = $1230
$1,230 total – $870 PITI = $360 allowed for monthly long term debt
The ratios for an FHA loan are more lenient than for a typical conventional loan. For conventional home loans, PITI expense cannot usually exceed 26-28% of your gross monthly income, and total expense should be no more than 33-36%.
Low Down Payment Mortgage Programs
Many homeowner hopefuls are often unable to complete the mortgage process due to their inability to make a large initial down payment. This is especially common for first time homeowners. What these people don’t know is there are many low down payment mortgage programs, which are far less taxing on a small budget. These programs are designed with first time buyers in mind. Here are some examples of low down payment mortgage programs:
The Federal Housing Administration (FHA) Program: This is an agency within the Department of Housing and Urban Development that provides insurance for residential mortgage loans offered by private lenders. With the help of FHA insurance, people can easily purchase a home at a down payment of three to five percent of the sale price or of the FHA appraised value. However, FHA mortgages do have a limit to how large of a loan they can support. This limit varies depending on the average cost of a house within the specified region.
Rural Housing Service: This is an agency within the Department of Agriculture that provides help to qualified borrowers and farmers who wish to purchase property in rural areas. This agency gives preference to people who are unable to find loans through other sources. The Rural Housing Service does not involve any kind of down payment for borrowers having low to moderate levels of income or living in rural areas.
Fannie Mae: Fannie Mae is a large, publicly chartered corporation that purchases mortgages from lenders and resells them to investors. The mortgages offered by Fannie Mae are known as Fannie Mae97. A Fannie Mae97 mortgage consists of a 97 percent loan-to-value ratio (LTV). This means that borrowers pay a three percent down payment on a 25 or 30 year fixed mortgage. Fannie Mae provides loans for people with modest incomes who seek homeownership. To qualify for this kind of loan, borrowers must first take a pre-purchase homebuyer education course.
Apart from the above mentioned program options, there is also a Veterans Administration Guarantee that allows qualified veterans to purchase a home for up to $203,000 without any down payment. This is an excellent resource for qualifying veterans as the loan guidelines for the Veterans Administration Guarantee are much more flexible than those involved in the FHA.
These are some low down payment mortgage programs that might be of help to first time homeowners, low income borrowers, veterans, and those wishing to buy land in rural areas. Ask your mortgage broker if you need help deciding if one of these programs is right for you.
