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 3.5% 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.
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 challenging time qualifying for conventional loans which often have more stringent qualification requirements.
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 any derogatory items, but will approach a person’s credit history with common sense credit underwriting. Most notably, borrowers with extenuating circumstances surrounding a 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 more 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 these items are in error). If your score is below the minimum standard, you will not qualify–end of story. However, we regularly work with our clients to help them increase their credit scores.
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 bankruptcy court in a Chapter 13). 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.
- Most recent two years complete tax returns with all schedules. (Not required in all cases.)
- Most recent two years W-2′s, 1099′s, etc.
- Most recent pay stubs covering one month period.
- Complete work history including dates of employment for minimum of two years.
- Most recent two months bank statements for any and all accounts with all pages.
- Most recent statement from retirement, 401k, mutual funds, money market, stocks, etc. (all pages)
- If using retirement funds for down payment or reserves, you may need to verify terms/conditions of withdrawal. Talk to your Mortgage Consultant for details.
- Name, address, and phone number of your landlord, and/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.
- Copy of Drivers License.
- Copy of Social Security Card. (or other 3rd party document showing your number)
- 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 from current loan.
- Copy of Property Tax Bill.
- Copy of Hazard (homeowners) Insurance Policy.
- Copy of Payment Coupon for current mortgage.
- If applicable: If investment property, please supply Rental Agreements.
How big of an FHA Loan can I afford?
For an FHA loan, your monthly Total Housing Expense should typically not exceed 29% of your Gross Monthly Income. Total Housing Expense includes mortgage Principal and Interest, property Taxes, and homeowner’s Insurance. Those four terms are often lumped together, and referred to as PITI. Nearly all FHA loans also have Mortgage Insurance and this expense is included as part of your Total Housing Expense. In addition, if you are buying a Condominium or home in a Planned Unit Development, any Home Owner’s Association fees are also included in your Total Housing Expense for qualification purposes.
Monthly income X .29 = Maximum PITI
For a monthly income of $5,000, that means $5,000 x .29 = $1,450 Maximum PITI
Your total monthly costs, adding PITI and long term debt, should be no more than 45% of your gross monthly income. Long term debt includes such things as car loans, credit card minimum payments, child support obligations, etc.
Monthly income x .45 = Maximum Total Monthly Costs
For a monthly income of $5,000, that means $5,000 x .45 = $2,250
$2,250 total – $1,450 PITI = $800 allowed for monthly long term debt
The ratios for an FHA loan are generally more lenient than for a Conventional loan. For conventional home loans, PITI expense should ideally not exceed 28% of your gross monthly income, and total debt expense should be no more than 36%. Note, however, that these ratio guidelines can often be exceeded with Automated Underwriting approval and Compensating Factors. Talk to your Mortgage Consultant for more information.
The most important factor in determining how much you can afford should be your own careful review and planning of your monthly budget. Many homebuyers qualify for more loan than they should realistically take on. Your Mortgage Consultant can help you make wise decisions that will help ensure your long-term success as a homeowner.
1. How much and what rate you qualify for.
2. How quickly we can close your loan.
3. How we will help you improve your credit scores.