FHA Loans 101 is a definitive guide to understanding FHA loans as a buyer. When obtaining financing for your home purchase, it is essential to understanding the different types of loans available and how they differ. The inspections, appraisal process, closing costs, can all be different based on the type of loan you choose.
What is an FHA Loan?
An FHA loan is a loan which is made by an FHA approved Lender and guaranteed by the Federal Housing Agency against default. They are designed for borrowers unable to make a large down payment. In addition to paying the interest and principal payments to the lender, the borrower will pay an insurance “premium” to cover the risk of default of the underlying loan. Loan Limits that determine maximum purchase price vary from state to state and from county to county.
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Who qualifies for an FHA loan?
With a credit score of 580 or higher, a buyer can purchase a home with as little as 3.5% of the purchase price loan. If a borrowers credit score is between 500 and 579, then the minimum down payment is 10%. There are no m aximum income restrictions when it comes to obtaining an FHA loan.
There are restrictions on debt levels and income relative to housing payments and total expenses. These are known as Debt to Income Ratios. There are two of them, and they are explained here.
Housing Ratio (aka Front End Ratio)
The Housing Ratio is calculated by taking the total monthly mortgage obligation (mortgage payment, property taxes, and insurance) and dividing it by the total gross monthly income. FHA limits to a maximum of 31% (some exceptions)
Total Debt Ratio (aka Back End Ratio)
The Total Debt Ratio is calculated by taking the total monthly revolving and installment debt (credit cards, car payments, student loans, alimony, child support, etc) and dividing by the total gross monthly income. FHA limits this to a maximum of 41% (with some exceptions)
What homes are eligible for an FHA Loan?
FHA loans are available on single family homes as well as multifamily units of up to 4 units. Condominiums can also be purchased, however the condo must be on the FHA approved condominium list.
When obtaining an FHA loan the lender will order an appraisal of the property. An “appraisal” may only be conducted by a licensed appraiser. When your real estate agent tells you what your home might sell for, that is an opinion of value. It is not used to replaced a required “appraisal”.
In an FHA transaction, the appraiser will also look at the physical home itself, to make sure that HUD’s minimum standards for safety and security are being met. This is not meant to replace an home inspection, which is always recommended. It simply makes sure that certain standards of safety and security are being met before the loan can be approved. Some of the items the appraiser will look for are:
- The home must be safe and habitable, posing no safety hazards to the occupants
- All bedrooms must have an egress to the outside. A window is acceptable as long as it is large enough
- The lot should be sloped so that water drains away – and not toward – the home
- All steps and stairways must have a handrail, if it is needed for safety reasons
- The heating system must provide “healthful and comfortable living conditions”
One of the major differences in FHA Loans and Conventional Loans is the requirement for mortgage insurance. The mortgage insurance premium is paid by the borrower at the time of closing and then monthly. The premium due at the time of closing is 1.75% of the purchase price (or $1,750 per $100,000 borrowed). The yearly amounts due for ongoing mortgage insurance are as follows.
Annual Premiums for FHA Loans
- 30 year loan, down payment (or equity) of less than 5% = .85%
- 30 year loan, down payment (or equity) of 5% or more = .80%
- 15 year loan, down payment (or equity) of less than 10% = .70%
- 15 year loan, down payment (or equity)of 10% or more = .45%
We hope you’ve enjoyed and found helpful FHA Loans 101. If you or someone you know is looking to buy, sell, or invest in real estate in South Florida, please contact us.