Even though a conventional home loan is a popular mortgage product, you may not meet the down payment and credit score requirements for this loan. If so, an FHA home loan might be a better fit for you. This is a government loan insured by the Federal Housing Administration. FHA loans only require 3.5% down and you can get approved with a credit score as low as 500 to 580 (depending on the lender). It’s a great product for cash-strapped first-time buyers, although anyone can apply for one. If you’re thinking about applying, here’s information on how to apply for an FHA loan.
Mortgage requirements are specific, so you might wonder whether you’re eligible for a loan. To remove the guesswork, complete an online pre-qualification form before submitting an “official” mortgage application.
Pre-qualification is often the first step to getting a home loan. The form will ask basic information related to your income, employment and monthly expenses, and the lender takes a cursory look at your credit history before responding. Based on their preliminary findings, the bank decides whether you’re a good candidate for a mortgage. If so, you’re then given the green light to submit an official mortgage application.
Understand, however, a pre-qualification doesn’t guarantee an FHA mortgage. The lender doesn’t verify any information during this stage of the process. It’s not until you submit an actual mortgage application that the bank’s underwriter takes a closer look at your situation and verifies stated information.
There aren’t income requirements per se with an FHA home loan. However, your income must be consistent (at least 24 months of consecutive employment) and you must earn enough to support a mortgage. For this reason, your mortgage payment with an FHA home loan cannot exceed 31% of your gross monthly income.
So, if your gross monthly income is $4,000, your monthly mortgage payment cannot be more than $1,240. This includes repayment of principal and interest, homeowner’s insurance, mortgage insurance and property taxes.
Keep in mind that 31% isn’t a hard or fast rule. Some lenders may allow a borrower to spend a greater percentage of their income on a monthly payment, but only when a borrower has compensating factors. These factors include an exceptionally high credit score, a large cash reserve, or a successful history of making similar house payments.
In addition to submitting a mortgage loan application, your lender will request supporting documentation to get a clear picture of your financial health. A mortgage is a long-term commitment, so it’s the responsibility of underwriters to ensure that each applicant can realistically afford a particular mortgage amount.
A list of supporting documentations for an FHA home loan might include:
- Bank statements for the past 60 days (to ensure that a borrower has enough in reserves for a down payment and/or closing costs)
- Gift letter (required if a relative will gift a borrower’s down payment and closing costs)
- Recent paycheck stubs and complete tax returns for the past two years
- Year-to-date Profit and Loss Statement (self-employed borrowers only)
- Credit report
- Divorce decree (if you’re using income from alimony or child support to pay the mortgage)
Once you have a signed purchase agreement, your mortgage lender will then prepare a Loan Estimate that provides a rough approximation of your loan terms (monthly payment, interest rate, type of mortgage, cash needed for closing, etc.)
The Federal Housing Administration doesn’t make loans, they only insure these loans. You must apply for an FHA home loan with an approved-FHA lender.
The good news is that many reputable banks and mortgage companies offer these types of loans. For example:
First, contact your personal bank to see if they offer FHA loans. If so, request a free mortgage quote. Because you’re an existing customer, your bank might offer a desirable mortgage rate and terms. Even so, make sure you also request free quotes from at least two or three other lenders. Comparison shopping is important to get the best mortgage rate.
Once you select a bank and the lender approves your application, you’ll receive a mortgage pre-approval letter that states the maximum you can spend on a home purchase.
As you shop for a home, use an online FHA loan calculator to estimate monthly payments based on a certain price. This is a handy tool because it can prevent bidding on a house that will stretch your budget too thin.
Let’s say you’re eyeing two properties, and one property is listed for $125,000 and the other property is listed for $150,000. A mortgage calculator can estimate the monthly payment for both properties so you know what to expect before submitting a purchase offer.
Keep in mind that some mortgage calculators don’t take into account mortgage insurance, property taxes and homeowner’s insurance, and they only provide estimations for repayment of principal and interest. Therefore, seek out a detailed online calculator that also determines the monthly impact of insurances and taxes.
An FHA home loan is an excellent product whether you’re a first-time buyer or a repeat buyer. Between its low down payment requirement and flexible credit guidelines, this loan can make it easier to realize the dream of homeownership when you can’t qualify for other types of loans.