FHA Loans

Learn why FHA Loans are today's most popular mortgage program.

By Spencer Llewellyn

The lending climate has been a rapidly changing environment in the last few years. New rules and regulations and the evaporation of sub-prime mortgage lending means millions of people who could purchase or refinance a home only a few years ago now find it difficult or impossible to get a loan approval. The flexible loan programs that were previously used just don't exist any more, with very few exceptions. The most popular exception right now is FHA Home Loans.

Over 3,000,000 application were submitted for FHA Loans during the 2009 fiscal year. That number is up from 1,900,000 from the 2008 FY. More and more home buyers are turning to the favorable terms and flexible guidelines for thier mortgage needs. In many cases, an FHA Loan is the only mortgage program that the borrower can qualify for.

What is the FHA?

The FHA, short for Federal Housing Administration, was founded in 1934 during the depths of the Great Depression. Over the past 75+ years, the FHA has insured more than 37 million mortgages in the U.S., making them the largest government insurer of mortgages in the world.

FHA Loans are more flexible than other loan types, however, they do carry certain rules and guidelines that a borrower must meet in order to be approved. Some of the most important guidelines are listed below.

Credit Guidelines

To qualify for an FHA Loan, the borrower will almost always need a "middle" credit score of 620 or above. The middle credit score is determined by eliminating the highest and the lowest credit scores provided by the 3 major credit bureaus, leaving only the middle score. While the FHA sets a minimum credit score of 580 for its loan programs, almost every lender and mortgage investor in the U.S. has set their own minimum credit requirements at 620 or above. The reason for the 620 minimum set by lenders is that, statistically, there is a much higher default rate on mortgages where the applicant had a credit score below 620.

It is acceptable to have a Bankruptcy in the borrowers past to qualify for an FHA Loan, but there are additional rules that will apply. If a borrowers Bankruptcy was Chapter 7, then they must wait 2 years from the discharge date before applying for an FHA Loan. If the Bankruptcy was Chapter 13, then the applicant must have proof that they have made all of their court ordered payments for more than one year.

Income Guidelines

The borrowers income verification is a very important part of the FHA Loan application process because it determines the borrowers ability to repay the mortgage. FHA Loans use debt-to-income ratios, or DTI, to qualify an applicants income. There are two debt-to-income ratios that today's FHA Loan programs use and the borrower usually must qualify for both ratios.

The first ratio is the housing expense ratio or "Top Ratio". Using this ratio, the borrowers new monthly housing expense payment including the new mortgage payment, principal, interest, taxes and insurance, should not exceed 31% of the borrowers monthly income.

The other qualifying ratio is the total expense ratio or "Bottom Ratio". For this ratio, the borrowers total monthly expenses, as reported on their credit report, should not exceed 43% of the their monthly income. Expenses used in the Bottom Ratio are the new housing expenses, credit card payments, car payments, student loans and any other monthly payments that are paid and reported by the credit bureaus.

Property Guidelines

In order for a property to be eligible for an FHA mortgage, it must first pass an appraisal that has to be performed by an FHA certified appraiser. The property must be in fairly good condition in order to pass the appraisal. Some of the conditions that will disqualify the property include a worn out or leaking roof, any sort of structural problem, missing paint on the exterior, and lack of bedroom access to outside the home in case of fire evacuation.

The appraised value of the property is very important. For a purchase, the property must appraise for at least the purchase price of the home. If it is an FHA Refinance, the home must appraise for enough that the requested loan amount will not exceed 97.75% of the value of the home. If the appraisal comes in at a lower value, it could mean that the maximum loan amount available to the borrower will be limited.

The maximum FHA loan amount varies for different areas across the U.S.. The lowest maximum loan amount in any area is $271,050 but is can go as high as $729,750 in certain high-cost areas. Maximum FHA Loan limits for your area can be found here.

FHA Loans can be used to purchase or refinance single family homes as well as FHA approved condo's, duplexes, tri-plexes and four-plexes.

Research Lenders

Do your research to find the right FHA Lender.
Try: When choosing a lender for an FHA Home Loan, it is very important to do your own research to find out if you are dealing with a reputable and reliable company. Some of the questions you should ask are if the lender is a FHA DE-approved lender, meaning that they are approved to underwrite their own FHA Loan applications, and if the lender is an FDIC insured banking institution or a mortgage broker.

Check FHA Loan Limits

Determine if your desired loan amount is below the maximum allowed loan for your area.
Try: To look up the FHA maximum loan amount for you area, you can visit the official HUD website here.

Choose the Right Property

The property must meet FHA Loan requirements.
Try: When choosing your property, make sure that it will meet the guidelines for an FHA appraisal and it does not need any major repairs.

Be Prepared to Provide Documentation

FHA Loans are fully documented loans, meaning you will have to provide evidence of almost everything involved.
Try: Once you have chosen your FHA Lender, your Loan Officer will ask you for a lot of documentation that will be required to underwrite and approve your loan. This documentation can include your tax returns, your W-2's or 1099's, your bank statements, your pay stubs, residence history and any other relevant information. Being prepared to provide this will save you time and stress in the application process.

To qualify for an FHA Loan today, you will need a minimum "middle" credit score of 620 or above.
To qualify for an FHA Loan, you must also make enough income to meet the required debt-to-income ratios of 31/43.
For the property to be eligible for an FHA Loan, it must contain enough equity to cover the desired loan amount. FHA Loans can be used for up to 96.5% financing for a purchase or 97.75% financing for a refinance.