Do I qualify for an FHA mortgage loan?
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UPDATED: Aug 14, 2012
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For those wondering how to qualify for a Federal Housing Administration (FHA) mortgage loan, we’ve got good news for you: it’s relatively easy.
In fact, eligibility requirements for an FHA mortgage loan are amongst the most relaxed of all the different types of home loans.
For instance, conventional wisdom tells most aspiring homebuyers that they need at least 20 percent of a home’s value to put towards a down payment. For first-time homebuyers and young couples, that’s a very difficult amount of savings to accrue. So difficult, in fact, that many people wouldn’t find their way into a home until well into their thirties (if not forties).
But young people are still attaining home ownership, and they’re doing it through FHA mortgage loans.
Introducing the Federal Housing Administration
The FHA isn’t a lender itself, so no money is given from this government organization to borrowers. Rather, it partners with FHA-approved lenders and simply secures the money those lenders lend. As a result, there’s no all-encompassing formula for eligibility, but instead each lender is free to tweak their requirements as they see fit. However, there are several general components that factor into a borrower’s qualification standards:
- Down payments
- Debt-to-income ratios
- Credit scores
The Down payment
If a borrower is trying to qualify for an FHA mortgage loan, they must first ask themselves how large of a down payment they can afford. FHA mortgages do still require down payments, but they don’t call for anything near the 20 percent down that conventional home loans typically require. Instead, FHA home loans can be obtained with just 3 percent down.
That means on a $200,000 piece of real estate, a homebuyer needs to come up with only $6,000 to put down.
It is this down payment requirement that makes government-backed home financing so attractive.
Debt-to-Income Ratio Limits
Another important factor considered by FHA lenders is an applicant’s debt-to-income (DTI) ratio.
A DTI ratio is calculated by taking an individual’s recurring debt and dividing that by their recurring income. There are two DTI ratios that the FHA is concerned with: a borrower’s potential mortgage DTI and a borrower’s overall DTI.
The FHA will not lend to anyone whose mortgage-specific DTI exceeds 31 percent.
A borrower’s mortgage-specific DTI is determined by taking the potential monthly payment on an FHA mortgage loan and dividing that by the borrower’s income.
For instance, if a borrower makes $4,000 a month and can put a full 3 percent down on a $200,000 home at 5 percent interest, he can expect to make monthly mortgage payments of $1041.43. If that monthly payment is divided by the borrower’s monthly income, we get a DTI ratio of 26 percent—well within the confines of the FHA’s requirements.
After looking at the mortgage-specific DTI, the FHA will consider a borrower’s overall DTI. The maximum overall DTI permitted is 43 percent.
If we consider the same scenario above, but factor in the borrower’s other monthly payments, say $200 for a vehicle, $250 for student loans, and $200 for medical insurance, then we can add that $650 to the borrower’s $1041.43 mortgage payment for a total monthly debt of $1691.43. Then the DTI would be calculated in the same way as the previous ratio was, yielding an overall DTI of 42 percent—just enough to qualify for an FHA mortgage loan.
The Usual Suspect: Credit Score
Finally, a borrower’s credit score is just as important to FHA lenders as traditional lenders. But credit requirements for FHA mortgage loans are much lower than conventional home loans. The reason being, these lenders know their money is secured by the government, so their risk in lending to “less credible” borrowers is greatly reduced.
That’s precisely why FHA mortgage loans have become so desired and sought by those who have poor credit histories and those who have been hit hard by the recent recession.