The Ultimate Guide To FHA Loans

FHA stands for federal housing administration and it's an agency loan that is governed by HUD. One of the misconceptions about an FHA loanis that it's a first time home buyer loan. While its true that first time home buyers can qualify for FHA loans, it's not a loan specifically for first time home buyers.

The FHA loan is actually an insurance product, which basically insurers or provides insurance to the lender that is funding the mortgage. HUD through the FHA sets guidelines for this insurance program.

D. Shane Whitteker is the owner and chief mortgage broker at State College, Pennsylvania based Principle Home Mortgage. Whitteker has helped many clients to navigate their way through the FHA loan process.

“Overall, the FHA loan is an aggressive product with a lot of good attributes for people looking to buy a home. The main reason FHA loans exist in my opinion is to offer a lower down payment option for moderate to lower income borrowers,” Whitteker says. “An FHA loan allows those borrowers to have access to a lower down payment option loan that is more forgiving as far as credit and debt ratio go. When I say more forgiving what I mean is an FHA loan can be done with a lower credit score than a conventional loan can be.”

If you tried a conventional mortgage loan option and were turned down because your debt to income ratio was too high, an FHA loan may be worth considering.

“An FHA loan has a significantly higher debt ratio than what a government or a Fannie Mae and Freddie Mac conventional loan can be done with,” Whitteker says. “And remember - it's not just low income borrowers who qualify for this - there's no income limit you can make any level of income and still qualify for this mortgage.”

What are the limits to an FHA loan? According to Whitteker, the FHA puts a cap on the amount your loan can be for.

“The FHA does sets loan limits for different regions throughout the country, and that includes some high cost areas, if you're in an area where the average purchase price is $500,000 the FHA sets the maximum loan limit higher in that area than they do in an area where the average purchase price is around $200,000. For example, in Pennsylvania the maximum FHA loan amount is about $294,515.”

Why does the FHA loan have limits on the loan amount?

“In general, they put limits on the product so people aren’t going out and buying million dollar houses with an FHA loan because its not designed to facilitate that kind of a transaction,” Whitteker says. “FHA is designed to facilitate the purchase of property to a spectrum of buyers, but it is limited so that you’re not able to abuse the program.”

What are the advantages of an FHA loan?

Higher debt to income ratio

“With an FHA loan it means you’re allowed to have a much higher debt to income ratio. This means you can have more debt in comparison to your income,” Whitteker notes.

Low minimum credit score

“FHA doesn’t actually set a minimum credit score - the banks issue the lowest scores they’re willing to do an FHA loan for. FHA does set a minimum credit score of 580 though if you want to put the minimum 3.5% down payment on the loan,” Whitteker notes. “If you want to get an FHA loan with less than a 580 credit score, you’ll need to put 10% down.”

Calculating your credit score sometimes confuses people. It’s important to take note of how banks determine your minimum credit score.

“Your minimum credit score is actually the middle of your 3 major credit scores. Those 3 credit bureaus are TransUnion, Equifax and Experian. We take the middle score - so if you have a 520, a 550 and a 580, your credit score that’s pulled is 550. This trips some people up,” Whittekersays.

Manual underwriting

“For people who don’t qualify through the automated underwriting system, the FHA loan allows for what’s called a manual underwriting,”Whitteker says. “A manual underwrite for an FHA loan means it wasn’t approved through the automated system so its given to an underwriter to manually go through the guidelines to see if it qualifies based on the manual guidelines, which are different from the automated guidelines. The FHA loan is one loan that I’m happy to have available to offer my clients. It has definitely helped me to get people into homes they otherwise wouldn’t have been able to qualify for without FHA.”

More options for out of pocket costs

According to Whitteker, another advantage of an FHA loan is that it allows homebuyers many options for paying out of pocket costs associated with buying a home, more so than other more restrictive loan programs. One way an FHA loan helps with out of pocket costs is it allows a higher amount of seller assistance towards closing costs.

“What this means is you can get the seller to pay your closing costs, up to 6% of the purchase price,” Whitteker says. “For most purchase prices, that 6% is enough to pay for all of your closing costs. On very low purchase prices - $100,000 or less - that 6% may not be enough to cover all your closing costs, but for most homes it is, as long as the seller agrees to offer the seller assistance, which comes out of the seller’s proceeds from selling the home.”

The FHA loan also allows money to be gifted from family members for the home’s down payment.

Whitteker also notes that there are sometimes grant programs available to help with the 3.5% down payment needed for an FHA loan.

Tips for getting an FHA loan - or any home mortgage

Whitteker recommends keeping your credit in good standing.

“Good credit enables you to have more options when it comes to your FHA loan, or really any type of mortgage.”

Build alternative credit - If you don’t have a high enough credit score, or if you don’t have any credit score at all, occasionally banks will allow you to build alternative credit.

“Typically banks are looking for 3 accounts with a 12 month history that you’ve paid on time, or 2 accounts with a 24 month history of on-time payments to build the alternative credit,” Whitteker says. “Pay rent by check so your mortgage broker can verify your payment history - rent checks are a great way to do that. Banks really like that and are more likely to approve you if you can show you have 12 months of on-time payments on your apartment. 24 months are even better.”

FHA allows for more options to help get people into homes. It can certainly help first time homeowners who may not be financially able to make a big down payment or who may not have a great credit score to get into a home and start building equity.

“One of the best ways we save money in this nation is through the increase in value of our property and also the decreases in the mortgage balance we pay every month. So, after owning a home for 10 years, you should see 30 to 40% - sometimes more - equity in that house, as long as real estate values have been increasing,”Whittekersays. “Many times that equity facilitates that family’s next home purchase - especially if that family has grown. Owning a home opens more options for you because of that equity factor, and FHA is a really good tool for someone who doesn’t fit into the standard categories so they can actually buy a home and begin to take advantage of growth and equity.”

Starting the process of owning a home earlier in life also allows you to save more money towards your retirement.

“A large portion of what we save is through the equity in our homes. Don’t wait to get your equity building process started. Whether you pull equity to buy a vacation home, or to facilitate the purchase of a larger home for your growing family, its never too early to get started, and an FHA loan opens that chance up to many people.”

Other expenses

There are sometimes changes to the way the HUD and FHA structure the mortgage insurance.

"With FHA you pay an up-front mortgage premium that is financed - they don’t make you pay it out of pocket,”Whitteker says. “It increases your loan amount and is currently 1.75%, although that’s subject to change if HUD decides to change it. Then you have a monthly insurance you pay based on a yearly factor. That is currently .85% on a 3.5% down loan. That payment drops to .80% if you put 10% down on your FHA loan.”

According to Whitteker, most of the news around FHA is usually in regards to changes to the program as far as qualification or mortgage insurance cost.

“There are occasionally changes to the FHA loan program. Recently a change was made to the program in relation to how a borrower was allowed to exclude debt,” Whitteker says. “If you have installment debt - for example a car loan - in the past if you had 10 or less payments left on that installment loan you were allowed to exclude that from the debt ratio. That calculation has been changed however, and now the person’s monthly income needs to be multiplied by 5%, and that number you reduce the payment on the installment debt by 5% of that persons income. That allows for a lower debt to income ratio.”

The FHA also recently increased the loan amount you can qualify for.

“Another change was maximum loan limits were recently increased for an FHA loan,”Whitteker says. “In Centre County, we went from around $271,000up to $294,515, which is a big difference, and allows the purchase of more properties, especially as property values increase.”