FHA Loan Qualifications are fairly simple to understand. FHA loans, and all mortgage loans for that matter, are based on four major factors – Credit, Income, Assets and Property. Fortunately with the advent of automated underwriting, or loan underwriting with a computer, there are exceptions to the guidelines that we will discuss. Think of it more like a balancing scale. If one area is close to meeting FHA Loan Guidelines but doesn’t quite make it, it can still be compensated for with strong factors in the other categories.
What many people do not understand is that FHA is not a lender themselves. FHA is an insurer of loans to lenders to ensure them against loss. As such, FHA Loan Guidelines are established by HUD, but lenders can have their own ‘overlays’ or stricter than FHA Loan Qualifications than FHA sets forth.
FHA Loan Qualifications – Credit
A potential borrower must possess a credit history that demonstrates a responsible use of credit, by the payment of one’s obligations on time. Generally speaking, lenders look at the last 24 months of payment history, but can look further back if warranted.
For the most part, lenders will require a clean payment history with no late payments. A payment to a creditor is considered late, when it is received by the creditor more than 30 days past the due date. This allows for delays in mail and minor oversights.
Although FHA loan guidelines technically do not require credit scores, most lenders have implemented a credit score minimum. The typical industry standard is a minimum of 620 credit score, however a few lenders will go down to a 560 score. Now there are very strict guidelines associated with these lower scores, as well as a premium to the interest rates and fees.
FHA Loan Guidelines – Income
Verifiable income is required in order to qualify for a FHA loan. The amount of income is relative to the loan amount being sought as well as the borrower’s debts. Debt to income ratio, or DTI as the industry refers to it, is a factor of one’s monthly debt payments in relation to his or her monthly income.
For example, if a borrower has a monthly income of $2000 and his or her monthly debt payments, including the payment on the proposed loan totals $600, his or her debt to income ratio would be 30%.
There are two different debt to income ratios to be aware of – housing expense and total debt service. FHA loan qualifications call for 31/43 ratios, or a 31% housing expense and 43% total debt service. Essentially, the proposed payment on a borrower’s new loan cannot exceed 31% of their gross monthly income, including property taxes and various insurances.
Total debt service, or the total monthly debt payments a borrower has, including the new loan payment, cannot exceed 43% of the borrower’s gross income.
As in other FHA loan qualifications there are exceptions to these ratios on a case by case basis, especially when a borrower has good compensating factors.
FHA Loan Qualifications – Assets
Assets, or sometimes called Cash Reserves, are liquid assets that a borrower has access to in the event of financial challenges. A borrower with 12 months’ worth of payments in reserve is in a much stronger position financially than someone who has no backup in the event of financial difficulties such as loss of job, or injury.
For 1-2 unit properties, there is no specified minimum cash reserve. On 3-4 unit properties, a minimum balance equivalent to 3 months of mortgage payments is required.
Assets must be verifiable and able to be accessed without difficulty. Examples of assets can be checking or savings accounts, retirement accounts provided they can be withdrawn from, CDs, money market accounts, etc.
Cash on hand, or “mattress money” is not an acceptable asset, regardless of the amount, as its ownership is not verifiable. A lender wants to know that the asset is the borrowers, and cash cannot be documented.
The only exception to the ownership rule is in the case of the down payment, which can come as a gift from a related party. The related party must verify the ownership of the funds and that they have not been borrowed. They will also need to attest that the funds are a true gift, and that no repayment is required. A borrower’s down payment cannot be borrowed. Here is a list of acceptable donors:
- A Relative of the borrower
- The borrower’s employer or labor union
- Charitable organizations
- Government agencies
- A close friend with a clearly defined interest in the borrower
FHA Loan Guidelines – Property
There are many FHA Loan Qualifications that pertain to a property and whether or not it will qualify for FHA financing. It would be best to consult a mortgage adviser regarding a particular property that you are interested in, but we’ll cover some of the major things to consider. Most single family homes will qualify. The home must be free of major defect and livable. Although FHA has programs that allow for repairs, the main FHA loan does not. Any repairs necessary must be completed prior to closing.
Condominiums or attached dwellings must be on HUD’s approval list. That list can be found here – FHA Loan Guidelines for Condos.
It is highly recommend to seek the assistance of a qualified mortgage professional. We have a list of FHA approved lenders on our home page and their corresponding rates. If you are considering a FHA loan, it would be ideal to seek out FHA loan qualifications sooner than later, even if you don’t intend on purchasing or refinancing today. It is much better to research lenders and programs well in advance of needing it. In most cases, an offer to purchase a home cannot be submitted until you have been pre-qualified for a loan anyway, so it pays to research early. The above is not meant to be an exhaustive list of all FHA Loan Qualifications. It is merely intended to assist you in understanding the general nature of FHA Loan Guidelines.