What is an FHA Loan?
The Federal Housing Administration (FHA) was established in 1934 to improve housing standards and conditions and to provide an adequate home financing system through insurance of mortgages. Families that would otherwise be unable to qualify for home loan finally able to buy the homes of their dreams under FHA loan program.
An FHA loan allows you to buy a house with as little as 3.5% down payment, instead of the higher percentages required to secure conventional loans. Taking advantage of the FHA loan program is a great way for first time buyers, or anyone with a shortage of down payment funds, to buy a home.
The FHA does not make home loans–it insures them. If a home buyer defaults, the lender is paid from the insurance fund. This is a perfect mortgage solution for those starting out or those having a tough time qualifying for conventional loans.
FHA Loans vs. Conventional Home Loans
The main advantage of FHA home loans is that the underwriting guidelines are more flexible in a number of areas than conventional loan programs. FHA will allow the borrower who has had a few credit difficulties in the past or those without a long credit history to qualify for a home loan. FHA will require a reasonable explanation of these derogatory items, but will approach a person’s credit history with common sense credit underwriting.
Credit: While conventional loans do require borrowers to have very good credit histories, FHA guidelines allow those that have had previous credit challenges to still obtain a home loan. The FHA guidelines attempt to preclude those that have a disregard for financial obligations, while making room for those that had previous financial hardships that impacted their ability to pay their bills. Whether you have had late pays, bankruptcy, foreclosure or a short sale, and FHA loan will most likely be your best opportunity to purchase a home.
A good FHA lender will have a good understanding of, and experience using both extenuating circumstances and exceptions to the clients advantage. While the FHA loan requirements state program guidelines, it is often possible to overcome challenges borrowers face by knowing and the requirements to get an exception. For example, the maximum Debt to Income Ratio (DTI) according to the FHA guidelines is 43%, this means that your new house payment with taxes and insurance included, cannot exceed 43% of your gross monthly income. However, we have seen more than a few loans that have had a DTI of 50% and on a few occasions higher. This is possible due to the fact that the FHA guidelines allow for exceptions to their guidelines. An good lender will know these exceptions and help them work for you. We have been able to help buyers get into their new home with an FHA loan, even after another lender turned them down because they exceeded the DTI guidelines. In addition to the exceptions for debt issues, credit issues that would cause a borrower to be disqualified can be overcome if the lender can show that the credit issues were a result of extenuating circumstances. This is an event or set of events that were outside of the borrowers ability to control and is not likely to reoccur, that was the cause of the credit difficulty. Using this provision can help a buyer qualify for a loan sooner than normal if their credit reflects a bankruptcy or foreclosure.
I’ve had a bankruptcy in recent years. Can I get an FHA loan?
The two bankruptcy types addressed in the FHA guidelines is the Chapter 7 and the Chapter 13.
While neither bankruptcy type will not prevent a borrower from obtaining an FHA loan, the requirements are different for each. In the case of the Chapter 7 bankruptcy, a borrower should have re-established a minimum of two credit accounts (such as a credit card, car loan, etc.) and wait 2 years since the discharge of a bankruptcy.
If a borrower has filed for a Chapter 13 bankruptcy instead of a Chapter 7, meaning that they made or are making payments to the bankruptcy court, the FHA guidelines allow for an approval in as little as 12 months after FILING for bankruptcy. While the Chapter 7 has to be discharged, the chapter 13 does not. However, the rules do state that the bankruptcy court must give permission for borrowers that are still making bankruptcy payments.
Of critical note regarding FHA’s willingness to allow those with past credit challenges to qualify for a home loan, it is IMPORTANT that they have ZERO late payments reporting on their credit report after the bankruptcy. Even the smallest late payment, charge off or collection after a bankruptcy filing is enough to have a loan denied.
What documents are needed for an FHA Loan?
It is important to understand that the loan approval is 100% dependent on the documentation you provide. To insure a smooth transaction, it is crucial that you have all your documentation in order before the initial application of the loan.
- Most recent two years complete tax returns with all schedules.
- Most recent two years W-2’s, 1099’s, etc.
- Most recent pay stubs covering one month period.
- If applicable: Self-employed will need two years Tax Returns and Ytd Profit & Loss Statement.
- Most recent two months complete bank statements for any and all accounts with all pages.
- Most recent statement from retirement, 401k, mutual funds, money market, stocks, etc.
- Most recent statements from your bills, indicating minimum payments and account numbers.
- Name, address, and phone number of your landlord, or 12 months cancelled rent checks.
- If applicable: Should you have no credit, copies or your most recent utility bills will be needed.
- If applicable: Copy of complete Bankruptcy and Discharge papers.
- If applicable: If you co-signed for a mortgage, car, credit card, etc, need 12 months cancelled checks. front and rear, indicating you are not making payments.
- Copy of Drivers License.
- Copy of Social Security Card.
- If applicable: Copy of complete Divorce, Child Support, Alimony Papers.
- If applicable: Copy of Green Card or Work Permit.
- If applicable: If you own another home(s) – see below
If a Refinance or you own Rental Property:
- Copy of Note & Deed from current loan.
- Copy of Property Tax Bill.
- Copy of Hazard (homeowners) Insurance Policy.
- Copy of Payment Coupon for current mortgage.
- If applicable: If property is multi-unit, need Rental Agreements.
How big of an FHA Loan can I afford?
For an FHA loan, your monthly housing costs should not exceed 29% of your gross monthly income. Total housing costs include mortgage principal and interest, property taxes, and insurance. Those four terms are often lumped together, and referred to as PITI.
Monthly income X .29 = Maximum PITI
For a monthly income of $3,000, that means $3,000 x .29 = $870 Maximum PITI
Your total monthly costs, adding PITI and long term debt, should be no more than 41% of your gross monthly income. Long term debt includes such things as car loans and credit card balances.
Monthly income x .41 = Maximum Total Monthly Costs
For a monthly income of $3,000, that means $3,000 x .41 = $1230
$1,230 total – $870 PITI = $360 allowed for monthly long term debt
The ratios for an FHA loan are more lenient than for a typical conventional loan. For conventional home loans, PITI expense cannot usually exceed 26-28% of your gross monthly income, and total expense should be no more than 33-36%.