65% of Americans own their own home these days. Buying a home can be a great way to lock in your monthly housing costs versus rent, which can go up yearly and negatively impact your budget. Owning your home has plenty of benefits, but the mortgage process can make you wonder if homeownership is out of your reach.
If you are ready to become a first-time home buyer, you may be swimming in information about the process. Plus, you might wonder if you can even meet the conventional or FHA loan requirements because you have had less-than-perfect credit. Do not assume that a home purchase is completely out of your reach just because you have lower income or a lower credit score. Thanks to the FHA mortgage program, you can step out of being a renter and into the realm of homeownership.
It is a lot to absorb as you work through the requirements to qualify for a mortgage, so we are going to walk you through the process of obtaining a specific kind of mortgage, the FHA loan program. We will share five things you need to know about the FHA loan requirements and some of the benefits this type of loan offers, particularly for first-time home buyers or those with less-than-perfect credit.
1. FHA Loan
The name is a little confusing because the Federal Housing Administration (FHA) doesn’t actually finance your mortgage, but they insure it, thus lowering the risk for lenders. The FHA is a government agency that was created back in 1934 to increase home ownership in America. Part of this work involves increasing access to financing for all Americans, particularly those who might not be in a position to save a traditional 10-20% down payment or meet other financing requirements. As home prices continue to increase, many families find themselves being priced out of the market. Even if they can save, it might be less than they hoped, especially since rents are also climbing.
The 2023 FHA loan requirements are a means for individuals and families to purchase a home that might have otherwise been out of reach. For areas where the price of homeownership is significantly high, the FHA loan requirements can be a way to purchase a home and lock in a fixed monthly mortgage payment. Those fixed monthly housing costs can often positively impact your budget since you won’t face a rent increase yearly.
FHA loans are popular mortgages, especially with first-time home buyers. Since the FHA loan requirements offer a smaller down payment, and the credit scores required for approval are typically lower than with a conventional mortgage, this type of financing is within reach for families, regardless of their area’s current housing market. That is why they have successfully gotten people into their first homes more quickly. Fifty-six thousand homes were purchased using the FHA loan requirements in 2022, which will likely increase in 2023 as the pandemic’s impact continues to fade. That means more families can take advantage of the benefits of homeownership, including finding a home within their budget. But what is involved in the FHA loan application process, and does it differ from a traditional conventional loan?
The application process is about the same as it is for a conventional mortgage. You will follow the same basic steps and have to provide the same information as part of the underwriting process. Below are these steps and what you must do to prepare for each FHA loan requirement.
Preapproval. You will give the potential lender information about your income, assets, debts, and expenses. The lender will check your credit and tell you what loan amount and interest rate you qualify for. Remember that although the government sets the FHA loan requirements, each lender can have their own qualifications you need to meet.
Application. This formal process is where the lender will verify all the information you provided. It is an early part of the underwriting process, which will eventually include an appraisal report from a third party to verify that the property is valued high enough to justify the purchase price and the loan amount requested. During this process, you will likely need to provide documentation proving your income, employment history, and debt-to-income (DTI) ratio.
Loan Estimate. The lender will provide you with this information about your loan in writing. You will be able to compare the offer to others if you are applying with more than one lender. Keep in mind, knowing your loan amount can help you determine how much to offer for a property based on what you can reasonably finance. You might also decide to try to finance less to keep your monthly mortgage payment in line with your current budget. Also, ensure that the amount you are financing meets your budget while leaving you a cushion for potential repairs and routine maintenance.
Appraisal. The lender will want to verify the real value of the home you want to buy. It is not necessarily the same as the asking price. For an FHA loan, the lender will choose a HUD-approved appraiser to assess the home’s value. Your home needs to be valued high enough for you to be approved for an 80% LTV. Otherwise, your lender might be unable to finance that home under the 2023 FHA loan requirements.
Insurance. You will need to purchase a homeowner’s insurance policy before you close. In fact, you will need to bring it with you to closing. That policy is meant to cover the costs of any damage to the home or to cover the mortgage if the home is destroyed. However, knowing exactly what your policy covers and ensuring it meets your lender’s requirements is important. The lender will want to see evidence of the policy because they are guaranteeing your loan based upon the asset’s value (your home). If it is damaged and not repaired, it loses value and might not be worth the current mortgage on the property.
Closing. This final step in the process is where all your hard work pays off! You will provide all the required information and the payment. If there are any closing costs you need to pay, this will be when you must provide those funds. However, with an FHA mortgage, you may be able to roll your closing costs into your loan, thus reducing the amount you need to bring to the closing table.
By completing this process, including meeting all the 2023 FHA loan requirements, you can purchase a home for your family. It is exciting when you pick up those keys and walk through your new home as an owner and not a renter. You can decide on paint colors, remodeling, and more, knowing you do not have to check with your landlord first. Plus, any changes you make could increase the value of your home over time.
2. FHA Loan Income Requirements
One of the requirements for an FHA loan is a steady income. In that respect, FHA loans are no different than conventional mortgages. You have to be able to make the payments.
When you apply for an FHA loan, you must prove your income. You can do that with your most recent tax returns and your paychecks. You will also want to demonstrate stability in your work history, although it is not a requirement. It will help if you show you have worked for the same company for at least the last two years. Gaps in your work history need to be explained. If you are self-employed, then your lender might require several years of tax returns to make sure that you can afford your monthly mortgage payment.
Your mortgage payment cannot exceed 35% of your income before taxes. Let’s say you earn $50,000 a year. Your gross monthly income is $4,166. That means your monthly mortgage payment would need to be about $1,458. Knowing this information can help you determine how much of a home you can reasonably finance and the home price you could offer. Knowing your housing budget in advance can help you during your home search.
You will also need to account for any other debt you have. Your mortgage and other monthly debt payments cannot exceed 50 percent of your income to get an FHA loan.
Let’s use our example above of a $50,000 gross annual income. Your gross monthly is $4,166. 50% of that is $2,083. So, your mortgage payment and other debt cannot be more than that. Before you apply for your mortgage, it is important to look at your current expenses and estimate your debt-to-income ratio. If you know that your current rent and expenses exceed 50%, it might be worth looking at ways to address your finances to get under 50% before applying for an FHA mortgage.
Also, make sure that your debt payments are made on time every month because it will help show a lender that you are responsible for repaying any funds you borrow. Regular, on-time monthly payments impact your credit score, which can impact your downpayment.
3. Down Payment Requirements
This part makes an FHA loan so popular with first-time home buyers. A conventional mortgage typically requires 20 percent down. An FHA down payment is much less, which makes it more affordable for individuals and families who might otherwise struggle to save a larger downpayment. In fact, it is possible to secure an FHA loan with as little as 3.5 percent.
What does that look like? Here is an example. Let’s say you want to buy a $100,000 home. With a conventional mortgage, you would need to put down about $20,000. If you are approved for an FHA loan, you would only need $3,500. Now instead of spending years paying rent, you can be in your own home and pay the mortgage on an asset.
That is a huge difference, especially for first-time home buyers who do not have money from selling another home to cover the down payment. However, options are available for your downpayment, including gifts from others or grants. Check with your lender to learn about the options available and what type of gifts can qualify.
Your credit score will affect the amount of your down payment. Your score must be 580 or better to qualify for the 3.5 percent down payment. If your score is between 500 and 580, you will need to put closer to 10 percent down. Both of these are budget-friendly options that can help individuals and families struggling to save a 20% down payment. Still, you might wonder if your credit score can impact more than just the size of your down payment.
The credit score requirements are significantly lower for an FHA loan than for a conventional mortgage. To be approved for a conventional mortgage with a traditional lender, like a bank, you will need a score that is in the mid-700s or better. An FHA loan requirement is at least 500, but to get the 3.5% downpayment, you must have a 580 credit score. To be clear, your lender can set their own credit requirements before approving your loan. Plus, your credit score impacts the interest rate for your mortgage loan. So the lower your credit score, the higher your interest rate. Taking the time to clean up your credit before starting your FHA mortgage process can help to save you money in the long run.
As with any mortgage, you will want to shop around for the best loan at your best interest rate. That might mean applying for more than one FHA loan. However, you do not need to worry about your credit report reflecting every application and being negatively impacted as long as you complete these applications within a specific time frame.
The credit bureaus count every mortgage application as one inquiry. You will have to submit all your applications within a certain time frame. That means your credit score will not take a hit while you shop for the right loan term and interest rate to fit your needs.
4. Loan Limits
There are federally-set limits to how much you can borrow with an FHA loan. Those vary by state and county. These loan limits are geared to reflect the housing market in a specific county. In urban areas where housing prices are higher, you might find that the loan limits are higher than in rural areas.
You can search for the loan limit in your area on the FHA website. Keep in mind, these limits can vary from county to county, so it is important to know what that is before you start looking at homes.
5. Private Mortgage Insurance
The drawback of an FHA loan is the private mortgage insurance (PMI). It is required with an FHA loan program, and it continues through the life of the loan.
PMI is insurance you have to pay to protect the lender if you default. You will have to pay a specific amount up front at closing. You will also pay PMI every month as part of your mortgage payment.
PMI is required for anyone who puts down less than 20 percent on a home. The difference is that with a conventional mortgage, you can request to have the PMI dropped after you have made payments for a period of time. With an FHA loan, the PMI stays unless you refinance down the road.
As with any mortgage, you will also have closing costs. These will include such things as appraisals and title insurance. Typically, FHA closing costs amount to around 3 percent of the purchase price. The FHA sets the 2023 FHA loan requirements, but you will also have eligibility requirements from the lender that must be met. Still, if you are looking for an affordable way to purchase a home, an FHA loan could be the right option.
We hope this has answered all your questions about FHA loan income requirements. We are happy to help you with your home-buying journey. Please feel free to contact us with any questions you have.
7th Level Mortgage is a leading one-stop mortgage company providing deeply informed, custom-tailored assistance with every phase of each mortgage transaction. If you are searching for a home loan in New Jersey, Pennsylvania, Virginia, Delaware, Maryland, New York, or Florida, please contact us today so that we can determine the best Mortgage Lender to place your loan with and get you the best possible rate and program.