65% of Americans own their own home these days. In fact, three and a half million mortgages were granted in 2017! If you are ready to become a first-time home buyer, you may be swimming in information about the process. Plus, you might be wondering if you can even meet the conventional or FHA loan requirements because you have had less than perfect credit. Do not assume that just because you have lower income or a lower credit score that a home purchase is completely out of your reach.
It is a lot to absorb, so we are going to walk you through the process of obtaining a specific kind of mortgage called an FHA loan. We will share five things you need to know about the FHA loan income requirements, along with some of the benefits that this type of loan has to offer, 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 issue the loan. It insures it. 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.
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 still purchase a home and lock in a fixed monthly mortgage payment.
FHA loans are popular mortgages, especially with first-time home buyers. FHA loans require a smaller down payment, and the credit scores required for approval are typically lower than with a conventional mortgage. That is why they have been successful in getting people into their first home more quickly. 73,000 new homes were purchased with FHA loans in 2018. That means more families are able to take advantage of the benefits of homeownership, including finding a home in 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.
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.
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.
Loan Estimate. This information about your loan is what the lender will provide you 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.
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.
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, it is important to know exactly what your policy covers and make sure that it meets the requirements of your lender. The reason the lender will want to see evidence of the policy is because they are guaranteeing your loan based upon the value of the asset (your home). If it is damaged and not repaired, then it loses value and might not be worth what the current mortgage is 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.
By completing this process, including meeting all the FHA loan requirements, you can purchase a home for your family. It is an exciting day when you pick up those keys and walk through your new home as an owner and not a renter.
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 will need to 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 can show you have worked for the same company for at least the last two years.
Your mortgage payment cannot be more than 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.
You will also need to account for any other debt you have. To get an FHA loan, your mortgage payment plus other monthly debt payments cannot be more than 50 percent of your income.
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 your 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.
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. In fact, it is possible to secure an FHA loan with as a 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.
That is a huge difference, especially for first-time home buyers who do not have money from the sale of another home to cover the down payment. However, there are options available to get your down-payment, including gifts from others or even grants. Check with your lender to learn about the options available.
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, which can help individuals and families who might be struggling to save a 20% down payment. Still, you might be wondering 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 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.
As with any mortgage, you will want to shop around for the best loan at the best interest rate for you. 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.
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. For example, in Camden County, New Jersey, the loan limit for a single-family home is $402,500. In Hillsborough County, Florida, it’s $314,827.
You can search for the loan maximum in your area here. 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. FHA loan requirements are set by the FHA, 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, then an FHA loan could be the right option for you.
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.