With housing prices at historic highs, many first-time homebuyers are considering Federal Housing Administration loans for their lower down payments and less-stringent credit requirements. Here’s what you need to know about qualifying for an FHA loan.
Know your credit score
Generally speaking, FHA loans are available to borrowers lower credit scores. They are issued by private lenders and only backed by the Federal Housing Administration, therefore each lender sets its own guidelines when it comes to selecting borrowers. This means many financial institutions will set higher credit score minimums, explains Nerdwallet contributor Kate Wood. As a result, it’s a good idea to thoroughly familiarize yourself with your lender’s requirements. Furthermore, it never hurts to work on improving your credit score by making payments on time, paying down debts, and catching up on any past-due payments.
Minimum down payment
The down payment of your FHA loan will depend on the quality of your credit score. If you have a credit score ranging from 500 to 579, you’ll have to make a minimum down payment of 10%, Wood explains. But if your credit score is above 580, your minimum down payment will be just 3.5%. With such a sizable difference in down payment requirements, it never hurts to work on improving your credit score. Many factors are involved in calculating your credit score, which can be improved by making payments on time, paying down debts, and catching up on any past-due payments.
Your debt-to-income ratio helps lenders assess your financial health. FHA guidelines allow your debt-to-income ratio to be as high as 50% if your credit score is above 580 and you meet all other requirements. Wood states FHA loan providers also compare your monthly income with your potential monthly mortgage payment. This is called your payment-to-income ratio, or PTI. If your credit score is above 580, your PTI can be a maximum of 40%, meaning that your monthly mortgage payment cannot exceed 40% of your monthly income.
Credit history considerations
When it comes to checking your qualifications, FHA lenders look beyond your credit score. In order to qualify, you’ll need two or more credit accounts, such as an auto loan and a credit card. Additionally, you cannot have outstanding federal debt or have any judgments, regardless if they are tax-related. Finally, previous debt from FHA loans is not allowed. Your lender will also verify any help you received to pay for your FHA loan’s down payment, such as monetary gifts from friends and family. According to Wood, you can account for these with a signed and dated statement issued by the gift giver.
While it’s important to meet the financial qualifications for your FHA loan, Forbes Contributor Jamie Young explains you’ll need to provide your lender with a few pieces of essential documentation. To prove your income, you’ll provide three years of tax returns, along with recent pay stubs and a bank statement. You’ll also be asked to provide the last two years of your employment history, a credit report, proof the home will be used as a primary residence, and an FHA-approved appraisal of the home you are purchasing.
For more information on qualifying for an FHA loan, consider speaking with a First Federal Bank loan officer about your FHA loan options.