If you don’t fit the typical profile of a homebuyer, then an FHA loan may be for you. These mortgages have more relaxed qualifications and down payment requirements, making homeownership more accessible to first-time buyers and people who have less in savings.
What Is an FHA Loan?
FHA loans are mortgages backed by the Federal Housing Administration (FHA), an agency of the U.S. Department of Housing and Urban Development (HUD). Unlike traditional mortgages, they don’t require that applicants have high credit scores or make a large down payment. These 15- and 30-year loans can be used to purchase single-family homes, as well as two-to-four-unit multiplexes and individual condominium units.
The FHA itself doesn’t provide the loans — you’ll need to go through a lender — but it insures the loans in case of default. This allows FHA-approved lenders to relax their standards and give the opportunity of homeownership to people they otherwise may not lend to.
FHA loans are popular among people who are new to the process of buying a home. “We see first-time homebuyers leverage them at higher levels because the lower down payment requirement can be more attainable,” says Bill Banfield, executive vice president of capital markets at Rocket Mortgage. With an FHA loan, the minimum down payment is 3.5% or 10%, depending on your FICO credit score.
But you’ll need to meet particular borrower and property requirements to get an FHA loan. The FHA releases new guidelines every year, and in 2021, it increased the maximum loan amounts for both low- and high-cost areas. We’ve recapped the qualifications you’ll need to meet below, and you can find more detailed answers in the 1,139-page FHA Single Family Housing Policy Handbook, issued November 18, 2020. Keep in mind that while the FHA outlines these minimum requirements, the lender has leeway to raise these standards and make them more strict.
How the Pandemic Has Affected FHA Loans
This past year, the lending industry has become more risk-averse as unemployment numbers rose to historic highs. The combination of low FHA interest rates and urgent need for cheap loans has led to increased demand for FHA loans, and that, in turn, has caused lenders to raise their eligibility standards. According to a report from the Urban Institute, the median credit score for a completed mortgage (both conventional and government-backed) jumped from 741 in February to 764 in October — and it’s not expected to let up anytime soon.
Homeowners with FHA loans have been disproportionately impacted by the pandemic, compared to those with conventional loans. In a survey conducted by the Mortgage Bankers Association, 10.76% of FHA borrowers surveyed had a loan either in the process of foreclosure or that was past due by 90 days or more.
As a result, you may find the FHA lending market to be much more competitive than usual. Prospective borrowers with “fair” credit who would have qualified for an FHA loan prior to the pandemic may now find their applications rejected or their interest rates higher.
To increase your chances of success, we recommend shopping around to get the best deal, as you may receive more competitive offers from particular lenders. Those who are rejected for FHA loans will want to take steps to rebuild their credit for the long term.
FHA Loan Requirements 2021
|Minimum Down Payment||3.5% with a credit score above 580; 10% with a credit score between 500 and 579.|
|Minimum Credit Score||500|
|Maximum Debt-to-Income Ratio||Front-end DTI (mortgage payments only): 31%Back-end DTI (all debt payments): 43%|
|Minimum and Maximum Income||None|
|Documentation Needed||-Social Security number|
-Proof of employment (e.g., original pay stubs, W-2s, 1099s)
-Permanent address and proof of residence
-Federal income tax returns from the past two years
-If refinancing: notes and deeds from other mortgages, property tax bill, homeowner’s insurance, property tax bill, rental agreements (if applicable)
|Loan Limits||Low-Cost Area|
Loan limits by state and county can be found on FHA.com.
*All information current as of December 15, 2020.
FHA Down Payment Requirement
The FHA requires different down payments, depending on what your FICO credit score is. If you have a credit score above 580 (considered “fair”), the minimum down payment is 3.5%. If your credit score is between 500 and 579, then you’re required to put down 10%.
FHA Debt-to-Income Ratio Requirement
Debt-to-income ratio (DTI) is your monthly debt payments (which can include student loans, credit cards, mortgages, and other types of credit) divided by your pre-tax monthly income. For example, if you make $2,000 per month and spend $450 per month on various debt obligations, your DTI is 22.5%. This measurement is used by lenders to evaluate whether you’re likely to pay off the loan you’re applying for.
With the FHA, you’re generally required to have a DTI of 43% or less, though it varies based on credit score. To be more specific, your front-end DTI (monthly mortgage payments only) should be 31% or less, and your back-end DTI (all monthly debt payments) should be 43% or less.
Individual lenders may also have stricter qualifications. In the application process, you must disclose all debt and open lines of credit to the FHA.
FHA Income Requirement
There is no minimum or maximum income requirement for an FHA loan.
FHA Loan Documentation
If you thought filling out an application was arduous, unfortunately there is more to come. “Anything the FHA deems as a qualification attribute needs to be proven by the client through documentation,” Banfield says. Lenders require you to provide these documents to verify you’re a creditworthy borrower. The documents you’ll need to share will depend on the lender, but generally, you should be ready to hand over the following:
- Proof of Social Security number
- Driver’s license
- Proof of employment (e.g., original pay stubs, W-2s, 1099s)
- Permanent address and proof of residence
- Federal income tax returns from the past two years
- Bank statements
- If refinancing: notes and deeds from other mortgages, property tax bill, homeowner’s insurance, property tax bill, rental agreements (if applicable)
FHA Property Requirements
Not every property will be eligible for an FHA-backed mortgage. Here are the qualifications the property must meet in order to secure an FHA loan:
- The loan must be a principal residence, not an investment property. To prove it, at least one borrower must live in the home within 60 days of closing on the loan.
- The property can’t be purchased within 90 days of a prior sale, so no house flipping allowed.
- The title of the property must be in your name or in the name of a living trust at settlement.
- All properties must undergo the FHA appraisal process, including a HUD-approved inspection vetting whether or not the home is safe, sound, and secure.
FHA Loan Limits for 2021
The FHA announced higher loan limits for 2021 — a move that’s great for first-time buyers, says Banfield. “This will help offset the rapid home price acceleration we have seen throughout 2020 given tight inventory throughout the country.”
The maximum loan amounts the FHA will insure depends on where you live in the U.S. The limits tend to be higher for urban areas with a higher cost of living. You can determine what limits apply to your area through the HUD website.
|Housing Type||Low-Cost Area||High-Cost Area|