How FHA Loans Work (2021)

In this article, we’re going to talk about FHA loans, how they work, and how much you can borrow from the program!

An FHA insured loan is a US Federal Housing Administration mortgage insurance backed mortgage loan that is provided by an FHA-approved lender.

What this means is that the loan is guaranteed by the Federal housing administration and given to qualified borrowers in the hopes that it can increase homeownership for the general population.

One of the main benefits of getting an FHA loan is that it allows you to buy a property with a low down payment and can help you get a loan even if you have a low credit score.

FHA loans are also assumable mortgages, which means you can sell your home to another buyer who may not qualify for a new loan, and they can just assume your current mortgage. This opens up the buyer pool to more people.

How To Qualify for an FHA Loan

• Borrowers must have steady employment history or work for the same employer for the past two years.
• Borrowers must have a valid Social Security number, lawful residency in the U.S., and be of legal age to sign a mortgage in your state.
• New FHA loans are only available for primary residence occupancy
• Borrowers must have a property appraisal from an FHA-approved appraiser.

The Front-end Ratio, and the Backend Ratio

FHA lenders look at two ratios. The front-end ratio is the mortgage payment plus HOA fees, property taxes, mortgage insurance, and homeowners insurance). This typically needs to be less than 31 percent of their gross income. Borrowers’ back-end ratio (mortgage plus all your monthly debt, i.e., credit card payment, car payment, student loans, etc.) typically needs to be less than 43 percent of their gross income.

FHA loans are famous for being able to help homeowners buy their homes for the super low down payment of 3.5%. This 3.5% can be gifted by a family member.

Minimum Credit Score

Borrowers must have a minimum credit score of 580 for maximum financing with a minimum down payment of 3.5 percent.

If they don’t have a 580 credit score, borrowers can still get an FHA loan. However, it’s capped at a maximum of 90% LTV. This means they’ll need to put down 10% for the down payment.

How Much You Can Borrow

There are also limits to how much you can borrow with an FHA loan. Some places are considered more expensive than others, so the loan limits vary by location.

For example, the typical loan limits are $548,250 for one unit but $822,375 in an expensive market like the Bay Area. In an expensive market, here is the breakdown of the numbers

• One-unit: $822,375
• Two-unit: $1,053,000
• Three-unit: $1,272,750
• Four-unit: $1,581,750

You can get more details about the limits here.

The Downside of an FHA Loan

FHA loans do come with a downside, and that comes in the form of mortgage insurance. Mortgage insurance protects the lender in case you stop paying the loan. There are two kinds of mortgage insurance premiums. One is paid upfront, and the other is a monthly payment that lasts throughout the lifetime of the loan.

The first one is the Upfront mortgage insurance premium (UFMIP) — which is a one-time upfront monthly premium payment, where you pay 1.75% of the loan regardless of your credit score.

As an example, let’s say your loan amount was $500,000 loan x 1.75% = $8750. You can either pay this amount up front or roll it into your mortgage.

The second mortgage premium is the Annual MIP. Even though it’s called annual, it’s actually a monthly charge that gets added to your mortgage payment. The amount of the mortgage insurance premium varies based on different factors; the loan amount, the length of the loan, and the loan-to-value ratio.

Conclusion

I hope you all learned a lot about FHA loans and how they can help you purchase a home with a low down payment. Let me know in the comments section if you have any more questions about the loans or if you felt like I left something out!