An FHA loan, or Federal Housing Administration loan, is a government-insured mortgage provided by banks or other approved lenders. These loans typically require a lower down payment compared to conventional mortgages and are accessible to applicants with lower credit scores. Designed to assist low- to moderate-income families, FHA loans are especially popular among first-time homebuyers looking to achieve homeownership.
Lower Credit Requirements
FHA loan requirements are more flexible compared to conventional loans, making it one of the easiest loans to qualify for, particularly if you have a lower credit score.
Qualifications are even more accessible due to compensating factors, which allow you to submit proof of additional strengths to support your application and demonstrate your creditworthiness.
Acceptable compensating factors for an FHA loan include:
Shorter Wait Time
Worried about qualifying for an FHA loan with bad credit? While past bankruptcies and foreclosures can make securing a mortgage more difficult, FHA loans offer a shorter waiting period after major credit events.
Conventional loans typically require a 4-year waiting period after a bankruptcy discharge and 7 years after a foreclosure. In contrast, FHA loans only require a 2-year wait after bankruptcy and a 3-year wait after foreclosure.
This means borrowers who have experienced significant credit issues may have a better chance of qualifying for an FHA loan sooner.
Low down payment
FHA loans do require a down payment, but you may find that saving for your home takes less time than expected. These loans are specifically designed to assist borrowers who don't have 20% to put down, which can be a significant hurdle, particularly in higher-priced markets.
The required down payment for an FHA loan depends on your credit score. Borrowers with a credit score below 580 must make a larger down payment. However, because many lenders require a credit score above 580 to qualify for an FHA loan, a down payment of 3.5% is often the standard.
Gift Fund Leniency
If you don’t have enough money for a down payment, you can get assistance. FHA loan down payment requirements allow gift funds from family members, close friends, an employer, a union, or government down payment assistance programs. These rules are more flexible than those for conventional loans, which only accept gift funds from relatives.
Seller Paid Closing Costs
Here’s some more good news for saving money: The seller can contribute up to 6% of the sales price toward certain buyer closing costs. FHA loan closing costs typically range from 3% to 5% of the loan amount, and negotiating for the seller to cover some of these costs can help reduce your out-of-pocket expenses. While conventional loans also allow for seller-paid closing costs, they may be limited to 3% with a minimal down payment.
There are other creative ways to lower your upfront costs. For example, some closing costs can be rolled into the loan itself. Another option is using lender credits, where you accept a slightly higher interest rate in exchange for the lender providing a credit to cover some of your closing costs.
Higher DTI
FHA loan income requirements focus on your debt-to-income ratio (DTI), which compares your total debt to your gross income (before taxes). A lower DTI is preferred, as it indicates you have more income available for a mortgage payment. While conventional loans typically cap the DTI ratio at 50%, FHA loans can exceed this limit if there are compensating factors that support your ability to repay the loan.
Non-occupants
With an FHA home loan, a borrower can be on the loan even if they will not live in the property. This is known as a non-occupant co-borrower. It’s a useful option if the primary borrower cannot qualify due to insufficient income.
For example, a parent can help their child buy a home, even if they live far away. The underwriter will consider the co-borrower's income. A child can also assist a parent or sibling.
Here’s who the FHA allows to be a co-borrower:
Lower Rates
FHA loan interest rates are among the lowest in the industry. If your credit score is below 640, the FHA rate will typically be lower than a conventional loan interest rate.
Interest rates are influenced by the perceived risk to lenders. Since FHA loans are backed by the Federal Housing Administration and insured by mortgage insurance, the lender faces less risk, which results in a more favorable interest rate for borrowers.
Buy 1-4 Units
FHA loans are not limited to just one-unit properties. Eligible borrowers can also purchase two-unit, three-unit, and four-unit properties.
However, you must live in one of the units as your primary residence for at least one year. The benefit of this is that you can rent out the other units to help cover the mortgage, making the monthly payments more affordable.
No Income Restrictions
Many low-down payment options for conventional mortgages come with income limits, meaning higher-earning borrowers may earn too much to qualify for these programs. In most cases, they would need to put down 10% or more, which can be a significant amount.
With an FHA loan, there are no income limits that could impact your approval. This gives you the flexibility to choose a loan that suits your financial needs, regardless of the neighborhood you are considering for your home search.
To qualify for an FHA home loan, you typically need to meet the following requirements:
