FHA Loans: What All First-Time Homebuyers Need to Do First
FHA Loans: What All First-Time Homebuyers Should Know Before Purchasing
FHA-insured loans have helped many traditionally high-risk borrowers realize the dream of home ownership, but it’s important to note the Federal Housing Administration (FHA) does not issue mortgages; rather, it insures them. The loans must originate from qualified lenders who have been approved by the FHA. The insurance provided by the federal government lessens the risk for lenders and makes it possible for individuals to purchase a home without making a cost-prohibitive down payment.
While the program is designed to provide assistance to help people reach their goal of home ownership, there are eligibility guidelines. All borrowers must meet specific financial, credit, and employment conditions before they can close on their new home. Knowing what these conditions are and seeing how you measure up will provide you with a good idea on whether your loan application will be approved or denied.
Let’s take a quick look at these categories.
Federal guidelines do not designate a minimum annual income to qualify for an FHA loan. The financial assessment is done primarily through an analysis of debt to income (DTI) ratios. There are two types.
- Front-end DTI is calculated by how much of a person’s income is committed to housing costs. FHA guidelines stipulate this percentage should not exceed 31%. This means if your gross monthly income is $5,000, your total monthly mortgage payment should not exceed $1,550.
- Back-end DTI looks at more factors. This ratio is determined by all monthly debt obligations such as housing costs, car payments, property taxes, child support, and student loans. As a rule, back-end DTI cannot exceed 43% percent of a person’s gross monthly income. This means if your monthly income is $5,000, your total monthly debt payments should not exceed $2,150.
- Credit Scores
There are two important FICO score ranges regarding FHA loans. The first is a credit score between 500 and 579. This range qualifies you for participation, but it also means you will need to make a 10% down payment on the purchase amount of the home. A score of 580 or higher will decrease your down payment obligation to 3.5%.
- A bankruptcy or foreclosure will not preclude you from eligibility although you will most likely need to wait two years before applying for an FHA loan after a bankruptcy and three years after a foreclosure.
- During this time, you will be asked to show the steps you have taken to rebuild your credit standing.
To qualify for an FHA loan, you must demonstrate a stable employment history and have worked for the same company (or in the same line of work) for at least two years. During this time, your pay must have remained the same or increased. Your employment and earnings history must be verifiable through pay stubs, tax returns or bank statements.
If you meet these general guidelines, your chances of FHA loan approval are favorable.
<h2>What are the first steps to take towards closing an FHA loan?</h2>
Find a mortgage lender that is approved by the FHA
You can find a suitable lender near you by using the FHA Lender finder (available on the U.S. Department of Housing and Urban Development (HUD) website.) It makes sense to talk with several possible lenders so you can compare information and have more leverage when it becomes time to negotiate the terms of your loan.
Provide a down payment
As mentioned earlier, your down payment depends on your credit score. While flexibility may exist in other FHA guideline areas, this is a concrete requirement. There are several allowable options, however, as to how you can secure the down payment. Be sure to ask your real estate attorney or FHA-approved lender about the different possibilities.
Complete a loan application with all required supporting documentation
Your lender will provide you with a list of all the documents you will need to complete the loan application. When answering the application questions, be 100% truthful, accurate, and completely certain of what is being asked of you. Strongly consider going through the pre-approval process before you complete the actual application. This will provide an accurate assessment of your credit history and financial situation and allow you to better gauge the likelihood for approval.
Get an approval
FHA loans have strict guidelines regarding property appraisals. These evaluations make sure the home complies with all pertinent health and safety codes and determine the property’s monetary value. As a rule, the lender secures an FHA-approved home appraiser to complete the assessment and the buyer pays for appraisal fees–which typically range between $300 to $500.
Prepare for the closing and closing costs
When it comes time to sign the closing documents, read and understand every document before you sign. Be advised there is a copious amount of information to review, including the mortgage, note, closing disclosure, riders, servicing documents as well as documents related to claims, and it may be tempting to sign and initial to expedite the process. This could be extremely risky. The closing is a critical point in the purchase process in which an experienced real estate attorney can be your advocate and make sure your interests are protected.
Also, you will need substantial funds to cover closing costs which can be as high as 5% of the home’s purchase price. Closing costs include but are not limited to fees for the property appraisal, title examination, prepaid interest, property taxes, recording the deed and mortgage into public record, and possibly, a loan origination fee.
Are FHA-Insured Loans Right for You?
While the program is a great option for many people, it’s not the best choice for everyone and there are some drawbacks to consider.
FHA loans have the same interest rate for everyone. If you have a solid credit history, you may be able to secure a lower interest rate with a conventional loan. Today, to compete with FHA lenders, some conventional mortgage companies have lowered their down payment requirements to only 3%. This is an important area for you to research thoroughly because even a moderately lower interest rate will save you thousands of dollars over the course of the loan. Also, conventional mortgage companies typically offer more options such as adjustable interest rates or interest-only loans.
You will likely pay more for mortgage insurance with an FHA insured loan because you pay two premiums. There is an upfront mortgage insurance premium (MIP), generally a fixed rate of 1.75% of the home loan. This can be paid as a lump sum or can be rolled into your monthly mortgage payments. You also must pay an annual insurance premium that’s based on factors specific to you such as the size of your loan and the amount of mortgaged years.
You will need to consider all possibilities and determine which course of action is best for you and your family. This is hard to do alone. Schedule an appointment with a qualified real estate attorney who can address all your questions and prepare you for the FHA or conventional loan process. The more knowledge you have in this complicated subject, the better your outcome will be.
Please review our blog series, What All First-Time Homebuyers Should Know Before Purchasing. Each entry has useful tips and information on this important topic. Also, be sure to keep an eye out for the upcoming Part 4 of this series that will provide a step-by-step guide of what to expect with the first-time homebuying process.
Remember, while exciting, the homebuying process can be overwhelming at times. If you’re looking for someone to be your legal advocate and help you understand the legal questions and considerations that come with buying a home, real estate lawyer Bruce Jacobs can help. Give him a call or contact him today.