In the world of mortgage lending, there are several financing sources available for those who need to borrow in order to buy a home. These options include conventional mortgages (i.e., FNMA or FHLMC) plus mortgage lending choices backed or insured by government agencies like the Veteran’s Administration (VA), the US Department of Agriculture (USDA), as well as the Federal Housing Administration (FHA).

The FHA, an agency of HUD [1], was introduced by FDR’s New Deal in the 1930s. The FHA’s ultimate objective was to make homeownership more accessible to Americans after the Great Depression.

Nearly a century later, the FHA, as the largest residential mortgage insurer globally, is still helping Americans reach for the dream of home ownership.

What is an FHA Loan?

The Federal Housing Administration’s home lending options are offered with lower down payment and minimum credit qualifications when compared with more traditional conventional mortgages. These less restrictive requirements are designed to help low/moderate-income families qualify more easily for a home loan.

Note that the Federal Housing Administration does not explicitly lend its own funds. The FHA insures the monies that are being mortgaged to borrowers through FHA-approved, third-party lenders [2]. The insurance offered to lenders reduces lending risks associated with low down payment loans or borrowers who have less than perfect credit.

The FHA offers a variety of home loans designed to meet specific financing needs.

• A Traditional Mortgage – financing for primary residences ONLY, including purchases and refinances.
• A 203(k) Mortgage – is a combo financing loan that provides purchase money and renovating funds. [3]
• A 235(a) Mortgage is a graduate payment mortgage designed for younger borrowers who anticipate increasing their income. [4]
• Home Equity Conversion Mortgage (HECM) – designed to convert equity to cash for homeowners 62+years old. [5]

Conventional Mortgages vs. FHA Loans

Home mortgages backed by the FHA are popular mortgage options – for home buyers and refinancers. This is because FHA-insured home loans are offered with more generous loan qualifications than conventional mortgages.

FHA Eligibility Criteria

While mortgage guidelines for FHA-backed loans are less restrictive than conventional lending guides, borrowers are still required to meet guidelines to obtain mortgage approval. FHA borrower qualifications include –

Credit Scores & Down Payment Requirements

FHA home loans are attractive financing options because the reduced credit score minimums offer a financing option not available by a conventional lender. The minimum FICO credit score for borrowers applying for an FHA home loan is 500. This is significantly less than

• Conventional Fixed-rate minimum FICO score of 620
• Conventional Adjustable-rate minimum FICO score of 640 [6]

To qualify for the FHA loan with the lowest down payment (3.5% of the purchase price), the minimum approvable FICO credit score is 580. Borrowers whose credit score falls between 500 and 579 may qualify for an FHA loan on a primary residence if they have a 10% down payment.

It is important to note that the FHA’s gift guidelines are more lenient than the rules for gifts found in conventional financing underwriting guides. In fact, the FHA allows for the entire down payment to be a gift or charitable donation.[7]

A gift, however, must be documented, which includes verifying –

• The Source of the Gift, including the Donor’s Contact Information.
• The Relationship of the Donor to the Borrower.
• The Donor’s Acknowledgement that the Gift is Not to Be Repaid.
• The Transfer of the Gift Funds into the Borrower’s Account.

Loan Limits

FHA loan limits are updated yearly to reflect current economic and market conditions. The FHA establishes floor and ceiling loan limits which vary based on the type of mortgage, the property type, and the county in which the property is located. For most areas, FHA’s 2022 single-family limit is $420,680, with certain higher limits in defined high-cost counties. [8]

The Federal Housing Administration’s online search tool can narrow down the limit to any county in the United States. [9]

Conversely, the 2022 conventional single-family loan limit for both Fannie Mae and Freddie Mac loans was $647,200 – an 18% year-over-year increase, with certain higher limits in defined high-cost counties. Loans exceeding conventional limits are offered through jumbo mortgage programs. [10]

Debt to Income Ratio (DTI)

To underwrite a mortgage, a lender must determine how much of the borrower’s monthly income will be used to meet monthly obligations. –

• The Front-End Ratio compares Monthly Housing Debt to Income
  • For FHA loans, the Front-End Ratio should be no more than 31% of total monthly gross income [11]
• The Back-End Ratio compares Total Monthly Obligations to Income
  • For FHA loans, the Back-End Ratio should be no more than 43% of total monthly gross income, although it may go as high as 50% with supporting compensating factors.

The Approval of the Property

The property securing an FHA-backed home loan must be a primary residence and meet established Minimum Property Standards (MPS) [12]. MPSs are designed to protect homeowners as well as lending institutions. These FHA requirements may differ from conventional lending guidelines and include things related to the safety and security of –

• Electrical System and Water Heaters
• Roof Conditions
• Site Conditions
• Utilities
• Property & Street Access, to name a few.

The Take-Away

FHA loans are popular loan options because their lenient guidelines open homeownership pathways to borrowers whose credit profile (or property) fails to meet conventional underwriting guidelines.

Sources
[1] https://www.hud.gov/federal_housing_administration

[2] https://www.hud.gov/program_offices/housing/sfh/lender/lenderlist

[3] https://www.hud.gov/program_offices/housing/sfh/203k/203k–df

[4] https://www.hud.gov/program_offices/administration/hudclips/handbooks/hsgh/4240.2

[5] https://www.hud.gov/program_offices/housing/sfh/hecm/hecmabou

[6] https://selling-guide.fanniemae.com/Selling-Guide/Origination-thru-Closing/Subpart-B3-Underwriting-Borrowers/Chapter-B3-5-Credit-Assessment/1041363231/What-is-the-minimum-credit-score-requirement.htm

[7] https://www.hud.gov/sites/documents/4155-1_5_SECB.PDF

[8] https://www.hud.gov/program_offices/housing/sfh/lender/origination/mortgage_limits

[9] https://entp.hud.gov/idapp/html/hicostlook.cfm

[10] https://singlefamily.fanniemae.com/news-events/lender-letter-ll-2021-16-confirmation-conforming-loan-limits-2022

[11] https://www.hud.gov/sites/documents/4155-1_4_SECF.PDF

[12] https://www.hud.gov/program_offices/administration/hudclips/handbooks/hsgh/4910.1