For most Americans, the purchase of a home is made possible with a mortgage. However, saving a 20 percent down payment is an unattainable goal for many would-be buyers in areas with high home prices. Compounding the challenge are strict underwriting requirements, including some that were put into place to protect the housing market from a crash. Underwriting is the process mortgage lenders use to determine whether to approve a loan, based on the borrower’s risk profile.
The Federal Housing Administration, or FHA, loan program was created to help Americans buy homes following the Great Depression, and it remains a popular choice for people who need an affordable mortgage option. FHA loans are a popular solution because they allow for smaller down payments, while also resolving some of the underwriting challenges borrowers face. FHA mortgages are made by lenders and insured by the Federal Housing Administration, a U.S. government agency. With a government guarantee, the lender can offer more flexibility in its underwriting requirements, including credit guidelines and the size of the down payment.
“If a borrower has good credit but limited cash on hand, other government-backed loans are available for less money down,” says Stephen Moye, senior loan officer for Citywide Home Loans. “For a borrower with a bankruptcy, foreclosure or other credit issue, the FHA loan has a much lower barrier to entry.”
This guide explains the FHA loan process and offers recommendations of lenders that can meet your home buying needs.
How FHA Loans Work
An FHA loan works like any other mortgage in that the lender that approves your application pays for the home you want to purchase and you repay that lender, with interest, over time. A mortgage is a secured loan and the house is the collateral. Your name will appear on the deed, but the lender will keep a lien against it until the loan is repaid in full. If you default, the lender has the right to sell the property and recover the balance due.
FHA loans are made by lenders, just like traditional mortgages. The difference is that FHA loans have a government guarantee. This guarantee allows lenders to loan to borrowers who might not qualify for a conventional mortgage.
Traditional conventional mortgage lenders typically expect a 20 percent down payment, but the FHA minimum down payment requirement is 3.5 percent. FHA loans have lower credit score requirements and may allow a higher debt-to-income, or DTI, ratio.
General FHA loan requirements include:
- The loan must be for a property used for your primary residence.
- The property must be appraised by an FHA-approved appraiser.
- The property must be safe, sound and secure, in compliance with minimum property standards as defined by the U.S. Department of Housing and Urban Development, or HUD.
- You must have a valid Social Security number and be a legal resident of the U.S.
- You must have a minimum credit score of 580 with a down payment of at least 3.5 percent, or a minimum credit score of 500 with a down payment of at least 10 percent.
- You may not have delinquent federal debt or judgments, or debt associated with past FHA loans.
- You must have steady employment history.
- You must make a down payment of at least 3.5 percent of the purchase price. If the down payment was gifted by a family member, documentation is required.
- You must have a DTI ratio that does not exceed limits.
- Any judgments or collections on the credit report must be resolved or satisfactorily explained.
- Any required waiting period has passed, as follows:
|Event||Waiting period||Waiting period with extenuating circumstances (nonrecurring events beyond your control that result in sudden, significant, prolonged reduction in income or a catastrophic increase in financial obligations)|
|Chapter 7 or 11 bankruptcy||Four years||Two years|
|Chapter 13 bankruptcy||Two years from discharge, or|
four years from dismissal
|Multiple bankruptcies||Five years if more than one filing in last seven years. Most recent bankruptcy must have been caused by extenuating circumstances.||Three years from most recent discharge or dismissal|
|Foreclosure||Seven years||Three years, with additional requirements after three years up to seven years:|
90 percent maximum loan-to-value purchase, principal residence, limited cash-out refinance
|Deed-in-lieu of foreclosure, preforeclosure sale (short-sale), or charge-off of mortgage account||Four years||Two years|
Debt-to-Income Ratio Limits
Two DTI ratio figures are calculated when considering an FHA mortgage. Thefront-end DTIratio is your total monthly housing expense, which includes the mortgage principal and interest, mortgage insurance, homeowners insurance, property taxes and applicable homeowners association fees, divided by your total monthly income. The back-end DTI ratio is your total monthly debt obligation, including housing, minimum credit card payments, auto loans, student loans and any other required monthly debt payment, divided by your total monthly income.
Standard FHA front- and back-end DTI limits are 31 percent and 43 percent, respectively. If you earn $3,500 per month, your front-end DTI cannot exceed $1,085 and the sum of all your monthly debt obligations cannot exceed $1,505.
Applications for borrowers with lower salaries and higher DTIs are manually underwritten. Manual underwriting means that your lender assigns a person to review your loan application and documents, versus running your information through an automated underwriting system. Manually underwritten FHA loans allow for front- and back-end DTI ratios of up to 40 percent and 50 percent, respectively. To qualify for these higher DTI limits, you will need to meet other requirements.
FHA Loan Limits for 2018
FHA loan limits are based on median local home values, county by county. Where the median local home value exceeds the baseline loan limit, the limit is raised. Most of the U.S. is subject to standard loan limits:
|Home type||Standard FHA loan limits|
Loan limits are higher in high-cost areas including San Francisco, New York City and Washington, D.C.
|Home type||High-cost FHA loan limits|
Special exception loan limits apply in a select few very high-cost areas, such as Honolulu, Hawaii.
|Home type||Max special exception FHA loan limits|
You can use HUD’s FHA loan limit lookup tool to find out the limit in your county.
The loan term is the number of years you will make payments. Typical mortgage loan terms are 10, 15, 20 or 30 years. FHA loan terms depend on the lender. One lender may offer only 15- or 30-year loans, while another may offer a customizable term between eight and 30 years.
Interest Rate Types
The two main types of mortgage interest rates are fixed and adjustable.
Fixed-rate mortgage: Fixed-rate loans are the most popular type of mortgage. With a fixed-rate loan, the interest does not change over the life of the mortgage. The advantage of a fixed-rate loan is a predictable payment set for the life of the mortgage. The disadvantage is that even if market conditions cause rates to fall in the future, the rate will not change.
Adjustable-rate mortgage: With an adjustable-rate mortgage, also called an ARM, the interest rate fluctuates along with a benchmark rate. The primary advantage of an ARM is that it often starts out at a rate that is lower than the lowest available rate on a fixed-rate mortgage. Not all FHA lenders offer ARMs.
With the most popular type of ARM, the hybrid ARM, the rate is fixed for a few years at the beginning of the loan and then adjusts periodically according to market conditions. For the early years of the loan, you might save money on interest. However, when the adjustable rate kicks in, the rate on an ARM is usually higher than the rate available for a fixed-rate loan.
With an interest-only ARM, you make only interest payments for a period of time. In this case, the principal balance does not go down during this time. After this interest-only payment period is over, you have to start paying on the principal of the loan.
If you choose a payment option ARM, you have some flexibility to choose your payment amount (often set once a year) from the following options:
- A traditional principal plus interest payment (loan balance goes down each month)
- An interest-only payment (loan principal balance does not go down each month)
- A payment that is less than the interest (loan balance increases)
You can save money in the short term with a payment option ARM by making low payments. However, at some point, the required payment could spike depending on the payment option you choose. The lender will recalculate, or recast, the required payment amount at periodic intervals, based on the remaining loan term and the loan balance. If your balance has grown and the remaining number of years on the loan has gone down, your required payment will increase considerably.
When comparing loan options, keep in mind that the annual percentage rate, or APR, on your loan is notthe same as the interest rate. The APR is a measure of the total annual cost of the loan, including the mortgage interest, points, fees and any additional costs. Mortgage points are a fee you can pay at the start of the mortgage to lower your interest rate for the duration of your mortgage. Each point costs 1 percent of your total loan amount. The interest rate reduction depends on the lender, but it is common to lower your interest rate by 0.25 percent in exchange for every point purchased.
Since costs vary from one lender to the next, you should compare APRs to make a meaningful comparison between similar loans.
Whether your lender requires mortgage insurance hinges on your loan-to-value ratio, or LTV. This number refers to how much you’re borrowing compared to the value of the property. Mortgage insurance is typically required on any mortgage with a loan-to-value ratio of more than 80 percent. It protects the lender from losses if you default on the loan. If you make a 3.5 percent down payment, your LTV is 96.5 percent and will be higher if additional costs are rolled into the loan.
Private mortgage insurance, or PMI, is one of the most important aspects of FHA loans to understand because it can make FHA loans more costly than conventional mortgages. FHA lending standards are less stringent than conventional mortgage lending standards, so FHA borrowers pay two different mortgage insurance premiums, or MIPs: upfront MIP and annual MIP.
Upfront MIP is 1.75 percent of the loan amount. This may be paid at closing or rolled into the loan.
Annual MIP depends on the loan size, loan term, LTV ratio and annual outstanding loan balance (see the chart below).
For example, if the loan is less than $625,500, the term is more than 15 years and the down payment is lower than 5 percent, the premium is equal to 0.85 percent of the outstanding balance. Annual MIP is calculated each year, based on the current outstanding loan balance, and divided into 12 equal monthly payments (which are added to your regular payments).
|Loan term of more than 15 years|
|Base loan amount||LTV ratio||MIP factor||Duration|
|Less than or equal to $625,000||≤ 90 percent||0.0080||11 years|
|> 90 percent but ≤ 95 percent||0.0080||Life of loan|
|> 95 percent||0.0085||Life of loan|
|Greater than $625,000||≤ 90 percent||0.10||11 years|
|> 90 percent but ≤ 95 percent||0.10||Life of loan|
|> 95 percent||0.105||Life of loan|
|Loan term of less than or equal to 15 years|
|Base loan amount||LTV ratio||MIP factor||Duration|
|Less than or equal to $625,000||≤ 90 percent||0.0045||11 years|
|> 90 percent||0.0070||Life of loan|
|Greater than $625,000||≤ 78 percent||0.0045||11 years|
|> 78 percent but ≤ 90 percent||0.0070||11 years|
|> 90 percent||0.0095||Life of loan|
Borrowers who make a down payment of 10 percent or more will pay annual MIP for 11 years; borrowers who make smaller down payments are obligated to pay this premium for the entire mortgage term.
Here’s what these costs might look like for a typical borrower:
|Home purchase price||$175,000|
|Down payment (3.5 percent)||$6,125|
|Base loan amount||$168,875|
|Closing costs (2 percent)||$3,378|
|Total amount financed with upfront MIP and closing costs rolled into loan||$175,208|
|Annual MIP first year||$1,489, or $124 per month|
If this loan has an interest rate of 5 percent, the principal, interest and MIP monthly payment in year one is $1,065. This figure does not include property taxes, homeowners insurance or homeowners association fees if required.
Hawaiian Home Lands loans are not subject to either form of MIP, and Indian Lands are not subject to upfront MIP.
Applying for an FHA Loan
The process of obtaining an FHA loan is largely the same as the process for obtaining any other mortgage. The main difference is that the search for a suitable lender is limited to those that offer FHA loans. As with any borrowing decision, it’s helpful to compare the loan terms you may qualify for with multiple FHA-approved lenders before committing to a mortgage. You can then move on to the next steps to get prequalifed or preapproved for a loan.
Prequalification: You’ll supply basic information to the lender about your debt, income and assets. No verification or credit check are performed. This allows you to start your home search with a general idea of the loan size and terms you might qualify for.
Preapproval: You’ll provide more detailed information and documentation to the lender about your income, assets, debts and regular expenses. The lender will check your credit and tell you what loan amount and terms you qualify for. Preapproval does not guarantee loan approval, but can alert you to problems in your credit report so that you are not surprised during the application process.
Application: If you are preapproved, the lender will confirm all of the details you provided and may require up-to-date documentation. If you were not preapproved, you’ll begin the process. The lender will now require details about the specific property you want to buy.
Loan estimate: Within three business days after you apply, the lender will give you a loan estimate. This is a standard three-page document that explains the terms and details of your loan. If you apply with multiple lenders, you can compare loan estimates and choose the best one. You must notify the lender within 10 business days if you intend to proceed.
Processing: After you notify the lender of your desire to proceed, the lender will verify all your financial information and order a property appraisal and title report.
Additional documentation: If questions arise during loan processing, the lender may ask you to submit additional documentation.
Appraisal: An appraisal lets the lender and borrower know the value of the home. For an FHA loan, the lender will choose a professional HUD-approved appraiser to evaluate the property you want to buy and give an opinion of its value. By law, the lender must provide a copy of the appraisal to you no later than three days before closing.
Underwriting: Once the application and appraisal are complete, a loan underwriter will evaluate the entire package and determine whether the loan is acceptable. It must meet guidelines set by the FHA and the lender.
Closing disclosure: The lender will provide a closing disclosure at least three business days before your loan closes. This is a standard, five-page form that describes the final details of the loan. You can compare it to your loan estimate to find out whether any terms or details have changed.
Insurance: Before your loan closes, you will need to purchase homeowners insurance that is effective no later than your closing date. You must bring proof of insurance to your closing.
Closing: To close your loan, you’ll meet with your lender’s closing agent. At this meeting, you’ll show identification and proof of insurance, sign all the necessary documents and deliver a cashier’s check for the down payment and closing costs. Then you will receive the keys to the home.
For more information about the mortgage process, including how interest rates are determined and details about additional costs and fees, see the U.S. News Mortgage Guide.
Choosing an FHA Lender
To find the best FHA mortgage lender to meet your needs, you should consider criteria including:
- Product offerings
- Eligibility requirements
- Interest rates
- Closing costs
- Customer satisfaction
Product offerings include loan terms and loan types. A large menu of product offerings may mean that the lender is more likely to have the right loan to meet your needs. Examples of popular product offerings include:
- 15-year fixed rate
- 20-year fixed rate
- 30-year fixed rate
- 5/1 ARM
- 7/1 ARM
- 10/1 ARM
While a 3.5 percent-down FHA loan is technically available if you have a FICO score as low as 580, lender guidelines vary. You should verify that you can qualify for each lender’s FHA loan offerings before applying in order to minimize credit inquiries and save time.
Although the FHA will guarantee the loan, not all lenders will make loans to borrowers who meet only the minimum requirements. Research the lender’s minimum credit score and maximum DTI ratio requirements.
Compare APRs from one lender to the next. Since this figure includes the interest rate, points and other fees, the APR will be higher than the interest rate and is a more accurate measure of the true cost of the loan. Even a few tenths of a percent can equate to thousands of dollars saved over the life of a loan.
While fixed rates don’t tend to be widely different from one lender to the next, you may find a broader range of options on adjustable-rate mortgages, so if you’re shopping for an ARM, pay special attention to the APR.
Virtually all FHA lenders offer fixed-rate loans, but not all offer adjustable-rate loans.
You can shop for a lender that has lower closing costs than the competition. Some common closing costs you can expect include:
- Application fee
- Origination fee
- Appraisal fee
- Credit report fee
- Title search fee
- Title insurance fee
You might find detailed closing costs on a lender’s website, or you may need to talk to the lender’s representative or apply for a loan in order to get a more clear picture of the lender’s costs. Since an application does not obligate you to a loan, you may wish to apply with multiple lenders before making a choice. Some lenders are willing to negotiate or waive certain costs in order to gain your business.
Evaluate closing costs along with the interest rate to determine the total cost of the loan over time. Low closing costs and a high interest rate could cost more over time than higher closing costs and a lower interest rate. Remember, if you roll closing costs into your loan, you will pay interest on those costs.
To measure past customer satisfaction, check with market research company J.D. Power. In its 2017 U.S. Primary Mortgage Origination Satisfaction Study, J.D. Power surveyed customers to measure satisfaction in six key areas:
- Loan offerings
- Application and approval process
- Loan closing
- Problem resolution
Each factor is rated on a scale of zero to five. A lender with an overall score of five is rated “among the best.” A score of four means its rating is “better than most.” A three means “about average,” and a two means “the rest.”
Not every lender is included in the J.D. Power report. You should review these and other lenders with the Better Business Bureau.
The Best FHA Loans of 2017
No single FHA lender is perfect for every borrower. U.S. News recommends these lenders for their overall performance in product offerings, eligibility requirements, interest rates, closing costs and customer satisfaction. These FHA lenders sell directly to the consumer and lend in at least 20 states.
These recommendations are meant to aid your research by showing companies that are most likely to meet your needs. Recommendations apply to first-lien mortgages, not second mortgages, refinance loans, home equity loans or reverse mortgages, although many of the lenders on this list also offer those products.
- Best for 30-year fixed rate: Chase
- Best for first-time homebuyers: Wells Fargo
- Best for loan options: PNC Mortgage
- Best for online application: Bank of America
- Best for adjustable-rate mortgage: PennyMac
- Best for fixed-rate loan terms: Fifth Third Bank
- Best for customer satisfaction: Quicken Loans
- Best for low closing costs: PrimeLending
- Best for term options: LoanDepot
- Best for military and veterans: Navy Federal Credit Union
Top Lender for 30-Year Fixed Rate
Top Lender for First-Time Homebuyers
Top Lender for Loan Options
Top Lender for Online Application
Top Lender for Adjustable-Rate Mortgages
Top Lender for Fixed-Rate Loan Terms
Top Lender for Customer Satisfaction
Top Lender for Low Closing Costs
Top Lender for Term Options
Top Lender for Military and Veterans
Advice for First-Time Home Buyers
Check Your Credit
The first step in the homebuying process is to find out where your credit stands. Get copies of your credit reports from all three major credit reporting agencies by visiting AnnualCreditReport.com. You are entitled to receive one free copy from each agency every 12 months; you don’t have to get all three at the same time.
Review your credit report for errors. Some errors can affect your credit score. Follow each agency’s process for requesting a correction.
Your free credit report will not include a free credit score. Many banks and credit card issuers offer free credit scores to customers and non-customers alike, including Capital One and Discover. Checking your own history or score does not hurt your credit.
If your credit history and score need improvement, take six to 12 months to clean it up before you apply for an FHA loan. A better credit standing may get you a better interest rate and save you thousands of dollars over the life of the mortgage.
Preapproval tells you whether you can afford the home you want, and lets sellers know that you are a legitimate buyer who stands a good chance of closing the deal. A preapproval does not commit you to a loan, but can enlighten you to the true cost of a loan so that you can choose the best possible deal.
Avoid Credit Changes
After you are preapproved, don’t apply for any new loans or credit cards. New debt will change your DTI ratio and could render you unqualified for the loan you want. Many lenders do a final credit check just before closing and could cancel the agreement in light of new information they find in your report.
Don’t close accounts, either. Closing a credit card account can negatively affect your credit utilization ratio if you have outstanding debt on one or more accounts. A higher credit utilization ratio could lower your credit score and prevent you from qualifying for the loan you want.
Make all of your mortgage applications within a time frame of 14 to 45 days, depending on the credit scoring model used. Since you likely won’t know which scoring model your lender will use, the safest bet is to shop within a two-week period.
That’s because credit inquiries can lower your credit score, but credit bureaus make exceptions for mortgage rate shoppers. Multiple inquiries from mortgage lenders within a certain time frame are treated as a single inquiry against your score.
Anticipate Closing Costs
In addition to the purchase price, “budget an extra 1.5 to 2 percent for closing costs and prepaids,” advises Moye. Prepaids are costs you must pay in advance of their actual due dates, like property taxes, homeowners insurance and the mortgage interest that accrues between your closing date and the end of the month. “Especially in high-cost markets, these can add significantly to the out-of-pocket costs,” he says.
Some sellers are willing to negotiate closing costs (for example, by offering a seller’s concession), and some lenders issue credits toward closing costs, typically in exchange for a slightly higher interest rate on the loan.
Anticipate Additional Costs of Homeownership
Your total housing budget will be greater than your mortgage payment. Although your monthly payment will probably include property taxes and insurance, it won’t include maintenance and utility costs. A new roof can easily come with a five-figure price tag. Needed repairs inevitably become more costly if ignored.
“One popular strategy is to set aside one percent of your purchase price every year for home repairs, but I recommend at least twice that,” says Ed Hanisko, a general contractor in San Diego. “Some years you won’t spend it all, but other years you’ll spend all of it and then some.”
Even fixed costs can rise. Your property taxes and homeowners insurance are all but guaranteed to go up over time, and with them, the monthly payment you make to your mortgage loan servicer.
Work With a Buyer’s Agent
Avoid working directly with the listing agent, especially if it is your first time buying a home. That person’s job is to make a deal that is in the seller’s best interest, and your concerns are secondary. If you want to shop multiple homes, a listing agent may only show you his or her own listings, which may not be the best homes for you. A buyer’s agent, on the other hand, works in your best interest.
Keep a prudent reserveDon’t cash out all of your savings to increase the size of your down payment (to avoid PMI) or cover other costs. Having no savings in the event of a financial emergency could prove far costlier than a mortgage insurance premium.
HUD sponsors counseling agencies across the country that can help you navigate the homebuying process. Housing counselors can help you sort through the industry jargon, avoid predatory lenders and choose the financial commitment that is in your best long-term interests.
“Numerous studies have demonstrated that pre-purchase homebuyer education can have a positive impact on a wide range of financial behavior,” says Bruce McClary, vice president of public relations and communications with the National Foundation for Credit Counseling. “A 2016 randomized study sponsored by the Federal Reserve Bank of Philadelphia revealed that pre-purchase homebuyer counseling had overall positive effects on financial health. Recent data from a number of other sources has also shown that counseled homebuyers are about one-third less likely to default on their mortgage once they become homeowners.”
Financial help is available, too. Programs in many states offer financial assistance to first-time or low-income buyers, including grants that can be applied to closing costs or the down payment. Some of these programs require housing counseling. Find your state on HUD’s website to discover options that may be available to you.
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