How to Qualify for an FHA Loan

An FHA loan is a government-backed mortgage insured by the U.S. Federal Housing Administration. FHA loans are typically geared toward new homeowners who can only afford a smaller down payment than what is required by conventional financing options.

If you qualify, it could be a worthwhile way for you to get the mortgage process going. You’ll have to jump through a few more hoops compared to traditional conventional mortgage financing, but there are significant perks to an FHA loan.

What is an FHA Loan?

The FHA program was established during the Great Depression (when foreclosures and default rates rose sharply) to provide lenders with adequate insurance. Some programs were subsidized by the government, but the mortgage insurance premiums made the program self-supporting. Eventually, private mortgage insurance (PMI) companies developed to insure lenders, and FHA loans now primarily serve borrowers who have poor or limited credit history, in addition to difficulty coming up with a full down payment.

Lower down payments are normally viewed as riskier, but FHA loans are insured by the Department of Housing and Urban Development (HUD) to reduce risk. If you receive an FHA loan, you’ll be required to pay two-part mortgage insurance in addition to monthly payments for risk compensation.

FHA loans allow borrowers to put as little as 3.5% down and receive up to 6% toward closing costs. Some lenders may limit seller contributions to 3% toward closing costs. If you have little to no credit history, a qualified non-occupant co-borrower can co-sign for your loan. The co-signer is not required to be a blood relative.

FHA loans allow for gifts to be used for down payment sources:

Your relative
Your employer or labor union
A close friend with a clearly defined and documented interest in you
A charitable organization
A governmental agency or public entity that has a program providing home ownership assistance

Pros and Cons of FHA Loans

Pros

Low down payment: Conventional financing requires 20% down to avoid paying PMI (private mortgage insurance). FHA loan requires only 3.5% down payment (10% for lower credit scores).

Lower credit score: Conventional financing minimum of 640. FHA loan minimum of 580 with 3.5% down or 500 to 579 minimum with 10% down.

Lower debt-to-income ratio: Conventional financing maximum DTI is typically 43% but FHA loan can approve up to 50% DTI.

Cons

Mortgage insurance: FHA requires a two- part mortgage insurance: 1.75% of the loan amount at closing and 0.85% of the loan amount paid annually for the life of the loan. Conventional financing PMI is typically 0.15% to 1.95% of the loan amount annually but only until the loan-to-value reaches 78% and the fee is discontinued.

Not all houses qualify for FHA loans: The property must pass an inspection to ensure the home meets the minimum standards to protect the health and safety of the occupants and is structurally sound. This decreases the chance of new homeowners needing to conduct significant repairs or renovations. These costs could increase the risk of foreclosure.

Loan limits: FHA publishes loan limits annually. The national loan limit for one-unit homes is $472,030 for 2023.

How to Qualify for an FHA Loan

A list of documentation and qualifications must be met in order to be approved for an FHA loan. Review the requirements below to ensure your eligibility. You’ll need:

A minimum credit score between 500 and 579 with 10% of the purchase price as a down payment or 580 minimum credit score with a 3.5% down payment. (For a loan of $100,000, a 3.5% down payment would be $3,500).
A maximum debt-to-income ratio of 50%: To calculate DTI, add together all current monthly debt payments plus the new mortgage payment obligation divided by gross monthly income and multiply by 100 to get the percent ratio. Taxes, homeowners insurance and mortgage insurance monthly costs must be included in the DTI calculations.
An appraisal by an FHA-approved appraiser.
A home inspection by an FHA-approved inspector.
Mortgage insurance (MIP): 1.75% of the loan amount due at closing and 0.85% of the loan amount annually for the life of the loan.
Steady employment and the ability to prove income with most recent two paycheck stubs and most recent W-2.
To provide your last three years of tax returns.
To prove two years of employment history.
To be at least 18 years old.
To occupy the home as a primary residence.
To factor in student loan payments into the DTI ratio (if in deferment, calculate 1% of the balance as the payment).
Your most recent two bank statement that shows seasoned funds (90 days in an account) for down payment and closing costs.
To obtain HUD housing counseling .