FHA Guidelines for Home Buyers - 2011 Update

By Brandon Cornett
© 2011 All rights reserved

For many years, the basic guidelines for FHA home loans did not change. But the status quo was disrupted after the housing crisis that started in 2008. Since then, the government has made numerous adjustments to the program. This article will bring you up to speed. It explains the latest FHA guidelines for borrowers, as of June 2011.

If you would like to move forward with this process and connect with a lender, you can use the link provided above. If you want to learn more about the program guidelines first, continue reading below. You can always come back to this link later.

The FHA Loan Program

The HUD 203(b) Mortgage Insurance program, commonly known as the FHA loan, offers a path to homeownership for people who might not qualify for a conventional mortgage. In order to apply for this program, you will have to work with an "FHA-approved lender." These are lending institutions that have been approved by the Federal Housing Administration to participate in the program.

The government does not make loans directly to consumers. Rather, they insure the loans made by lenders in the private sector. This insurance protects the lender in the event of losses resulting from borrower default. This program offers two key benefits to home buyers: (A) smaller down payments and (B) more flexible guidelines, when compared to a conventional loan.

Guidelines in a Nutshell

Here are the basic guidelines for FHA loan approval. At a minimum, borrowers must meet all of the criteria listed below. Keep in mind that mortgage lenders may impose their own guidelines, on top of the ones established by the Federal Housing Administration. We will talk more about these overlays later.

• You must meet the FHA's minimum cutoff for FICO credit scores, explained below.
• You must make a down payment of at least 3.5 percent of the sale price.
• You will have to pay an upfront premium for mortgage insurance, as well as an annual premium. These can be "rolled" into the loan.
• The house you are buying cannot exceed the FHA's loan limits for your area.
• The property itself must meet FHA guidelines (a residential structure of 1 - 4 units).
• You must be buying the home as your primary residence. No investment properties.
• Your debt-to-income ratio must fall within the guidelines of the particular lender you are using. This is not an FHA requirement, but one that is imposed by the lender. These limits vary from one lender to the next. It's something you'll have to ask about when you apply.

We will talk about each of these guidelines in more detail below. But first, I want to explain the concept of overlays. The rest of this article will make more sense to you, once you understand this important concept.

Two Sets of Standards - FHA and Lender

If you've been researching FHA loan guidelines for any length of time, you might be more confused now than when you first started. Take credit scores for example. You read one article, and it says you need a FICO score of at least 500 to qualify for this program. Then you read another article that says most lenders require a score of 640 or higher for FHA loans. That's a difference of 140 points. Believe it or not, both of these articles are correct. How is this possible? I can sum it up for you in one word -- overlays.

Mortgage companies often impose their own standards on top of those created by the Federal Housing Administration. The industry term for this is overlays. There are different types of overlays, but the three most common are credit scores, debt ratios and cash reserves.

So there are basically two sets of guidelines for FHA loans. There are the basic requirements set forth by the Federal Housing Administration, and it's parent organization the Department of Housing and Urban Development (HUD). On top of these, you have the additional requirements established by the individual lenders. And I can promise you this much -- the lenders are stricter than the FHA.

With that explanation out of the way, let's move on to discuss the specific guidelines for FHA home loans.

1. Your Credit Score

The Federal Housing Administration states that borrowers must have a FICO credit score of at least 500 to qualify for the program. There's another credit cutoff at 580. If you want to qualify for the 3.5-percent down payment, you'll need a score of 580 or higher.

But both of these numbers could be irrelevant, depending on the lender you use. Remember the overlays we discussed earlier? This is one of the areas where they come into play. Most lenders who are approved to make FHA loans will require a credit score of 620 or higher. So the FHA credit guidelines of 500 and 580 are sort of a moot point.

This is often the case, but not always. Some lenders will actually match the FHA's guidelines, instead of imposing their own requirements on top of the baseline criteria. In February 2011, the New York Times reported that Wells Fargo (the biggest mortgage company in the U.S.) lowered its FHA credit-score requirement to 500. In other words, they removed the overlay they used to have in place. So their guidelines are the same as the government's, from a credit standpoint at least.

This is one of the reasons you should check your credit score before applying for a home loan. Here are more reasons to check it.

2. Your Down Payment

You will have to make a down payment of at least 3.5 percent when using an FHA loan to buy a house. This is what attracts many people to the program in the first place. They are looking for a way to minimize their upfront costs when buying a home, so they use the FHA program. If you use a conventional mortgage loan (one that does not have any government backing), you'll have to make a down payment of 5 percent or more.

Refer to the stipulations above, regarding your FICO credit score. You'll need a score of at least 580 to qualify for the 3.5-percent option. If your score falls below 580, you will have to make a down payment of at least 10 percent. This is one of the FHA guidelines that changed in 2010.

3. Mortgage Insurance Premiums

Anytime you get a mortgage loan with a down payment less than 20 percent, you have to pay a mortgage insurance premium of some kind. There are two types of mortgage insurance -- government and private. FHA loans require government insurance.

There are two premiums, actually. Your annual premium will be 1.1 percent to 1.15 percent of the loan balance. The up-front insurance premium will be 1 percent of the loan balance. These premiums can be financed or "rolled" into the mortgage, which means you don't have to pay them at closing. But they will increase the size of your monthly payments.

You may encounter some different numbers in the course of your research. That's because the FHA changed this guideline in April 2011. They raised the annual premium. As a result of these changes, many websites now contain outdated information.

4. Loan Limits

You cannot use an FHA loan to buy a luxury home. There are limits to the size of the loan you can use. These limits are geographically assigned. The limits are higher in high-cost areas, such as California and New York. You can find limits for your area on this page of the HUD website. Just enter your state and your county, and then click the button. You can leave the other fields blank.

These are not the only FHA loan guidelines you'll encounter when using the program. But they are some of the most important. Remember, some lenders will impose additional requirements on top of the ones listed above. These are the "overlays" we discussed earlier. You might have to shop around for a lender that doesn't have any overlays (or at least smaller ones), if you have trouble meeting the stricter guidelines.  

See also: How to find FHA mortgage lenders

Disclaimer: The program guidelines listed in this article were current as of June 2011. There is currently some discussion in Congress about raising the down-payment requirement again. The FHA program has seen more changes in the last 18 months than in the ten years prior to that. So there's a chance that some of these guidelines will change again in the future. We will make every effort to keep this page up-to-date. Just don't take it as the final word on this subject.