If you are a home buyer thinking of using an FHA loan to buy a home, you should be aware of certain changes to the FHA program. This page offers a summary of FHA home loan requirements for 2011.
Note: There is an updated version of this article for 2012. Go there now
What is an FHA Loan?
An FHA home loan is a mortgage loan that’s insured by the Federal Housing Administration. The FHA is a federal agency that falls under the Department of Housing and Urban Development (HUD).
The government does not actually lend money to borrowers. Rather, they insure the loans made by primary lenders such as Wells Fargo and Bank of America. In order to participate in this program, a mortgage lender must be approved by the FHA.
The FHA insures the loan against losses resulting from borrower default. So if the borrower stops making payments on the loan, the FHA will cover the lender’s losses (as long as the loan was made in accordance with current FHA guidelines).
Credit Score Requirements for 2011
The first thing we need to talk about is your credit score. This is one of the most important FHA home loan requirements for 2011. In the past, the FHA did not establish any minimum requirements for credit scores. They mostly left it up to the lenders. But starting in 2010, HUD announced some new guidelines. In short, borrowers must have a credit score of 500 or higher to qualify for an FHA home loan. In order to qualify for the 3.5 percent down-payment program, the borrower must have a credit score of 580 or above.
But here’s the “catch.” The FHA’s minimum requirements for credit scores are actually lower than the guidelines used by most mortgage lenders. Most lenders will require you to have a score of 620 or higher, in order to qualify for an FHA home loan in 2011. For example, Wells Fargo and Bank of America announced at the end of 2010 that they were raising their minimum from 620 to 640, for most FHA loans.
Down Payment Requirements
When using an FHA loan to buy a home, you can put as little as 3.5 percent down. This is about the smallest down payment requirement you’ll find anywhere, aside from VA and USDA loans. This is also what makes the FHA home loan so popular among borrowers. In order to qualify for the 3.5 percent down-payment option, you’ll need a FICO credit score of 580 or higher. See the previous section for more information about FHA credit score requirements in 2011.
[See also: 20-percent down payment myth]
Debt-to-Income Ratios
A debt-to-income ratio is a comparison between the amount of money you earn each month, and the amount you spend on your various debts. These ratios use your gross monthly income, which is the amount you earn before taxes are taken out.
There are two ratios you need to know about:
- The first one is your housing ratio, also known as the front ratio. It only accounts for your mortgage-related debt. In short, your monthly mortgage payment should not account for more than 29 percent of your gross monthly income. The math is fairly straightforward. Start with the total amount of your mortgage payment (including principal, interest, taxes and insurance), and then divide that number by your gross monthly income. If you come up with a number that’s higher than .29, or 29 percent, you might have trouble qualifying for an FHA loan in 2011. *
- The second ratio is called the back-end ratio. It’s similar to the first, but it takes all of your other debts and credit lines into account (not just your mortgage-related debt). In this scenario, you must combine your monthly mortgage payments and all of your other monthly debt payments — car loan, credit cards, and other items that appear on your credit reports. Divide this number by your gross monthly income. If you come up with a number that’s higher than .41, or 41 percent, you might get turned down for the loan. *
* The above ratios are not set in stone. These are the general guidelines used for FHA loans, but allowances can be made for otherwise qualified borrowers. For example, if your front ratio is slightly higher than the FHA’s preference, but you have excellent credit, you might still be approved for the loan.
Debt ratios will be one of the key requirements for FHA home loans in 2011. So you should do the math now to find out where you stand. If your ratios are too high, you’ve got work to do.
[See also: Current FHA mortgage rates]
Mortgage Insurance Premiums
One of the drawbacks of using an FHA loan is that you’ll have to pay a mortgage insurance premium. Actually, you pay two premiums. There’s an upfront premium that is due at closing, as well as an annual premium that is paid monthly on top of your mortgage payment.
In 2010, the FHA made some changes to these two premiums. They increased the annual premium and decreased the up-front premium. This increases the total amount of insurance you’ll pay over the life of the loan, while lowering the up-front costs you must pay at closing. (Update: They will increase the annual premium again in April 2011.) When using an FHA loan in 2011, your annual premium will be 1.1 percent to 1.15 percent of the loan balance. The up-front insurance premium (a one-time payment) will be 1 percent of the loan balance.
Applying for an FHA Home Loan
Please note these are not the only FHA loan requirements for 2011. There are also exceptions to every rule. If you want to find out if you’re qualified for one of these mortgages, you’ll need to speak to an FHA-approved lender. This is how you would start the application process. You can find such lenders in your area on this page of the HUD website.