Reader question: “I’ve heard that FHA home loans are good for first-time buyers like myself, because they’re easier to get and you don’t have to put as much money down. Is this true? And if so, how do I get an FHA loan when buying my first house? Any advice would be much appreciated?”
FHA loans offer a lower down payment than conventional mortgages. This is partly what makes them so popular among first-time home buyers in particular. They are also slightly easier to qualify for, when compared to regular mortgages. It’s certainly an option worth considering. So let’s talk about how and where to get an FHA loan.
How to Get an FHA Home Loan
The first thing you should know is that the process varies from one borrower to the next. With that said, it usually includes the four steps outlined below: (1) save enough money to cover your expenses, (2) evaluate your credit and debt situation, (3) gather your financial documents, and then (4) apply for the loan through an HUD-approved lender. Here’s how to get an FHA loan:
Step 1 – Save Enough Money
The first thing you need to do is start saving money. The more money you can save, the better. How much money will you need? Let’s examine some of the typical costs associated with an FHA loan:
Down Payment Costs
You will need to make a down payment of at least 3.5% to get an FHA loan. This is one of the major appeals of the program — it requires less money down than a conventional mortgage. But this will depend on your credit score. If your FICO credit score is below 580, you’ll be required to put at least 10% down (if you can get approved at all).
Let’s assume you can get an FHA loan with the 3.5% down-payment option. Let’s further assume your loan is for $250,000. This means your down payment will be around $8,750.
Here’s an overview of the minimum down payments for various loan amounts:
|Examples of FHA Down Payments|
|Loan Amount||3.5% Down Payment|
The down payment is not the only expense you’ll face. In order to get an FHA loan, you’ll also have to pay closing costs. These costs will vary based on where you live, as well as the loan amount. As a general rule, you can expect your closing costs to be around 3% of the loan amount. As an example, this would come to $7,500 on a $250,000 mortgage amount. The costs can rise even more when you add in the third-party fees for appraisals, escrow services and the like.
The seller might be able to contribute to your closing costs, but you shouldn’t count on this. While the lender may allow this kind of “seller concession,” it doesn’t mean the seller will be inclined to do it. If you cannot afford all of your mortgage costs out of pocket (or with gifting from family members), you may not be ready to take on this kind of debt obligation.
But let’s get back to the question at hand: How and where do I get an FHA loan? Once you’ve saved enough money to cover the costs associated with the loan, you should start gathering your paperwork.
Step 2 – Check Your Credit Score
This step is optional but highly recommended. In order to get an FHA loan, you’ll need to have a credit score of at least 500. That’s the minimum score required by the Department of Housing and Urban Development (HUD), which manages the FHA program. But lenders require much higher scores. This is known as an “overlay.” These days, most lenders want to see a score of at least 600.
We encourage all home buyers to check their credit scores before applying for a mortgage, and this applies to those trying to get an FHA loan as well.
Step 3 – Check Your Debt Ratio
You should also measure your debt-to-income ratio. This is another qualification factor that could make or break your chances of getting a loan. This ratio, which is typically expressed as a percentage, shows how much of your gross monthly income goes toward debt.
Here’s a quote from HUD Handbook 4155.1, Chapter 4, Section F:
“The relationship of the mortgage payment to income is considered acceptable if the total mortgage payment does not exceed 31% of the gross effective income. A ratio exceeding 31% may be acceptable only if significant compensating factors … are documented.”
This ratio mentioned above is known as the front-end debt-to-income (DTI) ratio. It only considers your housing-related debt, in this case your monthly mortgage payments. You also have a back-end DTI that considers all other forms of debt as well. Here’s what the handbook says about back-end ratios:
“The relationship of total obligations to income is considered acceptable if the total mortgage payment and all recurring monthly obligations do not exceed 43% of the gross effective income.”
Here again, exceptions can be made for borrowers with compensating factors. A list of these compensating factors can be found in Chapter 4 of the aforementioned HUD handbook, and on this page.
Step 4 – Gather Your Mortgage Documents
When you submit an application to get an FHA loan, the lender will ask for a variety of documents. These documents may include (but are not limited to) the following:
Documents Need for FHA Loan
- W-2 statements for the last two years (for income verification)
- Pay stubs for the last month or two, showing year-to-date earnings
- Bank statements for the last couple of months, for all of your accounts
- Statements for any investment accounts you have (additional assets)
- If you’re self-employed, you’ll need tax returns for the last two years
- Divorce paperwork, if applicable
- Bankruptcy paperwork, if you’ve ever filed for bankruptcy
The lender might ask for additional item not on this list. But these are the most common documents needed for an FHA loan.
Step 5 – Find an FHA-Approved Lender
It’s common misconception that the FHA lends money to home buyers. This is false. The money comes from a mortgage lender just like it does with a conventional loan. The Federal Housing Administration only insures the loan, so the lender gets reimbursed if the borrower defaults later on. In order to get an FHA loan, you’ll need to choose a lender that’s approved to offer these loans. On the HUD website, there’s a tool that will help you locate an FHA-approved lender in your area. Here’s the link for the tool.
Once you find a lender, you would just tell them you want to use an FHA loan to buy a house. They’ll probably have you submit an application, or at the very least will ask for certain information (like your name, Social Security Number, etc.). Then they’ll check your credit score, income, and the other items we discussed in this article.
At some point, the lender will give you a Good Faith Estimate that shows how much your closing costs might be. They’ll eventually offer you an interest rate as well. At that point, you would either lock in the rate or keep shopping around.
Where to Learn More
This article explains how to get an FHA loan to buy a home. While this lesson is fairly comprehensive, it doesn’t cover the entire application, underwriting and approval process. An entire book could be written about FHA home loans (and several already have).
If you’re seriously considering this type of financing, we encourage you to continue your research on this website and elsewhere. See if you can find a HUD-approved housing counselor in your area. They offer free and low-cost advice on these types of loans.