The FHA mortgage process can be both intimidating and confusing to a first-time borrower. With so many steps in the process, where do you even begin? This article is a road map to get you pointed in the right direction. It explains how to start the FHA loan process the right way.
Start the FHA Loan Process with a Good Budget
We encourage borrowers to start the mortgage process by looking inward, instead of outward. In other words, you should review your own financial situation before you start talking to mortgage lenders about what they can offer you.
Start the FHA loan process by establishing a monthly housing budget for yourself. Not a ballpark figure — but an actual detailed budget. This is one of the most important, but often neglected, steps in the borrowing process. Fortunately, the math is fairly simple.
Review your monthly recurring debts. Add them all up and then compare them to your income. This will help you determine how much you can afford to pay toward a mortgage payment each month.
Next, subtract your monthly debts from your net income (i.e., your “take-home” pay). Use only a portion of the remainder for your house payments. You don’t want to use the entire remainder, because that wouldn’t leave you with any emergency funds.
Ideally, you want to be able to cover all of your debts (and savings-account contributions) while still having a little left over each month. Life is full of unforeseen events and emergencies, and they often come with big price tags. So have an emergency fund in place.
According to personal finance guru Dave Ramsey, you should ask yourself: “What would it take for me to live for three to six months if I lost my income?” The answer to that question is how much you should keep in your emergency fund.
Check Your Credit Situation
You should also review your credit reports and scores before you start the FHA loan process. The first thing to understand is that credit reports and scores are two different things. Many first-time buyers think they are the same, but they are not. Here’s the difference:
- Your credit report is basically a document that shows your history of borrowing and repaying money over the years.
- Your credit score is a numerical “grade” based on the information compiled within your report. It’s a three-digit number. The FICO score is the one most commonly used by lenders, and it ranges from 300 to 850.
You have three of each, because there are three credit-reporting companies within the United States. They are Experian, TransUnion and Equifax.
Before starting the FHA application process, obtain copies of all three of your credit reports and check them for accuracy. If there are mistakes on these documents (such as a credit account that’s not actually yours), it could lower your score. This can hurt your chances of getting approved for a home loan.
When checking the score itself, you’re trying to make sure that it’s high enough for mortgage approval. These days, lenders typically want to see a score of 580 or higher for loan approval (though that number is not set in stone).
Save Money for Home Buying / Loan Expenses
When you start the FHA loan process, you should also start saving money. The more, the better. Ideally, you should already be putting some extra cash aside, if you’re in the market for a loan (or soon will be). You’ll face a variety of expenses when buying a home — probably more than you realize.
For one thing, you’ll need to have enough money for your down payment. The minimum down payment for an FHA loan is 3.5%. Every borrower who uses this program must put at least 3.5% down.
According to HUD Handbook 4155.1, FHA borrowers “must make a required investment of at least 3.5% of the lesser of the appraised value or the sales price of the property.”
You also need money to cover your closing costs, which could add up to thousands of dollars. The lender will give you an estimate of your closing costs in advance, when you first start the FHA process. They are required by law to provide this estimate within a few days of receiving your loan application. But it’s fairly common for the actual costs to exceed the estimated amount. So the more money you can save, the more prepared you’ll be on closing day.
Weigh the Pros and Cons of Going FHA
Is a government-insured home loan the right option for you? How much will it cost you over the long term, once you add in the cost of mortgage insurance? Consider the differences between FHA and conventional financing, and weigh the pros and cons of each option.
Once you have these preliminary steps completed, you can move on to the next step of the process. You can get pre-approved for a mortgage loan by sitting down with the lender. This is not a final approval — that comes later on, after the underwriting process. But it’s a good place to start. Pre-approval will give you an idea of how much you can actually borrow (learn more about it here).
If you follow these recommended steps to start the FHA loan process…
- You’ll have a monthly housing budget established.
- You will have reviewed your credit reports and scores.
- You’ll be saving your cash to cover the various home-buying expenses.
- You will have been pre-approved by a mortgage lender for a certain amount.
The next step is to start house hunting and find a home that meets your needs. Once you do that, you could go back to the original lender who pre-approved you to get a final approval and close the deal.