FHA Loan

What is an 'FHA Loan'

An FHA loan is a mortgage issued by federally qualified lenders and insured by the Federal Housing Administration (FHA). FHA loans are designed for low-to-moderate income borrowers who are unable to make a large down payment. As of 2016, these loans allow the borrower to borrow up to 96.5% of the value of the home; the 3.5% down payment requirement can come from a gift or a grant, which makes FHA loans popular with first-time homebuyers.

BREAKING DOWN 'FHA Loan'

FHA loans were created after the Great Depression in the 1930s. During this time, defaults and foreclosures skyrocketed. In response, the government created federally insured loans that gave mortgage lenders peace of mind, reduced lender risk and stimulated the housing market. FHA loans are offered to low-income individuals who have credit scores as low as 500. Individuals with a credit score between 500-579 can obtain an FHA loan with a down payment of 10%; individuals with a credit score higher than 580 can get an FHA loan with as little as 3.5% down.

Even people who have no credit or have gone through bankruptcy and foreclosure may still qualify. However, the lower the credit score and the lower the down payment, the higher the interest rate. In addition to these traditional first mortgages, the FHA offers a reverse mortgage program known as a Home Equity Conversion Mortgage (HECM). This program helps seniors convert the equity in their homes to cash while retaining the titles to their homes.

Additional FHA Loan Requirements

While FHA loans give mortgage opportunities to people with low income, low credit and who may be be first-time homebuyers, there are specific lending requirements outlined by the Federal Housing Authority. First, all borrowers must have a steady history of employment.

This is important because the FHA also requires a borrower's front-end ratio, which is the summation of the monthly mortgage payment, HOA fees, property taxes, mortgage insurance and homeowners insurance, be less than 31% of total gross income. However, it is possible to be approved with a 40% ratio. Additionally, a borrower's back-end ratio, which is the summation of the monthly mortgage payment and and all other monthly consumer debts, is required to be less than 43% of total gross income. However, it is possible to be approved with a ratio as high as 50%.

Further, borrowers must be at least two years out of bankruptcy, unless a borrower who has recently gone through bankruptcy has demonstrated it was an uncontrollable circumstance. Borrowers must also be at least three years removed from any foreclosures and demonstrate they are working toward re-establishing good credit.