FHA Guide: How To Get a Mortgage with Low Credit or Low Down Payment

ByNadav ShemerFeb. 26, 2019
You can still get a mortgage loan, even if you have low credit or limited cash
Want to buy a new home, but have a low credit rating or don’t have a lot of cash? If this sounds like you, consider applying for an FHA loan: a Federal Government-backed loan that helps borrowers to secure mortgages from authorized FHA lenders for as low as a 3.5% down payment.

An FHA insured loan is a 15- to 30-year fixed-rate loan backed by the US Federal Housing Administration (FHA) and provided by an FHA-approved lender. Since 1934, FHA loans have helped millions of Americans secure home loans when they would not otherwise have been able to get one through other channels.

Unlike a traditional loan, 3 parties are involved in this kind of loan: the borrower, the lender, and the FHA. The FHA’s involvement provides security for both sides: it helps the borrower get a loan, and it help lenders by reducing their risk in issuing a loan to the borrower. As part of the terms of an FHA loan, the borrower must purchase private mortgage insurance (PMI), which protects the lender in the event the borrower defaults on a portion of the loan.

What are the FHA Loan Requirements?

When applying for an FHA loan, the main requirements to consider are: whether you meet the minimum credit score and whether you can afford the minimum down payment and PMI.

Whereas borrowers must typically have a credit score of at least 620 to qualify for a traditional home loan, an FHA insured loan has less strict requirements. Borrowers with a credit score of 500-579 qualify for a mortgage with a down payment of 10%. Borrowers with a credit score of at least 580 qualify with a down payment of just 3.5%. Using a 580 credit score and a median US house price of $200,000 as an example, an FHA loan could be used to buy a home for just a $7,000 down payment. In cases where a borrower has no credit history, the FHA has instructed authorized lenders not to automatically deny their application. Rather, the lender will gather history for non-credit accounts, such as insurance payments, electricity bills, or phone bills.

When a borrower makes a down payment of less than 20% on a home loan, the lender requires the borrower to pay PMI, to protect the lender from losing money if the borrower ends up in foreclosure. The PMI for a traditional loan is 0.41% per year, but for an FHA loan it is higher and comprises 2 parts: an upfront payment of 1.75% of the loan amount, and an annual premium typically ranging from 0.45% to 0.85%.

The FHA calculates loan limits each year based on median house prices, and these limits vary per Metropolitan Statistical Area and county. In 2019, it set the ceiling at $679,509 for the highest-cost areas of the country. The highest-cost areas were concentrated around the greater San Francisco, Los Angeles, New York, and Washington metropolitan areas. The floor in the lowest cost area rose this year to $294,515.

What Do You Need to Know About the FHA Loan Approval Process?

The process of applying for an FHA loan is similar to applying for a traditional loan, except it must be done with an FHA-approved lender, and you will need to show you meet the minimum credit score and other requirements specific to an FHA insured loan. 

Some FHA loan requirements are:

  • Borrowers must have a valid Social Security number, and be either a U.S. citizen or a lawful resident of the United States.

  • An FHA loan can only be applied to an owner-occupied family home of up to 4 units. It cannot be used for commercial or investment properties, or for any other type of property that is not used as a primary residence by the borrower.

  • An FHA-approved appraiser must conduct an appraisal to ensure the property meets certain minimum standards. If the home is deemed to not be up to standard and the seller doesn’t agree to make the required repairs, the borrower must pay for the repairs at closing.

  • Borrowers that have filed Chapter 7 bankruptcy must wait a minimum 2 years before applying for an FHA loan, and borrowers that have declared Chapter 13 bankruptcy must wait a minimum of 1 year.

  • Borrowers must wait at least 3 years after a foreclosure before applying for an FHA loan.

  • Total monthly mortgage payments must not exceed 30% of the borrower’s gross monthly income.

  • The borrower must have verifiable income or have been in consistent employment for at least 2 consecutive years.

How to Qualify?

To begin the application process for an FHA loan, select an FHA-approved lender in your area from this list. The process is similar to applying for a traditional loan, except you will need to show you meet the minimum credit score and other requirements specific to an FHA insured loan. The lender will usually ask you for the following:

  • Personal information, including driver’s license or state ID card, Social Security number, marital status, residential address, contact details, and signature.

  • Proof of income, such as recent pay stubs and W2 annual income tax forms, as well as employer contact details.

  • Bank or investment statements to prove you have the funds for a down payment or closing costs on their new home.

  • Other financial information, including: monthly expenses and bills, assets (e.g. stocks, bonds, cash), liabilities (e.g. credit card or student debt), and any additional income sources (e.g. rental income).

How to Apply for FHA Loans

In order to qualify for an FHA loan, you’ll need to show you meet all the prerequisites set by the Federal Housing Administration. Your lender will ask for the following:

  • Proof of verifiable income and proof that you’ve been in consistent employment for at least 2 years
  • Evidence that your monthly mortgage payments won’t exceed 30% of your borrower’s monthly income
  • Your agreement to pay Private Mortgage Insurance, although you can apply to stop paying PMI once you pay back 20% of the loan
  • If asked, you’ll need to prove you haven’t filed for bankruptcy in the past 1-2 years and haven’t had a foreclosure in the past 3 years

Pros and Cons of an FHA Insured Loan

Pros
Cons
Easier to qualify than a traditional loan
Upfront PMI required
Lower credit score requirements
Higher PMI each year
Lower down payments
Properties in need of repairs don’t qualify
Higher debt-to-income ratio permitted
Might require more paperwork

There is one clear reason why a home buyer would want to take out an FHA loan: if, for whatever reason, your credit score is below 620 and you find yourself rejected by traditional lenders, then the FHA loan might be the only realistic option on the table. Add to that the small down payments, and an FHA loan offers an affordable way of buying a property.

Of course, there are steps you can take to improve your credit score and put yourself in the picture for a traditional loan. But if you prefer to go ahead now and apply for an FHA home loan, just make sure to keep the PMI requirements in mind. While your total upfront payment (down payment plus PMI) will still work out lower than for a traditional loan, it is important to calculate both these payments in order to get a full picture of what it will cost you to secure your FHA home loan.

What Kind of Credit Do You Need for an FHA Loan?

Borrowers with a credit score of at least 580 can secure an FHA insured loan with just a 3.5% down payment, while borrowers with a lower credit score of 500-579 will be asked to pay 10% of the value of the loan as a down payment. Under the terms of an FHA loan, borrowers are also required to pay two types of private mortgage insurance (PMI): an upfront payment of 1.75% of the value of the loan, plus up to 0.85% per annum.

FHA Loan Limits

You can take out FHA loans only up to certain limits, determined by median local home values in your county. Most locations fall under the standard FHA limits, but there are places that are considered high cost, and have higher limits. There are even places in several very high cost areas, with a special exception FHA loan limit. 

Standard Limits: 

Home Type
Standard FHA Loan Limits
1-unit property
$421,100
2-unit property
$543,000
3-unit property
$656,350
4-unit property
$815,650

High Cost Limits: 

Home Type
High-Cost FHA Loan Limits
1-unit property
$636,150
2-unit property
$814,500
3-unit property
$984, 525
4-unit property
$1,223,475

Special Exception Limits:

Home Type
Special Exception FHA Loan Limits
1-unit property
$721,050
2-unit property
$923,050
3-unit property
$1,115,800
4-unit property
$1,386,650

What does FHA Pre-Approval Mean?

A pre-approval is a written, conditional commitment from a lender for a specific loan amount and is usually valid for 60 to 90 days. Where FHA loans are concerned, your lender will check that you meet all the usual requirements for a loan as well as the minimum credit requirements. Pre-approval is something you apply for before finding a home or if you’re in the process of negotiating with a seller. In a competitive housing market, pre-approval can give a buyer a big advantage over rival bidders. In fact, some sellers prefer to see a written commitment from a lender as it reassures them that the house sale won’t fall through at a later stage.

How Do You Get Pre-Approved for an FHA Loan?

Just as it would if you were applying for a conventional loan, your lender will ask you for:

  • Personal information, such as driver’s license, state ID card, or social security number
  • Proof of income, in the form of pay stubs and W2 forms
  • Bank and investment statements to show you can pay the 3.5% or 10% down payment
  • Other financial information testifying to your ability to make payments, such as bills and reports on additional income sources

When assessing your application for pre-approval, your lender will also pull a hard credit inquiry in order to check whether you meet the minimum credit requirements (of 520 for a 10% down payment or 600 for a 3.5% down payment). A hard inquiry can affect your score for up to 2 years. However, the credit bureaus typically consider all inquiries made within a 45-day period to be a single inquiry. Therefore, if you’re shopping around for FHA loans or you’re unsure whether you’ll be approved, it’s worth applying to all your preferred lenders within a short period of time so as not to cause unnecessary damage to your credit score.

Can You Be Denied a Loan After Pre-Approval?

Pre-approval is a conditional commitment from the lender to provide you a loan to a certain amount, but the lender is not legally obligated to provide the loan. However, if you haven’t yet found a home or if you’re having trouble getting a seller to agree to sell you a home, then it’s worth going through the pre-approval process as this gives you an advantage over buyers who haven’t been pre-approved.

So, Is an FHA Mortgage Right For You? 

The perfect answer is...it depends! Having a super low down payment may suit your budget, but having higher monthly payments may not be right for you and PMI can add up. Check if you qualify with various lenders based on your credit score, debt to income ratio and personal budget, consider pre-approval, and decide from there. For more information about lenders, check out these in-depth reviews of the leading mortgage loan companies